LOS ANGELES AND WASHINGTON — The Obama administration's impending effort to buy about $1 trillion in toxic assets in partnership with private investors -- aimed at solving the most intractable part of the credit crisis -- is now generating widespread fear that it is vulnerable to manipulation and carries sharp risks for taxpayers.
The program represents the biggest gamble yet in the federal bailout, but its still-hazy details have prompted bankers, economists, federal investigators and politicians to question whether it will solve the financial crisis. More than 400 written comments were recently submitted to the Treasury Department, many of them sharply negative.
The program is trying to create an artificial market for assets that have no known value, something that has never been done before on this scale. The only way to accomplish that is for the government to accept a mountain of risk.
In the process, critics fear that the banking system could be further damaged and the program subjected to a boom in fraud.
Nobel Prize-winning economist Joseph Stiglitz of Columbia University said the program violated so many laws of economics that it was little more than an "empty box."
The toxic assets are a multitrillion-dollar collection of mortgage loans, commercial loans and a variety of complex debt securities, in which many borrowers have stopped making payments and the value of the underlying properties have tumbled. There is so much uncertainty about the value of those loans -- held both by banks and by big institutional investors -- that they have become a black hole in the financial system.
Critics say the government's effort to engineer a solution is creating risks similar to the ones that created the financial crisis in the first place.
"We are repeating all the mistakes that the mortgage guys made," Stiglitz said. "In the worst case, the national debt goes up by $1 trillion."
Supporters of the program say that the economy would face bigger risks if nothing is done to solve the problem. The program, they say, represents a bold move by the government to unfreeze the financial markets. In the process, taxpayers could reap multibillion-dollar profits from the partnerships.
Indeed, when the program was unveiled one month ago, it was met by such euphoria that the Dow Jones industrial average shot up 500 points in a day.
The program, called the Public-Private Investment Program, is still being formed and basic answers about how it will work are being hammered out by officials at the Treasury Department, the Federal Deposit Insurance Corp. and the Federal Reserve.
The goal of the program is to create a market for the toxic assets that are now clogging the system. They sit on balance sheets, tying up funds and obscuring the condition of financial institutions.
The loans and debt securities are not worthless. In some cases, individual loans within complex bundles have not gone bad. And even in the cases of loans that have gone bad, the underlying homes or other assets still have some value. But because nobody knows how to value these loans and debt securities, nobody is willing to trade them.
If the program can help set prices for those assets and create markets for their sale, banks will more quickly regain healthy balance sheets and financial markets that trade in debt securities will regain their footing.
The government hopes to jump-start a market. Private investors would be enticed to join and, by competing against one another, finally set a price for the assets.
The Bush administration last fall had planned to simply buy all the toxic assets on its own, but there were concerns that it would end up overpaying and it didn't have enough money. With private investors involved, there is the hope that their competition and desire for profit will ensure that prices aren't set too high.
The government does not have to buy every bad asset, Treasury officials said, but simply get enough activity going so that buyers and sellers could begin to set prices on their own.
There are two separate pieces to the program -- one operated by the FDIC to auction bundles of troubled bank loans and another operated by the Treasury Department to buy securities without auctions from hedge funds, investment firms and others.
The money to operate these programs is coming from the $750-billion Troubled Asset Relief Program that was enacted last fall, along with additional lending by the Federal Reserve.
Under the Treasury plan, five so-called fund managers would raise a pool of private money, matched equally by the government. Then, the Fed would double that pool with loans or loan guarantees. Thus, the government would be putting up 75% of all the money.
The fund managers would negotiate to buy the toxic securities based on an analysis of the investments and a bit of educated guessing.