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Bank rescue plan looks like best hope yet to create a viable market for toxic assets

Yes, it has critics, but no one has yet come up with any other bank rescue plan that would be practical or politically acceptable.

March 24, 2009|MICHAEL HILTZIK

In these uncertain times, you take your certitude where you find it.

Platoons of academic economists and business commentators spent all weekend griping about the emerging details of the Obama administration's latest attempt to mount a bank bailout.

Then Treasury Secretary Timothy F. Geithner unveiled the plan in detail Monday morning, and the stock market delivered a decisive thumbs-up, with the Dow Jones index rocketing nearly 500 points higher.

Wall Street was signaling that it believed Geithner's program, imperfect as it is, bears a quality that has been lacking in the government's rescue efforts almost since the words "bank" and "bailout" became inextricably entwined last fall. Simply put: With every other option being worse, this is the way to go.

The new program aims to set up an auction process, financed heavily with taxpayer funds, to establish a market price for the mortgage pools and other troubled assets clogging the banks' balance sheets. Taxpayers and the professional money managers will share in any profits from the investments. The idea is to use public funds to turbocharge the potential gain for the private investors as a way of enticing them to participate.

The plan looks like the best hope yet for creating a viable market for all the toxic mortgage-based investments plaguing the balance sheets of banks large and small. The banks today don't have a suitable benchmark to guide them in valuing these assets on their books, let alone selling them.

That's because investors won't bid for the assets at a price anywhere near what the banks think they're really worth, and the banks won't offer them for sale at a price that the investors believe will compensate them for the risk of a loss.

One reason the two sides are so far apart (among many reasons) is that the investors can't raise debt financing for their bids -- which by raising their risk in the venture pushes their bids lower.

Under the new proposal, the government provides the debt financing. That makes it, once again, the lender of first resort, last resort and every resort between.

The plan turns the government into "the world's largest hedge fund investor," UC Berkeley economist J. Bradford DeLong wrote on his blog Sunday.

DeLong, one of the plan's more outspoken supporters in academia, argues that this could be a savvy investment for the taxpayer. The assets at issue are "probably fundamentally undervalued," he said, and placing them in the hands of investors who can afford to hang on to them until markets recover, rather than leaving them with banks that are desperate to unload them quickly, could produce "an immense profit" -- for the private investors and the government alike.

The doubters argue that the plan merely prolongs a doomed effort to place an artificially high price on toxic assets that may indeed be worth as little as the current market says they are. In doing so, critics contend, the plan only delays a necessary radical recapitalization of the banking industry.

The government's financing terms limit the private investors' potential losses, which naysayers argue will give them an incentive to overbid -- a strategy that could be overly costly to the taxpayers.

Yet such criticisms themselves skirt a couple of important points. One is that no one has yet come up with any other bank rescue plan that in the United States would be practical or politically acceptable.

Nationalization? More government oversight for the banks receiving bailout money is plainly needed, but any plan for wholesale bank takeovers would strain our bank regulatory system and produce rhetorical pandemonium, if not pure legislative gridlock, on the floor of Congress.

Another point is that any benchmark price for troubled mortgage assets is going to make someone unhappy today, based on whether that someone expects the housing market to recover (and how quickly) or deteriorate (and how far).

One can buy a mortgage pool at any price ranging between 100 cents on the dollar, or par, and zero cents on the dollar, or a dead loss. Any price between those extremes will potentially make winners out of the banks (if the government-investor partnerships pay more for the assets than they're ultimately worth) or the investors and taxpayers (if they underpay).

We can't know how this will play out until, well, it plays out. That will take a couple of years at least, so waiting for the issue to resolve before setting up the auction process is a non-solution.

That said, Geithner's plan still harbors many uncertainties. They include the role of bureaucrats at the Federal Deposit Insurance Corp. and other bank regulators, who are supposed to provide "rigorous oversight" over the public-private partnerships formed to invest in the troubled assets. No one is sure how much control they might want to exercise, or how.

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