- creating an entity, backed by the Federal Deposit Insurance Corp., to purchase and hold loans.
- expand[ing] a Federal Reserve facility to include older, so-called "legacy" assets. Currently, the program, known as the Term Asset-Backed Securities Loan Facility, or TALF, was set up to buy newly issued securities backing all manner of consumer and small-business loans. But some of the most toxic assets are securities created in 2005 and 2006, which the TALF will now be able to absorb.
- establish[ing] public-private investment funds to purchase mortgage-backed and other securities. These funds would be run by private investment managers but be financed with a combination of private money and capital from the government, which would share in any profit or loss.
"All told, the three efforts are designed to unglue markets that have seized up as investors have stood on the sidelines," state Solomon and Paletta.
However, they add, "One big problem is that many of these assets no longer trade, which means it's very hard to put a price on them. Banks are unwilling to sell at too low a price, and investors are unwilling to take the risk. The Treasury's hope is that introducing private investors will help create market prices. Earlier attempts to have the government set the prices foundered because too high a price would have hurt taxpayers and too low a price would have hurt banks. Private investors, by contrast, could set a market price because they are unlikely to overpay and banks are unlikely to undersell."
Similarly, Edmund L. Andrews, Eric Dash and Graham Bowley report in Toxic Asset Plan Foresees Big Subsidies for Investors (NYT) that, "Risk-taking institutional investors, like hedge funds and private equity funds, have refused to pay more than about 30 cents on the dollar for many bundles of mortgages, even if most of the borrowers are still current. But banks holding those mortgages, not wanting to book huge losses on their holdings, have often refused to sell for less than 60 cents on the dollar. The result has been a paralyzing impasse. Banks, unwilling to sell their loans at fire-sale prices, have had less capital available to make new loans. Mortgage investors, unable to leverage their investments with borrowed money, have been unwilling to pay more than fire-sale prices. To break that impasse, the government’s crucial subsidy is meant to provide investors with the kind of low-cost financing that has been utterly unavailable in today’s credit markets."
"To entice private investors like hedge funds and private equity firms to take part," write Andrews, Dash and Bowley, "the F.D.I.C. will provide nonrecourse loans — that is, loans that are secured only by the value of the mortgage assets being bought — worth up to 85 percent of the value of a portfolio of troubled assets. The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that, while private investors would put up as little as 20 percent of the money, according to industry officials. Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent. The government would receive interest payments on the money it lent to a partnership and it would share profits and losses on the equity portion of the investment with the private investors."
In related news, Brian Blackstone reports in WSJ.com, Bernanke Says Capital Rules May Need to Change. His article cites form a speech given by Federal Reserve Board Chairman Ben S. Bernanke yesterday to the Independent Community Bankers of America (ICBA), in which Bernanke said:
- some aspects of existing capital rules and accounting standards may unduly magnify the ups and downs in the financial system and the economy.
- as many institutions and auditors will attest, determining the appropriate valuation of illiquid or idiosyncratic assets can be very challenging, especially in highly strained market conditions.
- The economic downturn also has renewed the debate concerning the appropriate levels of loan loss reserves over the cycle.
- the issues surrounding procyclicality are not easy, and their consideration will require a careful balancing of important public policy interests.
- Policymakers should review existing capital rules and accounting standards to determine whether these rules and standards could be modified to reduce their potential to have unduly procyclical effects without weakening their ability to achieve their fundamental objectives.
Acknowledging recent efforts of FASB (see our related summaries here, here and here) Bernake added, "I'm pleased to note that the Basel Committee and the Financial Stability Forum already have work under way to address excessive procyclicality in capital regulations, and that the Financial Accounting Standards Board is issuing new guidance that relates to market-to-market accounting in inactive markets and other-than-temporary impairments."
Separately, in a wide-ranging speech at the ICBA gathering on Thursday, FDIC Chairman Sheila C. Bair noted that in testimony before the Senate Banking Committee earlier this week, "I said that while a new systemic risk regulator may be a good idea, what we really need to do is end too big to fail." To accomplish this, she said:
- We need to reduce systemic risk by limiting the size, complexity, and concentration of our financial institutions.
- We need to create regulatory and economic disincentives for systemically important financial firms. For example, we need to impose higher capital requirements on them in recognition of their systemic importance, to make sure they have adequate capital buffers in times of stress.
- We also need to impose greater market discipline by creating a legal mechanism for the orderly resolution of a large troubled institution similar to the one for FDIC insured banks. The ad hoc response to the banking crisis is because we don't have a playbook for taking over an entire complex financial organization.
In related news, in the run-up to the G-20 meeting set to begin April 2, we see action on both sides of the Atlantic (and Pacific). See our separate post today, The Turner Review: U.K. FSA Recommends Response to Global Banking Crisis.
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