The long awaited toxic asset buyback initiative has finally arrived. U.S. Treasury secretary Timothy F. Geithnerrevealed the plan today, which involves the government and private investors purchasing the bad assets from financial institutions that have caused this economic meltdown.
The New York Times offers a good explainationon how it works: “A pool of bad residential mortgage loans with a face value of, say, $100 is auctioned by the F.D.I.C. Private investors would submit bids. In the example, the top bidder, an investor offering $84, would win and purchase the pool. The F.D.I.C. would guarantee loans for $72 of that purchase price. The Treasury would then invest in half the $12 equity, with funds coming from the $700 billion bailout program; the private investor would contribute the remaining $6.
“For a relatively small equity exposure, the private investor thus stands to make a considerable return if prices recover. The government will make a gain as well. In the worst case, the bulk of the risk would fall on the government. The presumption, of course, is that the auction will lead to realistic purchase prices.”
So far the markets are responding favourably the Dow is up 286 points, while the S&P/TSX Composite Index has climbed 366 points. (That also has to do with the Suncor/Petro-Canada merger announced this morning.)
While the plan doesn’t directly affect Canada our banks have nearly no toxic assets on their books, at least compared with the U.S. what’s good for America is good for us.
I spoke to TD economistRichard Kelly this morning about the plan, and he seems to think it’s a good one. “It sounds promising,” he told me. “It offers up a lot of government gurantees, a lot of government matching and a lot of buying power. It’s the most intriguing plan we’ve seen in months.”
He’s right, it does seem a lot more original than throwing billions at infrastructure projects, and conceptually it could work. The most intriguing part of the plan is that it will finally force the market to put a price on the bad assets. That’s been the biggest hurdle in getting these investments off the books. Because no one could decide how much the assets were worth, it was impossible for investors to buy them.
“That’s been the main drawback,” Kelly explains. “There’s been no way to come to a price. But if you get enough people bidding in the process, they’ll find that price. ”
Now we wait and see if the American government has finally figured out how to get its economy and ours back on track.