Is it possible to "discover" a market? We've all had a little more than a week now to digest the recent Treasury announcements regarding the creation of two public-private investment programs which, through Washington, DC wizardry, will magically convert heretofore "toxic" assets into "legacy" assets.
Briefly, here's what the two programs look like:
The Legacy Loan Program ("LLP") will purchase residential mortgage loan pools and other troubled eligible assets from participating banks through the provision of FDIC debt guarantees and Treasury equity co-investment with private investors. A wide array of private investors are expected to participate. The program will particularly encourage the participation of individuals, mutual funds, pension plans, insurance companies and other long term investors. The program is intended to boost private demand for distressed assets that are currently held by banks and facilitate market priced sales of troubled assets. The FDIC will provide oversight of the formation, funding and operation of a number of public-private investment funds ("PPIF"), that will purchase assets from banks. U.S. banking institutions of all sizes (including state banks) will be eligible to sell assets under the Legacy Loan Program. To start the process, the banks will identify for the FDIC "troubled assets" setting on the balance sheets; typically pools of mortgage loans they wish to sell. Assets eligible for purchase will be determined by the participating bank organizations, including the primary bank regulators, the FDIC and the Treasury. The FDIC will guarantee the debt issued by the PPIF to the banks to purchase these assets. These loans will not exceed a 6:1 debt to equity ratio. After the banks and FDIC have identified the loan pools and established financing terms, the eligible pool of loans, with committed financing, will be auctioned by the FDIC to qualified bidders. Private investors will bid on a 50% equity basis, with the Treasury contributing the remainder of equity.
See linked diagrams:
Legacy Loan Program
Legacy Securities Program
The Legacy Securities Program ("LSP") creates PPIF's designed to purchase the over-hang of Residential Backed Mortgage Securities ("RMBS"), Commercial Mortgage Backed Securities ("CMBS") and other non-real estate asset backed securities, all originally rated AAA without credit support. The Treasury intends to make this program available under the previously announced TALF Program or through pre-qualified PPIF accounts run by five pre-approved "Fund Managers" who are experienced fund managers and meet specified criteria. The equity for these funds will be 50% from private investors and 50% from Treasury. Additionally, the Federal Reserve will provide supporting loans (on terms yet to be determined) equal to 50% of the fund's total equity. The Treasury will consider requests for senior debt for PPIF's in an amount up to 100% of the fund's total equity. Additionally, it is possible that these funds will be independently funded by TALF senior debt.
This second fund will invest in the targeted assets classes mentioned previously (RMBS and CMBS) whether held by banks, insurance companies, other financial institutions or pension plans. The goal of the Legacy Loan Program and Legacy Securities Program is to stimulate private investor capital, establishing a market for either home mortgage loan pools or securities which currently languish on financial institutions' balance sheets. Without a doubt, this is being done in a somewhat "artificial" manner by government sponsored lending capital from the Federal Reserve and government equity through the Treasury. The role of the private investor and how prices will be established for these assets is unclear. The Treasury Department describes this process as "discovering the market." Some detail is provided by the Treasury in describing the auction process for the Loan Program, but is generally left open as investors/markets react to this announcement. It seems to be a process which attempts to create a public-private partnership where the private investors will have "skin in the game," in spite of criticism that the program is simply another disguised attempt by the government to bailout banks and other financial institutions from ill advised acquisition of "toxic assets."
The whole idea here is that these assets will be more palatable and acceptable to PPIF investors after deep discounts and with the Fund private investors having full knowledge that these assets are likely "long term hold" assets. Secretary Geithner made the point that this is the least unattractive of a number of alternatives and success is far from guaranteed. However, if appropriate senior officers at our banking institutions can collaborate with their regulators in a effort to identify and target these "legacy assets" (assuming they have been previously written down to appropriate levels), this process could result in pricing accretive to the banks' balance sheets and get banks lending again.
But don't hold your breath. It will not be a quick process and we should all be patient as it unfolds later this year.
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