investing

The latest Treasury plan is no quick fix

Highlights
  • "Waiting to see the impact on the economy will take some time."
  • Banks decide which assets they want to sell and then notify the FDIC.
  • "Seventy percent of our economy is predicated on consumer spending."

The Treasury Department says its latest invention, the Public-Private Investment Program, or PPIP, will relieve banks of their toxic assets and get them lending again -- breaking up the logjam that has ground the economy to a halt. Not all experts are sure the plan will work, and some say it's a rotten deal for taxpayers.

But one thing seems sure -- even if the plan does work, it could take quite a while before consumers reap any benefits.

"It's by no means a done deal in many ways and it will take a bit of time before this has a noticeable effect on the financial markets and the economy," says Dorsey Farr, Chartered Financial Analyst at French Wolf & Farr, and former chief economist at Wilmington Trust.

"It's not going to be like flipping a switch where everything is resolved and we're wondering why we didn't think of this six months ago. It's a lot more difficult than that. This is basically the bare bones of an idea of how something might work. Now you have to go out and actually implement it. Coming up with an idea is the easy part; implementing it is the challenge. Waiting to see the impact on the economy will take some time."

In brief, the PPIP calls for using a combination of public and private money to encourage investors -- pension funds, hedge funds, insurance companies, etc. -- to buy $500 billion, possibly up to $1 trillion, in toxic assets -- euphemistically called "legacy securities" in the plan -- from banks.

According to the Treasury Department, banks decide which assets they want to sell and then notify the FDIC, which analyzes the assets and determines the amount of funding it's willing to guarantee. Leverage is not to exceed a 6-to-1 debt-to-equity ratio. The assets are then auctioned to the private investor who is the highest bidder. The private investor and the Treasury Department each fund 50 percent of the equity requirement, with the FDIC guaranteeing the rest.

Here's an example from the Treasury Department:

Step 1: A bank has a pool of mortgages with a $100 face value that it wants to sell.

Step 2: The FDIC determines it's willing to leverage the pool at 6-to-1 debt-to-equity.

Step 3: The FDIC auctions the pool. The highest bid is $84.

Step 4: Of the $84 purchase price, the FDIC guarantees $72 of financing, leaving $12 of equity.

Step 5: The private investor and the Treasury each provide 50 percent of the equity funding, $6 each.

Step 6: The private investor manages the servicing of the pool using asset managers subject to FDIC oversight.

advertisement
replacecontent-tcm:8-120510

"It's ironic that they're using the very tools that have been working against the system -- leverage and certain leveraged investors -- to help jump-start it," says Joseph Davis, chief economist at Vanguard.

"I'm more optimistic about the economic prospects of our financial system now than I have been in over a year. That's not to say I don't see other issues that need to be addressed. This isn't the all-clear button. Just the rise in unemployment alone will continue to stress the financial system. But the number of forces they're bringing to bear on the problem, and in somewhat of a diversified way, is much closer to what I would have hoped they did a year ago."

          Connect with us
advertisement
CD & INVESTING NEWSLETTER

Learn the latest trends that will help grow your portfolio, plus tips on investing strategies. Delivered weekly.

CDs and Investment

Start retirement savings at 24?

Dear Dr. Don, At age 24, I recently started a job working for a corporation. I'm interested in individual retirement accounts. I'd like to look at investing in stocks and bonds and learn more about choosing a 401(k) plan.... Read more

advertisement

Blog

Sheyna Steiner

McDonald’s horrible, no good year

McDonald's returns have floundered in 2014. Are consumer tastes changing or is this a mere blip on the radar for the legendary fast food chain?  ... Read more

Partner Center
advertisement

Connect with us