U.S. Plan for Mortgage Debt Gets Initial Support From Investors

U.S. Plan for Mortgage Debt Gets Initial Support From Investors


By Jason Kelly

March 23 (Bloomberg) -- The U.S. plan to relieve banks of real estate debt won initial support from investors, who set aside for now questions about asset pricing and whether they will be demonized for profiting from the financial crisis.

“This is not a panacea; it is not a silver bullet,” Laurence Fink, chairman of BlackRock Inc., the largest publicly traded U.S. asset manager, said today in an interview. “But this will take some of the overhang out of the marketplace. It is incrementally a really good thing.”

The Obama administration said today it’s counting on investors such as New York-based BlackRock, hedge funds and private-equity firms to buy devalued real estate loans and mortgage-backed securities from banks so they can raise capital and resume lending. The government aims to spur as much as $1 trillion in purchases by providing $100 billion in capital, as well as financing from the Federal Reserve and Federal Deposit Insurance Corp.

Financial markets rose on speculation the plan will help end the first global recession since World War II. Blackstone Group LP and Fortress Investment Group LLC, New York-based private-equity firms that have said they are interested in increasing their holdings of distressed debt, jumped 28 percent and 35 percent, respectively, in New York Stock Exchange composite trading. BlackRock gained 10 percent.

“This ambitious program is structured in a way to attract private capital and help banks sell distressed or toxic assets,” said David Marchick, head of government and regulatory affairs at Washington-based Carlyle Group, a closely held private-equity firm.

The Standard & Poor’s 500 Stock Index rose 3.9 percent to 802.43 at 1:51 p.m. in New York, and the S&P 500 Financials Index climbed 9.8 percent.

Enthusiasm Tempered

The initial enthusiasm was tempered by concern that the plan detailed today by Treasury Secretary Timothy Geithner still doesn’t address whether banks will be willing or able to unload securities at a loss.

“The big issue is whether the financial institutions will sell securities at below the current marks,” said Richard King, who oversees about $40 billion as head of U.S. fixed-income investments at Invesco Ltd., an Atlanta-based fund manager.

Banks could face another round of writedowns if assets are sold for less than the current value on their books. If that occurs some could need to raise more capital to absorb those losses.

Paulson’s Dilemma

“This is one of the details that sunk the plan initially, and it’s still an issue,” said Steven Persky, chief executive officer of Dalton Investments LLC, a Los Angeles-based hedge- fund manager that invests in mortgages. He was referring to former Treasury Secretary Henry Paulson’s reversal last October on using federal bailout money to buy troubled assets from banks.

“The structural issue is a real problem that they have to resolve,” he said.

Half of the $75 billion to $100 billion in Treasury’s funds will go to a “Legacy Loans Program” that will be overseen by the FDIC. The Treasury would provide half of the capital going to purchase a pool of mortgages from banks, with private fund managers putting up the rest. The FDIC will then guarantee financing for the investors, up to a maximum of six times the equity provided.

The FDIC will hold auctions for the pools of loans, which will be controlled and managed by the private investors with oversight by the FDIC.

Market Will Work

The second half of the Treasury’s contribution will go to the “Legacy Securities Program.” The objective of the initiative is to generate prices for securities backed by mortgages that are no longer traded because investors have little confidence about the underlying value of the home loans.

“The market will find a way to price these assets,” said Edward Gainor, a partner at law firm McKee Nelson LLP in Washington who advises funds on distressed investments.

BlackRock’s Fink said his company will raise money from investors such as pension funds and endowments for the new Treasury programs. The company might consider creating mutual funds so that individual investors can also participate.

Bill Gross, co-chief investment officer for bond manager Pacific Investment Management Co., said his Newport Beach, California-based firm also would participate in the bailout programs.

‘Win/Win/Win’

“This is perhaps the first win/win/win policy to be put on the table,” Gross said.

Other fund managers that may jump in include Legg Mason Inc. and State Street Corp.

Legg Mason’s Western Asset Management unit, which manages about $550 billion in bonds and money funds, will benefit from participating in government bailout programs, analysts at Jeffries & Co. in San Francisco wrote in a report earlier this month. Mary Athridge, a spokeswoman for Baltimore-based Legg Mason, declined to comment.

State Street spokeswoman Carolyn Cichon said the Boston- based firm is evaluating “what, if any opportunities” will come out of today’s plan. State Street manages about $1.4 trillion through its investment unit.

Lawrence Summers, the White House National Economic Council Director, said in a Bloomberg Television interview today that investors in the new debt plan wouldn’t be subject to compensation restrictions applied to banks rescued by the government.

AIG Factor

Still, questions remain over whether Congress and the administration will keep that promise in the face of mounting public pressure over bonuses paid to employees of American International Group Inc. and Merrill Lynch & Co.

“The biggest obstacle is whether the government is going to set limits on executive compensation at these funds,” said Steven Nadel, partner at Seward & Kissel LLP, a New York-based law firm whose clients include hedge funds. “If the government can give assurances that there won’t be limits, then the terms could potentially work out for all involved and create liquidity in these markets.”

The level of participation ultimately lies in the details, an area where the Obama administration has disappointed investors in previous attempts.

“We think there’s a fair amount of money on the sidelines that would be enticed back into the market,” said Andrew McCormick, head of securitized products at T. Rowe Price Group Inc., a Baltimore-based fund manager. “We would expect the program to provide clarity. We wouldn’t want to put our best investors into something where the rules are open to debate later.”

Why Not Nationalize?

Kenneth Windheim, chief investment officer of Strategic Fixed Income LLC in Arlington, Virginia, questioned the underlying premise of the Treasury’s plan: that getting private investors involved is the only way to set asset prices and unclog bank balance sheets.

“It would possibly be cheaper to nationalize the banks, get new management and sell the assets off, rather than heavily subsidize or bribe asset managers into taking part in this program,” said Windheim, whose firm manages $1.7 billion in assets. “It’s the same managers who got us into the financial mess who are now going to benefit.”

U.S. seeks to unfreeze credit markets

WASHINGTON – The Obama administration launched a new effort Monday to end a paralysis in lending, saying it will team with investors to initially buy up to a trillion dollars of bad assets from banks that have been reluctant to make loans to consumers and companies.

In announcing the program, Treasury Secretary Timothy Geithner pleaded for patience, saying that work to rehabilitate an industry with such systemic problems must go forward despite "deep anger and outrage" over executive bonus payments.

Geithner's performance in President Barack Obama's cabinet has come under heavy criticism from some in Congress. The secretary announced the initiative in a Treasury Department room with no cameras allowed. He was with Obama later in the morning, however, when the president spoke briefly, saying he was "very confident" the latest plan will succeed.

Obama called it "one more critical element" in a multi-pronged effort to revive the economy and said the depressed housing market is beginning to show glimmers of hope.

Geithner said the new program will initially seek to harness government and private resources to purchase a half-trillion dollars of bad assets off the balance sheets of banks and said he expects that purchases eventually could grow to $1 trillion.

Wall Street seemed to feel rejuvenated, at least at the opening. In late morning, the Dow Jones industrial average was up 221 at 7,500. Reaction to an earlier administration bank rescue program on Feb. 10 was anything but enthusiastic, with dispirited investors sending the Dow Jones plummeting by 380 points.

The administration's newest toxic-asset repellent was another in a string of banking initiatives that have included efforts to deal directly with mortgage foreclosures, boost lending to small businesses and thaw out the credit markets for many types of consumer loans.

Administration officials said the plan put forth Monday will deploy $75 billion to $100 billion from the government's existing $700 billion bailout program for the purchase of bad assets – resources that will be supported by loans from the Federal Deposit Insurance Corp. and a loan facility being operated by the Federal Reserve.

Under a typical transaction, for every $100 in soured mortgages being purchased from banks, the private sector would put up $7 and that would be matched by $7 from the government. The remaining $86 would be covered by a government loan provided in many cases by the Federal Deposit Insurance Corp.

Whereas Geithner suggested there was no alternative to the plan, Republicans said otherwise. House GOP Whip Eric Cantor said he hoped the administration would consider instead an earlier GOP proposal to set up a government-sponsored insurance program for mortgage-related securities.

Cantor called Obama's plan a "shell game" that hid the true cost.

"As described, the plan seems to offer little incentive for private investors to participate unless the subsidy is made so rich that it comes at the expense of the taxpayer," Cantor said in a statement.

Geithner was scheduled to testify on Tuesday before the House Financial Services Committee.

The secretary defended the decision to have the government carry so much of the risk. He said the alternative would have been to do nothing and risk a more prolonged recession or have the government carry all of the risk.

Geithner also said there would be significant advantages from having private market participants bidding against each other to set prices for which the bad assets will be purchased.

"There is no doubt the government is taking risks," he told reporters. "You can't solve a financial crisis without the government taking risks."

Devising bailout plans has never been easy work, and the brouhaha surrounding millions in executive retention bonuses paid out by financially strapped American Insurance Group, Inc., hasn't improved the political atmosphere.

Officials said they expect participation by a broad array of investors ranging from pension funds and insurance companies to hedge funds. To achieve that goal, the program would be set up to entice private investors with low-cost loans provided by the Federal Deposit Insurance Corporation and the Federal Reserve. The government itself would shoulder the bulk of the risk.

Geithner has said that the country cannot afford to simply wait for banks to work off these bad assets over time.

Christina Romer, who heads the White House Council of Economic Advisers, said: "It's absolutely about helping a system so that people can get their student loans, and that families can buy their house and buy their cars, and small businesses can get their loans."

The government has been struggling since the credit crisis hit last fall to figure out a way to sop up the bad assets, many of them involving home loans. Former Treasury Secretary Henry Paulson never did come up with a solution and the Obama team has been wrestling with the same thorny problems of how to price the assets and make sure the government's resources are up to the task.

The program surfaced after a week of Wall Street-bashing in Congress, where lawmakers were outraged with the action by troubled insurance company American International Group Inc. to distribute $165 million in bonuses after obtaining more than $170 billion in government bailouts to remain in business.

Some hedge funds and other investors have expressed reluctance to participate in the new program for fear that Congress will subject them to what they view as onerous restrictions on executive compensation.

But administration officials insisted that they believe they have found the right mix to attract private investors and make a dent in what, by some estimates, could be more than $2 trillion in troubled assets on banks' books.

They said the program has the capacity to purchase $500 billion and possibly as much as $1 trillion in troubled loans, which go back to the collapse of the housing boom and the subsequent tidal wave of foreclosures.

But private analysts believe that with the $700 billion bailout fund nearly tapped out by capital disbursements to banks and lifelines provided the auto companies and AIG, there are only enough resources left to get the asset purchase program launched.

Mark Zandi, an economist with Moody's Economy.com, estimated the government will need another $400 billion to make a sufficient dent in the bad asset problem.

Administration officials said they want to get the new program launched and see how successful it is before deciding whether to ask Congress for more resources.

The administration included a placeholder in its budget request to Congress last month for an additional $750 billion, more than doubling the financial rescue effort, but many lawmakers have said the current bailout fatigue among voters dims the prospect of getting further resources.

According to administration officials, the toxic asset program will include a public-private partnership to back private investors' purchases of bad assets, with government support coming from the $700 billion bailout fund. The government would match private investors dollar for dollar and share any profits equally.