The New Treasury Program (March 2009 edition)

We have another new Treasury program.  The mechanics are best understood through the examples offered by the treasury (full details here), which describe a loan program and a securities program:

Sample Investment Under the Legacy Loans Program
Step 1: If a bank has a pool of residential mortgages with $100 face value that it is
seeking to divest, the bank would approach the FDIC.

Step 2: The FDIC would determine, according to the above process, that they would
be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.

Step 3: The pool would then be auctioned by the FDIC, with several private sector
bidders submitting bids. The highest bid from the private sector – in this example,
$84 – would be the winner and would form a Public-Private Investment Fund to
purchase the pool of mortgages.

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

Step 5: The Treasury would then provide 50% of the equity funding required on a
side-by-side basis with the investor. In this example, Treasury would invest
approximately $6, with the private investor contributing $6.

Step 6: The private investor would then manage the servicing of the asset pool and
the timing of its disposition on an ongoing basis – using asset managers approved
and subject to oversight by the FDIC.

Over time, investment returns pay a guarantee fee to the FDIC, interest on the debt, a management fee to the investor, and then further returns split between the government and the investor.

Sample Investment Under the Legacy Securities Program

Step 1: Treasury will launch the application process for managers interested in the
Legacy Securities Program.

Step 2: A fund manager submits a proposal and is pre-qualified to raise private capital
to participate in joint investment programs with Treasury.

Step 3: The Government agrees to provide a one-for-one match for every dollar of
private capital that the fund manager raises and to provide fund-level leverage for the
proposed Public-Private Investment Fund.

Step 4: The fund manager commences the sales process for the investment fund and is
able to raise $100 of private capital for the fund. Treasury provides $100 equity coinvestment
on a side-by-side basis with private capital and will provide a $100 loan to
the Public-Private Investment Fund. Treasury will also consider requests from the
fund manager for an additional loan of up to $100 to the fund.

Step 5: As a result, the fund manager has $300 (or, in some cases, up to $400) in total
capital and commences a purchase program for targeted securities.

Step 6: The fund manager has full discretion in investment decisions, although it will
predominately follow a long-term buy-and-hold strategy. The Public-Private
Investment Fund, if the fund manager so determines, would also be eligible to take
advantage of the expanded TALF program for legacy securities when it is launched.

The best independent commentary is at Brad DeLong's blog.

My evaluation of the new treasury plan:  It's not what I would have done–I'm not convinced that we need this, rather than more reasonable behavior by bank examiners in the field (as I've written about here).  But here's what I like about it:  the private sector actions set the price of the assets.  We economists call this "price discovery," and the Treasury's use of this phrase demonstrates that they have listened to an economist, something many Treasury secretaries never have done.  Leveraging public money with private money is a good idea (if you're going to use public money at all).

However, Secretary's Geithner plan after plan after plan reminds me of the gardener who planted an apple seed.  The next day, he was surprised that he had no apple tree.  So he watered the yard.  The following day he was surprised that he still had no apple tree, so he fertilized to spot where he had planted his seed.  The next day, surprised again, he ran water for half the day.  The following day, surprised, disappointed and angry, he dumped a 50 gallon drum of fertilizer over the ground that had the apple seed.  He never got an apple tree from his seed.  He became a socialist.