“The financial system as a whole is still working against recovery.”
In an op-ed article for The Wall Street Journal March 23, Secretary of Treasury Timothy Geithner announced that the government was prepared to increase the bailout budget to $1 trillion from $700 billion in an effort to combat the current economic crisis. He laid out a nebulous three-layered plan called the Public-Private Investment Program. The plan may sound like yet another complex solution not guaranteed to work, but the layers are far simpler than one may realize: buying, investing and loaning.
The first part of the plan involves buying “toxic assets.” Many Americans purchased houses using controversial sub-prime mortgages. Essentially, these mortgages allowed average income families to purchase homes normally thought to be beyond the average income price range. Someone with an income of $50,000 could get a loan for more than $500,000 and an initially low interest rate without any trouble.
After the housing market crashed and house values plummeted, however, people found themselves paying more on their mortgage than their houses were worth. This prompted massive defaults on mortgages, which banks then reassumed. Now, many banks are stuck with mortgage notes that are worth more than the houses they finance and therefore cannot be sold.
“Nobody wants to pay more for something than it is worth in the market,” second-year College student Robbie Pradhan said.
According to The New York Times, Geithner’s PPIP will encourage private investors to purchase toxic assets by allowing the Federal Deposit Insurance Corporation to loan up to 85 percent of the price. This means that the initial cost of a bundle of toxic assets will be greatly reduced by the government.
“It’s an example of spreading the risk,” fourth-year Commerce student Hannah McBride said. “Both the government and the private investors share the risk and possibility of reward.” The lower initial cost most likely will encourage investment firms who have little capital to invest.
The next layer of the plan is investment. According to the U.S. Department of Treasury Web site, the Treasury will invest half of the cost of private equity. Thus, if a private investor buys a pool of bad residential mortgage loans, the Treasury would invest in half of what was left of the purchase price after the FDIC loans.
The purpose of this is to spread the risk further by involving the taxpayer. Again, the private investor is encouraged to purchase the toxic assets because of less risk. “Politically, [the government] is really trying hard to have a private sector solution,” Assoc. Commerce Professor Patrik Sandås said.
The last part of the plan involves making loans to private investors interested in buying other types of toxic assets. Specifically, the government is expanding the Term Asset-Backed Securities Loan Facility. This facility, with support from the Federal Reserve Bank, will provide a special type of loan called a “nonrecourse loan.” This type of loan is tied to a piece of collateral rather than a monetary contract. By making a nonrecourse loan, the government is telling private investors that if they default on the loan, they only have to surrender the collateral specified in the loan contract and the difference to cover the loan balance.
Again, the government is taking away most of the risk of buying toxic assets. For an investment firm, this means that in the event that they default on a nonrecourse loan, the government seizes the toxic asset property instead of the full value of the loan contract.
The government is making a substantial attempt to encourage private investment. The $1 trillion could begin to repair the damage done by the sub-prime mortgage crisis and put America on the right track to financial normalcy.
“There is the sense that if the banks don’t get the bad assets off their balance sheets one way or another,” Sandås said, “you will not be able to get back to normal.”
Critics of the plan, however, are concerned about the amount of government involvement in buying the toxic assets.
“The amount of government involvement in trying to fix the crisis borders on socialism,” Attorney Lisa Blumenthal said. “By accepting the government’s bailout plan, we sacrifice the basic idea of the casino that we live in.”
Whether Americans are supportive of the plan or not, it certainly represents new territory for government involvement in response to the economic crisis.
“The process of repair will take time, and progress will be uneven, with periods of stress and fragility,” Geither wrote.
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