Page last updated at 20:23 GMT, Monday, 23 March 2009

US unveils $1tn toxic asset plan


Obama: 'We think that we are moving in the right direction'

The US has announced details of a plan to buy up to $1 trillion (£686bn) worth of toxic assets to help repair banks' balance sheets.

The "Public-Private Investment Programme" will purchase the troubled mortgages and securities that have been at the root of the credit crunch.

The Treasury has committed $75bn to $100bn to the programme and said the private sector would also contribute.

On Wall Street key share indexes soared by up to 7% on the news.

The widely followed Dow Jones index gained nearly 500 points or 6.8% to close at 7,775 points, while the wider S&P 500 index was up 7.1% or 54 points to reach 823. Technology shares on the Nasdaq index ended the day up 99 points or 6.8%, at 1,556.

"The actions that we're getting... are very helpful in removing the sand from the gears" of the financial system, said Alan Gayle of Ridgeworth Investments.

'Long way to go'

President Barack Obama said the move was a vital step forward.

"The good news is that we have one more critical element in our recovery," he said.

Timothy Geithner's partnership with the private sector to buy impaired assets is considerably less ambitious than Alistair Darling's asset protection scheme
Robert Peston, BBC business editor

"But we've still got a long way to go."

The Treasury said the plan would help the financial system recover.

US banks still hold many mortgage-related assets that they cannot value or sell.

Having so many of so-called toxic assets on their books has made them reluctant to lend, causing the financial system to freeze up, and pushing the economy further into recession.

Detailed plan

"This approach is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly," the Treasury said.

"Simply hoping for banks to work legacy assets off over time risks prolonging the financial crisis," it added.

The $75bn to $100bn will come from the Treasury's $700bn Troubled Asset Relief Program (Tarp), which has already been approved by Congress. This money will be used to fund the government's purchase of assets.

To encourage private investors to take part in the scheme, low-interest loans and guarantees will be offered to private investors via the Federal Reserve and the Federal Deposit Insurance Corp - a government agency that backs bank deposits.

Bank seeks to sell pool of mortgages worth $100
Private auction decides that asset is now worth $84
Private investor and government put up $6 each
They then borrow remaining $72 from government
That loan is guaranteed against any losses
If asset is later sold at higher price, government makes profit and private investor pays back loan and pockets profit.
If asset is sold at lower price, government and private investors could lose initial investment.
Source: US Treasury

This means that the private investors, which the US hopes will include private equity, individual investors, pension plans and insurance companies, will shoulder relatively little risk, with 93% borne by the government.

The programme initially aims to buy $500bn of toxic assets, with the potential to expand up to $1 trillion.

"Over time, by providing a market for these assets that does not now exist, this programme will help improve assets values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets," US Treasury Secretary Timothy Geithner wrote in the Wall Street Journal before the programme was officially announced.

Analysts welcomed the plan but said that a number of questions remained unanswered.

Paul Ashworth, an economist at Capital Economics, said the success of the programme depended on the willingness of private investors to take part.

"And, just as importantly, the willingness of the owners of these distressed securities and loans to sell at the price that investors are ready to pay," he added.

Several leading pensions funds have already indicated that they are interested in investing in the proposed scheme.

Alternative approach

Banks own large amount of US mortgages or complex financial instruments (securities) based on US mortgages
Due to the bursting of the US housing bubble in 2007, many of the loans are very unlikely to be paid back by borrowers
Investors desperately try to sell-off mortgages and mortgage-backed securities
But as prices decline and investors realise the risk, potential buyers disappear, causing the market for these assets to seize up
Wider impact: Banks stop lending to each other because their assets are worth less so they can't afford to do deals, and because the lack of clarity about value of these assets causes crisis of confidence
Government plan aims to kick-start the market for these mortgage-related assets and get the wider financial system working

Mr Geithner added that the plan was needed because the US financial system as a whole was "still working against recovery" and "many banks, still burdened by bad lending decisions, are holding back on providing credit".

He said that encouraging the private sector to take part would be better for the taxpayer as the risks of purchasing toxic assets would be shared.

BBC business editor Robert Peston said the aim of the plan is to remove as many bad assets as possible from banks' balance sheets.

This should mean that banks become less anxious about future write-offs and become more confident that they have the capital resources to re-start lending.

It is an alternative approach to that taken by the UK Treasury, which has used taxpayers' money to insure Royal Bank of Scotland and Lloyds Banking Group against future losses on some £600bn of poor loans and investments, he added.

Stocks rise

The markets have been eagerly awaiting the details of the US plan to tackle bank's toxic assets, which have been seen as a drag on world recovery.

We have fallen into the habit of taking the term 'toxic' a bit too literally
Stephanie Flanders, BBC economics editor

Stocks rose worldwide on hopes that the plan would go some way to cleaning up the world financial system. The price of crude oil also hit its highest in almost four months at close to $53 a barrel on optimism the plan would help the US climb out of recession.

The plan was originally announced in February, shortly after Mr Geithner took up his post as Treasury Secretary but details were scant on how it would work.

The Bush administration abandoned its earlier plans to buy up toxic assets in October 2008, and decided instead to use funds from the Tarp programme to take stakes in banks.

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