February 12, 2009 / 11:58 AM / in 9 years

Vague U.S. toxic asset plan aggravates credit crunch

By Kevin Drawbaugh - Analysis

WASHINGTON (Reuters) - Global credit markets are unlikely to revive as long as the U.S. government continues to dangle the vague prospect of a toxic asset purchase plan in front of distressed banks, some lawmakers warned on Wednesday.

The chance that taxpayers could be made to overpay for underperforming assets is making bankers, whose balance sheets are saddled with them, reluctant to sell to lower bidders, suggested Texas Republican Rep. Randy Neugebauer.

“People are afraid to buy and afraid to sell because they’re afraid the government is going to sweeten the deal,” he told Reuters in an interview. “The markets are just waiting to see when we’re going to be done.”

Uncertainty about the government’s strategy for toxic assets props up their value above what private investors might pay for them and delays potential resolution of the problems they pose, said California Democratic Rep. Brad Sherman.

“As long as there’s the prospect the federal government will overpay for the toxic assets ... these banks would be insane to sell” in the private market, Sherman told Reuters.

“As long as they hold the toxic assets, they have regular value, plus a politically enhanced value that you may be able to sell it to Uncle Sam for more than it’s worth. Why dispose of an asset where it has politically enhanced value?”

The nub of the global credit crunch -- toxic bank assets and their real value -- surfaced only briefly at a U.S. congressional hearing on Wednesday, then vanished amid questions about corporate jets and CEO bonuses.

The House Financial Services Committee grilled eight chief executives of the nation’s largest banks at the hearing, with no coherent line of inquiry, reflecting lawmakers’ struggle to come to grips with the complexity of the financial crisis.

But Neugebauer hit on the toxic assets issue in questioning of Goldman Sachs Group Inc’s Lloyd Blankfein and Citigroup Inc’s Vikram Pandit.

Both CEOs told Neugebauer they could sell some of the worst toxic assets on their balance sheets, but they won’t because the price private investors would pay is too low.

“That low price is generated by the fear in general ... and the lack of risk capital,” Blankfein said.

Similarly, Pandit said: “When we look at some of the assets that we hold, we have a duty to our shareholders. The duty is that if it turns out they’re marked so far below what our lifetime expected credit losses are, we can’t sell them.”

Toxic assets are at the core of the world credit market paralysis. Dealing with them is crucial to reviving bank lending, restoring trust in the financial system and giving the economy a firm footing from which to climb out of recession.

The assets consist mostly of debt instruments backed by subprime mortgages that are now worthless or worth much less than expected due to the collapse of the home price bubble.

Banks have already taken heavy losses on these assets. But many are still being carried on their books, aggravating doubts in the market about the banks and sowing mistrust.

Two administrations -- Bush and Obama -- have been unable to find a way to wipe these assets off the books of banks and get credit markets moving again.

Four months into a $700 billion bank bailout program, uncertainty about the government’s approach is perpetuating the problem posed by the toxic assets, lawmakers said.

Former Treasury Secretary Henry Paulson proposed in September that the bailout money be spent on buying up toxic assets. But then he abandoned the idea and shifted the program toward injecting capital by buying preferred shares in banks.

Paulson walked away from a toxic-asset purchase plan after being unable to fix on a price for the assets that was high enough to help the banks, but low enough to prevent taxpayers from having to hand over a massive subsidy to the banks.

On Tuesday, current Treasury Secretary Timothy Geithner proposed a public-private venture to address the toxic assets issue. But his plan was greeted as too vague by the markets.

Editing by Andre Grenon

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