WASHINGTON (Reuters) - The Obama administration on Monday offered a raft of incentives for private investors to help rid banks of up to $1 trillion in toxic assets that plunged the world economy into crisis.
U.S. stock prices shot up, led by bank shares, as Washington ended weeks of speculation about details of its attack on the heart of the credit crisis, offering generous government financing to underpin the public-private plan.
The U.S. Treasury said it will launch the program with $75 billion to $100 billion from existing financial rescue funds aimed at thawing the market for mortgage-backed securities and other hard-to-sell assets.
President Barack Obama said the plan was critical to a U.S. economic recovery, but added, “We still have a long way to go and we have a lot of work to do.”
Major U.S. share indexes, which recently scraped 12-year lows, jumped about 7.0 percent on optimism over the plan. The Dow Jones industrial average closed up nearly 500 points.
Public fury over big bonus paid to executives at bailout recipient American International Group has made some investors wary of partnering with the government. But some of the world’s most powerful investors said the plan could work and indicated interest in participating.
In an effort to spur participation, Treasury Secretary Timothy Geithner said private investors will not face executive pay restrictions.
Analysts cautioned that success would depend on whether banks are prepared to sell assets cheaply or want to wait in the hope of getting a better price when the economy recovers.
Nobel Prize-winning economist and New York Times columnist Paul Krugman slammed Geithner’s plan.
In his Monday column, Krugman said it was a rehash of a “cash-for-trash” proposal the Bush administration floated last fall, and that the incentives meant investors could profit if asset values increase but “walk away” if they fall.
Some Republican lawmakers also expressed concern over the incentives offered by the government, which could end up providing more than 90 percent of the funds to buy the assets.
“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,” said Representative Eric Cantor of Virginia, a member of the House of Representatives Republican leadership.
Geithner, who sent markets plunging on February 10 by releasing only a bare-bones sketch of the plan, said it was needed to get the private sector involved in cleaning up the banking mess.
“The great risk that we face now is that after a long period of irresponsibility and excessive risk-taking, that the system will not take enough risk now,” he said.
The plan is the latest step in a series of aggressive actions to restore credit flows and combat a virulent recession. Less than a week ago, the Fed ramped up its efforts, vowing to pump an additional $1.15 trillion into the economy.
Geithner said investors will set the price for toxic assets through the degree of interest they show in buying them, sparing the government from having to make that decision.
One aim is to restart markets for securities not currently trading and, in the process, tamp down investor fears that some form of bank nationalization might have to be considered.
The Treasury and private investors would combine their capital and turn to the Federal Deposit Insurance Corp, a U.S. banking regulator, or the Federal Reserve for loans.
Under one part of the plan focused on sopping up bad loans, the Treasury will provide up to 80 percent of the initial capital and the FDIC would offer debt financing for up to six times of the combined public-private capital pool.
A separate component, aimed at toxic securities, will have the Federal Reserve broaden its Term Asset-Backed Securities Loan Facility. That $200 billion program will be bumped up to $1 trillion and will begin accepting older mortgage-related and other securities as loan collateral.
In addition, the Treasury will approve up to five investment managers and match their money one-for-one. It will then offer debt financing for 50 percent of the combined capital to buy securities banks want to unload.
“My hope would be that you’ll see ... the first actual loans within the next 60 days, perhaps sooner than that,” Lawrence Summers, head of the White House National Economic Council, told Public Broadcasting’s “NewsHour with Jim Lehrer.”
The plan aims to help set prices for poorly performing debt left over from the U.S. housing market bust, while involving the market to avoid the risk taxpayers will overpay.
Geithner’s future may partly ride on its success. He has faced harsh scrutiny over whether he could have stopped the AIG bonuses, and some lawmakers have called for his resignation.
Two major U.S. money managers, BlackRock and Pimco, expressed interest in participating.
“From Pimco’s perspective, we are intrigued by the potential double-digit returns as well as the opportunity to share them with not only clients but the American taxpayer,” Bill Gross, Pimco’s co-chief investment officer, told Reuters.
Additional reporting by Jennifer Ablan; Editing by Leslie Adler