A Closer Look At The Financial Black Holes That Are Clogging Up The Nation's Credit Flow
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March 23, 2009
'Toxic-Bank' Details Released
Public and private money will buy up bad assets in an effort to jumpstart the economy, reports Bill Plante. Harry Smith talks to Dr. Christina Romer, a White House adviser, on the economic strategy. | Share/Embed
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A look at the series of government moves to try and stem the financial meltdown.
Stories
* White House Embarks On Toxic Asset Purge
* Stocks Surge On Bank Plan, Housing News
Answers.com
(CBS) The Obama administration rolled out a plan Monday that could facilitate the purchase of up to $1 trillion worth of toxic assets from struggling banks in an effort to clean up their balance sheets and get them to start lending again.
So what exactly are these toxic assets, which have caused such huge problems in our financial system?
Every time you see foreclosure signs littering neighborhoods, you're probably looking at the makings of a toxic asset, reports CBS News correspondent Bianca Solorzano.
"Toxic assets are the ones that nobody wants to touch because they're just considered too dangerous," Doug Rediker, of New America Foundation, told CBS News.
Normally banks can sell their healthy assets, such as a borrower's timely paid mortgage, to other banks. This allows Bank A to get money quickly and Bank B to profit from the interest that the homeowner is paying.
But if you go into foreclosure and the price of your home drops below the value of the loan itself, then that asset, namely the mortgage, is losing money. It becomes toxic and sits on the banks' balance sheets like a black hole.
Since the banks can't tell how large the black holes are on other banks' balance sheets, they have no confidence to lend money to each other and they stop making new loans, clogging up the nation's financial system.
And although the Treasury Department's plan makes allowances for up to $1 trillion worth of these toxic assets, some economists think the toxic clog could be more than twice that size.
Timothy Geithner unveils $1 trillion toxic asset scheme
The treasury intends to use between $75bn and $100bn from its emergency bailout fund to generate co-investment from hedge funds, private equity funds and other private-sector investors
* Andrew Clark in New York
* guardian.co.uk, Monday 23 March 2009 14.56 GMT
* Article history
Timothy Geithner
US treasury secretary Timothy Geithner. Photograph: AFP/Getty
The Obama administration has kicked off an effort to clean up America's troubled banks through a programme matching private sector money with treasury funds to buy up to $1 trillion (£684bn) of toxic assets from the sagging balance sheets of failing institutions.
In an initiative greeted enthusiastically with a surge in stocks on Wall Street this morning, the US treasury secretary, Timothy Geithner, sought to shake off criticism of vagueness and inertia which followed initial outlines of his approach towards the troubled banking industry last month.
The treasury intends to use between $75bn and $100bn from its emergency bailout fund to generate co-investment from hedge funds, private equity funds and other private-sector investors willing to participate in buying derivatives, mortgage-backed securities and other troubled financial instruments.
To help raise money, the Federal Deposit Insurance Corporation, which insures US bank accounts, will provide a guarantee for any debt financing issued by public-private entities to pay for their toxic purchases.
Geithner said that doing nothing was not an option, citing Japan's 1990s banking crisis: "Simply hoping for banks to work legacy assets off over time risks prolonging a financial crisis, as in the case of the Japanese experience," he said today.
Financiers agree that until banks find a way to dispose of troubled assets on their books, the flow of loans and credit to re-invigorate economic activity will be blocked. But one of the key stumbling blocks over the last year has been disagreement over how to price these assets which have plunged in value due to a collapse in the US mortgage market.
Geithner said that the involvement of private investors would help generate fair prices: "If the government acts alone in directly purchasing legacy assets, taxpayers will take on all the risk of such purchases - along with the additional risk that taxpayers will overpay if government employees are setting the price for those assets."
Within minutes of the opening bell on Wall Street, the blue-chip Dow Jones industrial average was up by 156 points to 7435. In a clear indication of confidence in the administration's plan, shares in struggling banks leapt sharply higher. Citigroup's stock surged by 16%, Bank of America was up by 17% and Morgan Stanley rose 9%.
One of the biggest credit funds in the US, Pimco, declared that it would participate in the programme. Pimco's co-chief investment officer, Bill Gross, said: "This is perhaps the first win/win/win policy to be put on the table and it should be welcomed enthusiastically. We intend to participate and do our part to serve clients as well as promote economic recovery."
Treasury officials are hopeful that a relatively modest sum of seed money from government funds will be sufficient to generate an initial $500bn in purchasing power, rising to $1 trillion over time.
The government's $75bn to $100bn will be matched on a broadly dollar-for-dollar basis by private investors to form the equity component of investment vehicles. But with the help of the FDIC's guarantee, the Treasury expects these vehicles to be able to leverage their funding by borrowing on an up to six-to-one debt to equity basis.
Initial indications suggested that financiers see the proposals as credible - a reaction which will come as a relief to the White House after a tepid response to broad outlines set out by Geithner in early February. At the time, stocks plunged and Geithner was savaged in Congress over fudged details and a lack of specificity in his remarks.
But still, not everybody is convinced that Geithner's approach will work. The recent furore surrounding bonuses at insurer AIG has provoked wariness among Wall Street institutions about getting involved in government programmes for fear that their finances will be subject to scrutiny by lawmakers and to popular attack from the public.
David Trone, a banking analyst at Fox-Pitt Kelton, said he believed "hysteria" over AIG had created deep distrust among potential investors, with doubts arising over future restrictions over issues such as compensation and dividends.
"Credit and asset-backed securities investors do not like uncertainty, and rely very heavily on contracts' terms, since they can make or break the risk/reward equation," said Trone.
Economic commentators in the US have noted a few glimmers of hope of stability beginning to return - including a 30% rise in the number of people refinancing mortgages over the last month.
But in a television interview over the weekend, president Barack Obama made it clear that he still sees danger in the weakness of financial institutions.
"I think that systemic risks are still out there," Obama told CBS's 60 Minutes. "There are certain institutions that are so big that if they fail, they bring a lot of other financial institutions down with them. And if all those financial institutions fail at the same time, then you could see an even more destructive recession and, potentially, depression."
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By David Gardner
Last updated at 9:24 AM on 24th March 2009
British bank shares climbed this morning after Barack Obama's $1trillion buy-out of toxic bank assets prompted massive gains on global markets overnight.
Royal Bank of Scotland was up more than nine per cent, Lloyds Banking Group up six per cent and Barclays four per cent on the back of the U.S. Treasury's latest plan.
However, the FTSE-100, which rose 2.9 per cent yesterday after the measures to free up the frozen credit markets were announced, failed to build on earlier gains.
It appeared to keep hold of the rise in early trading, but by 9am had slid back into the red despite Asian markets soaring overnight.
President Barack Obama stands with Treasury Secretary Timothy Geithner as he makes remarks about AIG and his economic recovery last week
President Barack Obama stands with Treasury Secretary Timothy Geithner as he makes remarks about AIG and plans for the economy
Japan's Nikkei index closed up 3.3 per cent, while in Hong Kong the Hang Seng finished with a gain of 3.4 per cent - a 10-week high.
The Dow Jones in New York enjoyed its fifth largest ponits gain in its history as it ended the day up 497 points or 6.84 per cent at 7,775.
More...
* Obama's 'spend, spend, spend' budget will bankrupt America, warns man President wanted in his Cabinet
Mr Obama said there were 'glimmers of hope' in the housing market after February sales of previously owned U.S. homes rose at their fastest pace in nearly six years.
The global economic crisis started after U.S. banks sold too many mortgages and loans to high-risk customers with a negligible income or poor credit rating.
These 'toxic assets' have lost so much value that lenders have been unable to sell or even realistically value them.
Banks have become so burdened with debt that they cannot free up enough cash for new loans and mortgages - which is how the credit crunch got its name.
Mr Obama has now promised to remove as many bad assets as possible from the banks' balance sheets.
He will encourage private investors to take part in the scheme with lowinterest loans offering the possibility of big profits when the economy recovers and those assets hopefully rise in value.
'Are you punch drunk?': Barack Obama is interviewed by CBS' Steve Kroft for '60 Minutes'
Some analysts say the move is the last in a series of measures that have failed to work, but last night Mr Obama hailed it as a vital step to revitalise the U.S. economy.
'The good news is that we have one more critical element in our recovery,' he said.
But he downplayed expectations of a quick fix, adding: 'We've still got a long way to go. It's not going to happen overnight. But we think we are moving in the right direction.'
In Britain, the Treasury has taken a different approach, using taxpayer money to insure Royal Bank of Scotland and Lloyds against future losses on £600billion of poor loans and investments.
The U.S. Treasury dismissed that policy in a statement yesterday, saying its own strategy was more likely to bear fruit.
Treasury secretary Timothy Geithner said low-interest loans of up to £70billion will initially be offered to private investors from the bail-out fund approved by Congress, to entice private-sector investors to buy an estimated $ 500billion worth of toxic assets.
The administration said this effort could grow to cover $1trillion in toxic debts, and that it expected participation from a wide range of private sources, from pension funds to insurance companies and other long-term investors.
If investors sell toxic assets such as mortgages at a higher price later when the economy recovers, the investor pays back the treasury and pockets the profit.
But if the prices fail to improve, the loan is still guaranteed against any losses by the treasury and the investor only stands to lose a minimal initial investment.
The treasury chief said the plan was needed because the U.S. 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 encouraging the private sector to take part would be better for the taxpayer as the risks of purchasing toxic assets would be shared.
How the German economy is falling
Germany's economy is set to plunge as its traditionally strong export industries reveal emptying order books, analysts warned last night.
Commerzbank, the country's second largest lender, said gross domestic output in Europe's biggest economy would fall by up to 7 per cent this year - almost double the previous estimate.
Chief economist Joerg Kraemer said: 'January order intake and production data plunged at a dramatic pace that has no precedent in Germany's post-war history.
'This has pulled the rug from under our previous forecast. The global economy is in a state of shock brought about by uncertainty.'
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Obama's 'spend, spend, spend' budget will bankrupt America, warns top Republican
By David Gardner
Last updated at 8:15 AM on 23rd March 2009
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* Add to My Stories
A top Republican who snubbed Barack Obama’s offer of a Cabinet post has dealt another damaging blow to the president by claiming his economic policies would bankrupt America.
Judd Gregg warned Mr Obama’s 'spend, spend, spend' budget plans would leave the U.S. trillions of pounds in debt.
‘This clearly creates a scenario where the country’s going to go bankrupt. It’s that simple,’ said the senator who changed his mind after initially accepting the Commerce Secretary job.
He spoke out as Mr Obama was preparing to address the nation in yet another attempt to sell his financial recovery plan to a sceptical public on Tuesday.
Judd Gregg
U.S. President Barack Obama
Bankruptcy road: Judd Gregg (left) has told Obama his budget plans would leave the country in massive debt
One of the president’s top financial aides, Christina Romer, head of the White House Council of Economic Advisors, went on Fox News Sunday to try to ease the gloom by declaring that the administration is ‘incredibly confident’ the economy will rebound within a year.
‘We will be seeing signs the economy is turning around,’ she said.
Mr Obama is desperate to regain the initiative after appearing to be blindsided and wrong-footed in his response to the bonus scandal at bailed-out insurance giant AIG.
The fury over the bonus payouts boiled over so dangerously that AIG executives have been flooded with death threats and they have employed security guards and been warned not to go out alone.
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* 'Don't wear anything that says AIG on it': Insurer gives employees security tips as fury over bonuses grows
At the weekend, a bus company was even organising tours around the multi-million pound homes of AIG bosses in upmarket suburbs in Connecticut.
One tour stop was a mansion owned by Douglas Poling, a senior executive at the embattled insurer, who says he is giving back the biggest single AIG bonus of £4million, which he received a week ago.
But the debacle shows no sign of fading away.
Last night, Vice President Joe Biden’s economic advisor admitted a plan to impose a 90 per cent tax to reclaim the £100million paid out in AIG bonuses may have gone ‘too far.’
Christina Romer
Stay positive: Christina Romer has been on TV telling the public the economy will rebound
Jared Bernstein said a bill passed last week by the House of Representatives may face legal problems by using the tax code to ‘surgically punish a small group.’
Mr Obama was expected to announce a plan on Tuesday to help thaw America’s still frozen credit system that has compounded the recession by denying loans to businesses and consumers.
The Treasury Department hopes to take as much as £700billion in so-called toxic assets off the books of endangered banks.
Billions of taxpayer enticements will be shelled out to private investors to persuade them to buy the bad debts and hold on to them until the economy recovers.
In response to the AIG debacle, there is also likely to be much tighter regulation of executive pay at banks and financial institutions.
The president will follow up the announcement with a nationally broadcast news conference aimed at promoting his budget plans to create jobs by revamping US healthcare, education, energy and tax policies.
‘I realise there are those who say these plans are too ambitious to enact,’ the president said in his weekend radio address.
‘To that I say that the challenges we face are too large to ignore. I didn’t come here to pass our problems to the next president or the next generation – I came here to solve them,’ he added.
Appearing on CNN, Senator Gregg, a senior member of the Senate Budget Committee, said he had no regrets in withdrawing his nomination to join Mr Obama’s Cabinet.
He said the scale of the administration’s spending plan in the midst of a prolonged recession would leave the next generation with a country too expensive to afford.
The non-partisan Congressional Budget Office said that the president’s policies would raise government spending to an all-time high.
The watchdog group said the huge deficits would mean the US would have to borrow nearly £6.5trillion over the next decade – £1.6trillion more than Mr Obama predicted when he first unveiled his budget last month.
The tour of AIG executive homes was dubbed ‘Lifestyles of the Rich and Infamous’ by activist organizers, Connecticut Working Families, a small liberal political party.
But some of the recipients of the biggest cheques have already announced they are giving the money back.
Security guards met visitors at a mansion belonging to Douglas Poling, the AIG vice president for energy and infrastructure investments who got the biggest (pounds) 4 million payment.
A spokesman said Mr Poling was returning the money ‘because he thought it was the correct thing to do.’
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UPDATE 6-
AIG to sell $6 bln in AIA stock to repay US bailout
Mon, Mar 05 15:14 PM EST
* Selling via placement to institutional investors
* Selling at HK$27.15 to HK$27.50 a share - term sheet
* AIA stock trading suspended in Hong Kong
* Goldman, Deutsche 'active' bookrunners - sources
By Denny Thomas and Clare Baldwin
HONG KONG, March 5 (Reuters) - American International Group is selling part of its stake in AIA Group to raise about $6 billion, which will help the U.S. insurer repay part of its government bailout.
Markets reacted favorably, with AIG shares rising to their highest levels in 10 months on the news.
AIG is looking to sell about 1.7 billion AIA shares at HK$27.15 to HK$27.50 each, according to a term sheet Reuters saw on Monday. That would be a discount of up to 7 percent to Friday's closing price.
The shares will go to institutional investors. AIG expects to use the net proceeds to reduce the balance of the U.S. Treasury Department's preferred interest in a special-purpose vehicle that holds the AIA shares. As of last month, those preferred interests were worth about $8.4 billion.
The Treasury also owns 77 percent of AIG's common stock following a massive $182 billion bailout in the wake of the 2008 global financial crisis.
At Friday's close, AIG's one-third stake in AIA was worth $14.9 billion. Following the share sale, the U.S. company will hold about 19 percent of AIA.
Institutions are expected to buy into the offering because of AIA's strong performance since the company's $20.5 billion Hong Kong IPO in 2010 -- Asia's third-largest public listing. But a big run-up in the stock price may have some feeling that the current offer is expensive.
With such a large sale and AIA's free float increasing, though, the company's weighting on benchmark indexes should rise, making the stock a target for fund managers tracking the Hang Seng and the Hang Seng Finance Index.
"The issue of getting the deal through shouldn't be a problem, plus there should be some index buying," said the head of a large U.S.-based asset manager in Hong Kong who was not authorized to speak publicly on the AIA sale.
Kenneth Yue, a Hong Kong-based analyst at CCB International Securities, said the sale looked well timed.
"If you look at AIA's new business growth last year, it went up 40 percent," he said. "I believe they've gone to the peak already -- it would be very challenging for them to increase their new business value going forward by 40 percent every year."
Pricing of the AIA share sale will occur no later than Tuesday, AIG said.
BANK CREDIT
Deutsche Bank and Goldman Sachs are the "active" joint global coordinators, according to two sources with direct knowledge of the process. Both requested anonymity because they are not authorized to speak publicly on the matter.
Deutsche and Goldman were among the four banks that led AIA's IPO, along with Citigroup and Morgan Stanley. The sources said Citi and Morgan Stanley were taking "passive" roles in the current AIG sell-down.
The distinction is important, not just for the fees that such a large offering brings, but also in the league table credit that can help a bank's external marketing. For the AIA sell-down, the banks will get equal league table credit, but Deutsche and Goldman will take home the fatter fees, according to one of the sources.
The deal should be "well distributed" among different investors, instead of large chunks going to just a handful, the source noted.
Shares of AIA, headed by former Prudential Plc executive Mark Tucker, have risen 47 percent since early October and touched a seven-month high last week. The stock closed at HK$29.20 on Friday.= 3.76124 USD
AIG has been on a similar run, gaining 46 percent over the same period. Its shares rose 1.2 percent to $30.16 in afternoon trading, their highest level since last May. Fitch Ratings said on Tuesday that the sale would improve AIG's focus on its core operations and would help its credit rating profile.
CROWN JEWEL
AIA was founded in Shanghai in 1919 by U.S. entrepreneur C.V. Starr. Twenty years later, Starr temporarily relocated to the United States to avoid political instability in Asia and, following World War II, decided to run his U.S. businesses from New York. They came to be known as AIG, whose shares began trading in New York in 1984.
Now Asia's third-largest insurer, AIA has built a sprawling and successful business across the region, with an army of hundreds of thousands of agents.
AIG was forced to spin off AIA, widely considered its crown jewel, and other assets following the bailout by the U.S. government.
AIG Chief Executive Robert Benmosche has said little about his plans for the AIA stake. As recently as Feb. 24, AIG said it had not decided what to do with the stake and had earlier hinted it may even increase its holding.
But the company appears to have opted instead to start paying the government back and focus on other parts of its business.
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