Geithner's Grand Moment is Here

The Treasury Department is now finally prepared to release its Financial Stability Plan. The goal of the plan is to leverage the public TARP capital ($100bn) with equity capital from private investors and loans from the FDIC for impaired loans and TALF for toxic securities (FT) to buy up to $500bn - $1 trillion of toxic assets.

According to Geithner's prepared statements the plan incorporates three separate approaches:

1) the FDIC will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled loans that banks want to sell;

2) for toxic securities, the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government equity and senior debt;

3) the Treasury plans to expand lending through the Term Asset-Backed Securities Loan Facility, a joint venture with the Federal Reserve, to include AAA-rated legacy assets (including CMBS) rather than only new consumer loans.

It is expected that the government will provide the overwhelming bulk of the money — possibly more than 95% (i.e. 97% see below) — through loans or direct investments of taxpayer money. In particular, to entice private investors like hedge funds and private equity firms to take part, the F.D.I.C./TALF will provide nonrecourse loans (loans secured only by the underlying value) worth up to 85% of the value of a portfolio of troubled assets. The remaining 15% will come from the government (i.e. 80%) and the private investors (i.e. 20%).

Overall, private investors, then, would be contributing as little as 3% of the equity, and the government as much as 97%.

The government would receive interest payments on the money it lent to a partnership and it would share profits and losses on the equity portion of the investment with the private investors. Administration officials refused to say what kind of interest rates the government would be charging investors.

Here are my questions:

1) Haven’t we created a situation where the government now has maximum exposure, instead of minimum exposure that the government should have in a free market? Why is our government taking 100% of the risk for anything than 100% of the upside?

2) How does this improve on the original TARP plan, and was that money just squandered when Paulson got cold feet and decided to dedicate that money (or at least the first half of it; and probably infinitely more if you include the guarantees) directly as debt in this financial institutions that we are still trying to rescue?

3) Doesn’t this entire program give private equity funds and hedge funds a free call on these assets, especially as there is no recourse, with the government taking the risk? Is this not a free call for the financial investor? Since when is someone who puts up 3% of the total funds and gets 20% of the equity a partner?