U.S. to Use Funds to Create Massive Debt Buying Market for Bad Loans

U.S. Treasury Secretary Tim Geithner Tuesday unveiled the outline of a plan to rescue financial institutions and unfreeze credit markets. Geithner, however, while providing some bullet points, still didn’t define many details beyond the basics.

Under the plan, the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve, in partnership with private investors, will establish a Public-Private Investment Fund (PPIF) to provide government capital, financing, and guarantees to help get private investment markets working again. The fund will be targeted at the “legacy” bad loans and assets that are now burdening many financial institutions. The PPIF would look to buy $500 billion in toxic assets in the near term, a figure that could eventually grow to $1 trillion – far beyond the second half of the $700 billion in the Troubled Asset Relief Program (TARP) fund allotted last year.

“By providing the financing the private markets cannot now provide, this will help start a market for the real estate-related assets that are at the center of this crisis,” Geithner said. “Our objective is to use private capital and private asset managers to help provide a market mechanism for valuing the assets.”

Banks with more than $100 billion in assets will be required to undergo a "comprehensive stress test" to determine if they can continue to lend through a severe downturn. The government said it will provide capital support for institutions that need it.

“There has been lot of confusion about the various programs announced by the government and how these programs are intended to help get the economy on the right track again,” said the American Bankers Association after the plan was unveiled. “The Capital Purchase Program, designed for healthy banks, needs to be separated from programs to aid Wall Street, automobile companies and others.  The vast majority of banks never made the type of toxic subprime loans that led to the current financial crisis and more than 90 percent remain well capitalized.”

The Capital Purchase Program enacted last year by Treasury used nearly all of the first $350 billion allotment of TARP funds. Originally designed to take bad loans off of banks’ balance sheets, then-Treasury Secretary Henry Paulson made an abrupt about face and decided to purchase equity positions in many of the nation’s largest banks.

Under the plan announced Tuesday by Geithner, the government will use $1 trillion to support consumer and small business lending through an expansion of the Term Asset-Backed Securities Loan Facility (TALF). Additionally, the government will increase the federally guaranteed portion of Small Business Administration loans, along with an expedited approval process.

But more details were sparse or simply unavailable, shaking the financial markets as the Dow Jones Industrial Average plummeted nearly 400 points in trading Tuesday. According to politicians and economists who spoke on several news and business programs, the markets were disappointed in the lack of detail in Tuesday’s announcement.

Barry Fromm, CEO of Value Recovery Holdings and a founding member of USA Recovery Group LLC — a coalition of accounts receivable management (ARM) firms, including many that had worked with the Resolution Trust Corporation in the 1980s and 1990s — said that economists, forecasters and others should not have expected “a silver bullet in one speech.”

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The details of any such recovery plan will be necessarily complex, Fromm added. So government officials will likely be meeting with asset recovery firms, accountants, lawyers, collection companies and others as more details of the plan are defined over the next few weeks and months.

Though not cited as a major element of the program by the government, Fromm added that the recovery plan will likely bring jobs to Middle America, not just Wall Street. USA Recovery Group is based in Columbus, Ohio.

Even though the details are unknown at this time, Fromm complimented the government for planning to use a private-public partnership to deal with the toxic assets.

“It’s a win-win,” Fromm said. “The private asset and private capital community includes many professionals who are experienced [with troubled assets]. Professional asset managers will be involved. The government will get a better yield from working with people who do this every day.”

The private sector firms will benefit as well by sharing in any upside of the sale of the toxic assets, Fromm added. Many of the potential contractors are already vetted by the government, removing one important hurdle in moving the process along. The vetting process can take a year, according to Fromm.

While saying that Tuesday was too early to have had a very detailed plan, Fromm urged the government to move quickly from here in order to have the most success with the plan.

“We think that the toxic assets are in the eyes of the beholder,” said Rozanne Andersen, EVP and General Counsel at ACA International, an association that represents the ARM industry. “Our industry is founded on turning bad debt into good debt. The collection industry working with the knowledge and the tools it has at its fingertips can be part of the solution. This is probably the first time in history of the industry that the needs of the federal government have aligned so perfectly with the collection industry.

“I do think we have to be mindful of history look at one of the deficiencies of the RTC, including oversight and haste,” Andersen added. “Hasty decisions regarding the bailout and use of funds can lead to disenfranchisement as happened in the fall [with the first half of TARP]. The collection industry has systems in place to provide the transparency that’s so desperately needed.”

Andersen pointed to the Fair Debt Collection Practices Act (FDCPA), Fair Credit Reporting Act and the resolution systems built into those two laws as providing better transparency than has been used thus far.

“We have systems in place today that weren’t in place during the time of the RTC,” Andersen added.