RAY SUAREZ: It’s a good news, bad news story. Led by Citigroup, bank stocks have been trading higher for two straight days. At the same time, nobody can say what the billions in bundled mortgages weighing down sagging balance sheets are really worth.
The Treasury Department and the markets are struggling to determine the true financial condition of large banks holding bad debt, institutions like Bank of America, JPMorgan Chase, and others.
Treasury Secretary Tim Geithner confirmed yesterday he’s working on a plan to remove so-called toxic assets from the banks by having the federal government partner with private investors to create special funds. Similar to Wall Street, the funds would be used as a market to trade toxic assets.
The government could potentially commit as much as $1 trillion toward that effort. Private investors would run the funds and try to attract additional private money. If the bad assets were later sold for a profit, both parties would earn money. But if they dropped in value, the government would assume most of the loss.
Geithner discussed the broad outlines of the plan on “The Charlie Rose Show” last night.
TIMOTHY GEITHNER, Treasury Secretary: What this plan will do is to make financing from the government available, alongside public and private capital, so that we can get these markets open up again.
The reason why these markets are not moving now is because there’s no financing available and no confidence in people’s capacity to make judgments about ultimate losses.
And so, by providing financing, government leverage alongside public and private capital, we think we can make a meaningful difference in starting to open up these markets and starting to trade again.
CHARLIE ROSE, Host, “The Charlie Rose Show”: You have private investors who are prepared to step forward and buy these toxic assets if — if…
TIMOTHY GEITHNER: If they’re able to get financing from the government, because, again, that financing is not available now. So that’s the — one of the kind of important things that governments have to do in a financial crisis, because, again, you know, financial crises reflect an unwillingness by the private sector to take risk because of uncertainty and things that they just can’t do in the economy.
And that’s why governments have to step in, in financial crises and take risks the market would otherwise not be prepared to make. So with financing, we’re confident you’re going to see private investors come in and put some capital to work to sort of unfreeze these markets.
Hard to appraise assets
RAY SUAREZ: Geithner said he expected full details of the plan to be released in the next week or two.
To help us understand more about the broad shape of such a plan, as well as its potential benefits and pitfalls, we talk to Wilbur Ross, the chairman of WL Ross and Company. He has a record of buying distressed companies, restructuring and selling them for a profit. He's expressed some interest in the Geithner plan.
And Peter Wallison, former general counsel of the Treasury Department, he studies banking and insurance issues at the American Enterprise Institute.
And, Mr. Ross, let me start with you. What do you think of the plan to create a public-private partnership to clear these distressed assets off bank books?
WILBUR ROSS, Chairman, WL Ross and Company: Well, I think conceptually it's a good idea, because it means that the ultimate management of those potentially bad assets will be in the hands of private-sector people who are accustomed to dealing with such things.
So while I think it's important that government provides leverage so that you can get some kind of halfway decent rate of return on the risky piece, I think the structure and concept is a very good one.
RAY SUAREZ: And, Peter Wallison, granted, there's still a lot we haven't heard about it yet, but given the broad outlines that are in the public domain, what do you make of the plan?
PETER WALLISON, American Enterprise Institute: Â I don't think it's a very good plan, and I think it is intended, really, to solve some political problems rather than some economic problems.
RAY SUAREZ: Explain that.
PETER WALLISON: Well, it is very easy to buy these assets from the banks at a value that the banks would like to sell them, or close to it. The banks are getting cash flows on these assets, and the assets determine the value of -- the cash flows determine the value of these assets.
The government could buy these assets at a discounted cash flow value, which the banks do every day -- they try to value their assets that way -- and then take them off the balance sheets of the banks, hold them itself -- the government would actually make some money on this, because its cost of funds is very low compared to the banks' cost of funds -- and hold them until the market comes back, and then the government can sell them.
Meanwhile, the banks would become much healthier and would start lending again.
RAY SUAREZ: You say it's very easy, but wasn't that what was tried in the waning days of the last administration, when the tranche of money was appropriated and Henry Paulson and company were going to go out there and start to mop up some of this bad debt?
PETER WALLISON: Yes, it was a very good idea.
RAY SUAREZ: Well, nobody took it, though.
PETER WALLISON: That's why the TARP was passed. Nobody did it because there was still the political problem. And the political problem is that the market price, not the net asset value price that I was talking about before, but the market price is very low because there isn't any liquidity in the market. You don't know who you could sell these assets to so no one wants to buy them.
As a result of that, people are looking at the market price, and the government, if it took them at the net realizable value that I'm talking about -- that is, the cash flow price -- would be paying a lot more than the market price.
And the politicians and the administrators, like Henry Paulson and now, I think, Tim Geithner, do not want to be criticized for paying much more than the market price for these assets.
Cost of borrowing from Treasury
RAY SUAREZ: Wilbur Ross, what do you think? Is it as easy as Peter Wallison suggests to set a price for these bad assets and clear them off the books without resorting to extraordinary measures?
WILBUR ROSS: No, the fact is, it wouldn't happen. I'd like to address several of his observations, one, the observation that there will be an overpayment. If so, you'd have to assume that people like myself, who would be putting up the equity, would ourselves overpay. That's not a very good assumption to make; it certainly isn't the basis on which we're going into the program.
The second thing is, as to the cost of the borrowing that the Treasury has versus what the securitization will have, Treasury will be getting some fees out of this, so they will, in fact, be making something from it.
But they will be taking less risk, because somewhere between 5 percent and 20-odd percent of the whole pile of assets will be financed with equity, and the equity would, obviously, take the first loss. So it is a safer thing for government to do, and it's safer in another regard: Not all of this paper will perform.
And if government were to take it onto their books, they would have to set up some kind of a bureaucracy to track down the credit card receivable borrowers, track down the car loan borrowers, and all these other people. I'm amazed to hear that you would feel that it's a good idea for government to duplicate personnel resources that are already quite plentiful in the private sector.
RAY SUAREZ: Peter Wallison?
PETER WALLISON: Well, of course they would not pay more for these assets, but what you are thinking about -- or what he's thinking about is that the banks are eager to sell them for less than the banks are carrying those assets at. And, in fact, they're not.
In some testimony a couple of weeks ago, the chairman of Citibank said he understands the value of these assets and, because he has fiduciary responsibilities to his shareholders, he can't sell them for less than the bank thinks they are worth.
The fact that Citibank is now reporting or possibly could be reporting this quarter a profit indicates that his assessment of these assets is probably right. They are flowing cash at a level that is high enough to give them some real value. And so I'm...
WILBUR ROSS: If you're right -- if you're right that there's a disconnect between real value and where the banks are carrying it, there won't be any trades done. So we'll know in a very few weeks whether you're right or you're wrong.
The public-private aspect
RAY SUAREZ: But aren't you both trying, struggling for an answer about something that the market's been struggling to come to for months now, that the value of these is somewhere between the stated price and zero, and so far nobody knows exactly what that is?
WILBUR ROSS: And this mechanism will define what that price is. And the reason it's important to have the large amount of non-recourse lending from the government is, about half of all the consumer loans that were made in this country in recent years were not, in fact, even made by the banks. They were done in securitizations in the so-called shadow bank sector.
This is an attempt to rehabilitate the shadow bank sector and bring new sources of capital in that wouldn't normally be funding consumer paper. And I think, to the degree that it accomplishes that and at the same time is a clearing mechanism, I think it's precisely what's needed to get the economy going again.
RAY SUAREZ: Peter Wallison, what about this public-private aspect? Would it reassure both parties to have them both in there?
PETER WALLISON: Well, it solves a political problem for the Treasury Department, and that is, the price is going to be set by the private group, so the Treasury Department can say, "Hands off. We did not rip off the taxpayers by paying more for these assets from the banks."
Unfortunately, that is going to set up a long process of negotiation between the banks and the private-sector buyers, because for reasonable -- from the point of view that Wilbur Ross is talking about, that's very reasonable. He wants the lowest possible price he can get for these assets, because if they are, in fact, valuable, then the profits will be higher.
But the banks are not eager to sell these assets. And so the most important thing from my perspective is making sure that we get the banks healthy as quickly as possible by getting these assets off the balance sheets of the banks, replacing them with cash, so that the banks feel that they are now healthy, and people will look at bank capital and say, "This is real capital; this isn't risky capital," and they'll start dealing with the banks again.
A standoff is possible
RAY SUAREZ: Wilbur Ross, what's in it for the public? I think you've been pretty straightforward about what might be in it for private investors.
WILBUR ROSS: Well, I think there's a lot in it for the public, in the sense that, if government's going to play a role here, it's best that it play a temporary role. You can't have an economy function if forever and for all time the only way you can get a loan is with government assistance, and that's a direction we're moving in right now because of the peculiar time we're in.
By moving these into a public-private partnership, all you're really doing is distributing gain and loss between the selling banks on the one hand and the private equity investors on the other hand.
So that doesn't really change the interface between private sector and government, except it reduces the amount of exposure government will have, I would argue to where there's a vanishing point, and they won't really have any risk, and it keeps in the private sector the ultimate solution. I think that's a very good, practical solution, not just a political solution.
RAY SUAREZ: Very quickly, before we go, Peter Wallison, you heard Wilbur Ross talk about the transitional nature of it.
PETER WALLISON: Yes.
RAY SUAREZ: Does that reassure you at all as someone who's skeptical about this plan?
PETER WALLISON: Well, it reassures me a bit, but my concern, as I indicated, is that we do this quickly. And what I think we are setting up here is a process of negotiations with the banks that believe these assets are worth a lot more than the private sector is willing to pay for them.
The private sector is going to say, well, we can't sell them to anybody, because there's no one out there offering liquidity. And as a result, we'll have a standoff.
That will get the government out of the problem, because the government will not be able it to do anything while this negotiation is going on, and yet this will not cure our problem with the banks.
RAY SUAREZ: Quick point, Wilbur?
WILBUR ROSS: Tell you what. I'll bet you a nice dinner at a restaurant of your choice that a lot of this paper changes hands.
PETER WALLISON: That's a deal.
RAY SUAREZ: OK, well, at least we settled that. Gentlemen, thanks a lot.