Could you profit from Obama and Geithner's toxic assets plan?

This week the United States Treasury announced the Legacy Loans Program.  The program is meant to be a partnership between the government and private investors to clear "toxic" assets off the books of banks.  Some large financial firms have expressed that they may set up  mutual funds to buy these assets. Could you possibly profit by buying these funds as an individual investor?

First of all, lets explain how this plan from the Treasury works.  First, banks pick out the loans and mortgage backed securities they want to sell.  Then private investors would bid for these assets through the program, and the highest bid wins.  Presumably these investors should have done their research and evaluated how much they are willing to pay for the assets.  Next, the FDIC will finance a significant part of the purchase at a subsidized rate for the investor.  The Treasury will kick in another portion of the purchase price, and the investor puts in cash equivalent to the amount the Treasury puts in. The amount the FDIC finances is at most six times of what the investor contributes.

Here is an example with actual numbers from the Treasury press release:

Sample Investment Under the Legacy Loans Program

  • Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.
  • Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
  • Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector . in this example, $84 . would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.
  • Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.
  • Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6.
  • Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis . using asset managers approved and subject to oversight by the FDIC.

Why is this attractive to investors?  First of all, it is possible that they will be getting a significant discount on performing loans and securities through the bidding process. Also, the investors are putting up a much smaller stake than the government so the leverage gives them bigger returns.  Lets revisit the sample investment.  Suppose the $84 investment ends up being worth $90, then the net profit is $6.  Of this $6, the investor gets $3, and the Treasury gets $3 because they put up the same amount of equity in their 50/50 partnership.  The FDIC gets its $72 loan paid back.  This means that the investor gets a 50% return on their principal of $6 while the government technically gets a 3.8% return on its principal of $78.  The goverment will also get some  fees and loan interest paid by the investor related to the FDIC  loan,  but for the government to get a 50% return these fees and interests would have to add up to $36, and that is very unlikely.

So what happens if the assets are actually worthless?  The loan the FDIC makes to the investor is a non-recourse loan, which means that the investor could walk away and the most he or she would lose is $6 plus any fees and interest paid in case the  $84 investment is worth nothing.  On the other hand, the government or taxpayers stand to lose a combined $78.  So basically, most of the downside of the investment will be shouldered by the American taxpapyers.

It should be interesting to see how this plan turns out.  Personally, I believe that some investors with deep pockets could potentially profit handsomely from this plan if they manage to somehow bid intelligently on the assets they buy.  Currently at least three mutual fund companies are considering starting mutual funds to buy these toxic assets, and these funds will allow  smalltime individual investors to get in on the action.  However, these assets are still extremely risky because noone seems to know what they are actually worth so they are truly a gamble.  I definitely would not bet my retirement on these funds, but considering that I already pay tens of thousands of dollars in taxes to support the program, perhaps it is not a bad idea to invest on the side that may give a positive return. 



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Guest's picture

The entire economic crisis started with subprime mortgages and was continued by people investing in securities structured around them. However, this is just another untested investment vehicle and will probably go down as another investment fad.

Sure your investment is "guaranteed". Even though you won't lose anything, you face the very likely risk of not gaining anything. What's lost is opportunity.

I don't know when anyone would invest in something untested when blue chips are almost half off. Keep it simple and stick to the tried and true: buy high quality stocks, bonds and mutual funds with long histories of gains and dividends.

Guest's picture

Thanks for a great explanation of a very complicated program.

I'm sure people would like to know (I sure would) how individuals can learn more and/or participate or is this only for very large investors. Do you have any information on that?

Guest's picture
Michael Haren

NPR's planet money covered this topic and why we're not actually on the hook for as much as is being reported.

It seems that the FDIC loan is covered by the usual fees paid by banks (not regular folks).

I'm not saying that if this thing falls apart that the FDIC will be fine and we'll all be happy--just that as it stands now, we're only on the hook for 7%.

Guest's picture

This might be an investment opportunity,but it sucks royal for the U.S.A.. The geniuses now running the economy (government) have no idea what the unintended consequences will be, but they won't be very good.

Sure, the government offers to loan up to 95% of the cost to a private entity to enable them to buy up some of the toxic junk. Why wouldn't you do it - you only have 5% exposure? What got us into this fine mess in the first place is that those playing didn't have SKIN IN THE GAME!

What will they pay for these poor, much maligned assets? That's the the crux of the whole plan. The banks don't want to accept what they're really worth, nearly worthless. The government says - and if you believe them, you truly are foolish - they don't want to pay too much. Ha! The taxpayer is going to get reamed because the big banks are calling the shots. Meet the new boss, same as the old boss. Obama no different than Bush.

Hey, Wake Up!

The Fed, the congress, the administration is trying to inflate the bubble ... again. They are desperate.

Will it work? No. It stands no chance. The national debt is soaring past 5% of GDP. Only two things can happen now: we renege on the debt or hyperinflation. Take your pick.

I really think it will be the latter - the dollar will be trashed and inflation will rage.

Xin Lu's picture
Xin Lu

Michael, the FDIC loans are covered by bank insurance fees, but lately the FDIC is running dry.  Who do you think will pick up the bill when the FDIC can't handle the volume of failed banks and these loans?

Kelja, the national debt is actually nearly 40% of GDP  now and the total debt is over 60%.  If it were only 5% then this country isn't really doing that bad.   See

Guest's picture

Xin Lu:

You're right, of course, about the National Debt compared to GDP.

What I should have said Obama's new Federal Budget compared to GDP.

Guest's picture

At a time when 5% of the people control 85% of the wealth, (and of course power too), it's probably the right thing to try... to scratch back at least a little of what we've lost.

It just puts a sickening feeling into the psyche, to realize what has happened with the concentration of wealth that has now brought our nation to near ruin. Even worse, to see that the people who, without conscience, greedily changed the rules and now, have ensured a dynastic machine that is no longer subject to moral laws.

As to the overall breadth of the fiscal problems, I believe we've only scratched the surface. My own list of the "undiscovered" losses includes:

Public and Private Pension Funds (Broken PBGF)
Endowment Funds
Insurance company assets

And most importantly the CAFR's from over 80,000 municipalities which list an asset total which is unknown, but estimated to be over sixty trillion dollars. If, as we might expect, the losses that exist in the bank/broker financial sector are also reflected in the Municipal Reports, then the state of our economy is even worse than the Federal Government estimates.

Each time we look at a "worst case scenario", up pops another, even "worser" problem.

Stepping back to reflect on the "new" Public/Private attempt to liquify the market, it looks to me as if we're just building another "bubble".