Public-Private Teamwork

Story Highlights:

• The US Treasury Department, Federal Deposit Insurance Corporation (FDIC), and Federal Reserve unveiled on Monday long-awaited details of the Public-Private Investment Program.
• The program will use TARP and private capital to initially provide financing for $500 billion of legacy asset purchases and potentially expand up to $1 trillion over time.
• US markets rose sharply Monday, but it'll be weeks (if not months) before investors see these programs in action.
• A much less ballyhooed, but no less important, event happened last week—the US Financial Accounting Standards Board (FASB) issued two proposals to add flexibility to FAS 157, the mark-to-market accounting rule.

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Four months after the Troubled Asset Relief Program's (TARP) objective to buy troubled assets, the US government is again poised to buy said assets—this time with help from private investors. The US Treasury Department, Federal Deposit Insurance Corporation (FDIC), and Federal Reserve unveiled on Monday long-awaited details of the Public-Private Investment Program—which was back in February.

Monday's announcement offered much more clarity, but contained few major surprises. The Public-Private Investment Program aims to repair financial institutions' balance sheets by addressing "legacy assets" (heretofore referred to as "toxic assets"). The Treasury regards legacy assets still clogging financial arteries and impeding economic recovery. The program will use TARP and private capital to initially provide financing for $500 billion of legacy asset purchases and potentially expand up to $1 trillion over time.

The Public-Private Investment Program is : the Legacy Loans Program and Legacy Securities Program. The Legacy Loans Program aims to help banks clear troubled legacy loans from their balance sheets. In this program, participating banks identify eligible assets, usually pools of loans, to be auctioned by the FDIC. The FDIC will provide guaranteed financing for bidding investors, up to six times the private capital invested. In addition, the Treasury provides 1:1 capital matching for the winning bid. The Legacy Securities program seeks to restart the stagnant market for legacy securities. This program expands the Term Asset-Backed Securities Facility (TALF) to include legacy mortgage- and asset-backed securities originated before 2009 with AAA ratings at origination. This program will also choose up to five (maybe more) private asset managers to manage funds for purchasing legacy securities, with the Treasury providing 1:1 equity co-financing and offering senior debt to leverage more financing if certain guidelines are met.

US markets rose sharply Monday, but it'll be weeks (if not months) before investors see these programs in action. Several key details are still undecided, and the problem of valuing legacy assets at prices agreeable to both seller and buyer still remains. Plus, the programs' success heavily hinges on public-private partnership, so it's to be hoped the government's heavy-handedness with other financial rescue programs haven't deterred private investor interest. There's no question the programs' terms are attractive, but we'll see if investors want to play.

A much less ballyhooed, but no less important, event happened last week—perhaps overshadowed by the . The US Financial Accounting Standards Board (FASB) quietly altered its stance on FAS 157, the mark-to-market accounting rule. After staunchly defending FAS 157 as it stood despite the financial storm, FASB staffers to add flexibility to the rule. One will provide guidelines for making fair value measurements when a market for an asset or liability is "not active" and determine if a transaction is distressed. The second will provide additional guidance on how to analyze illiquid securities that are not likely to be sold before recovery. This proposal would separate losses related to credit deterioration from those related to a distressed market on the income statement.

FASB will vote on the proposals April 2nd, though if passed, they will be back-dated to March 15 and potentially affect first quarter reporting. It's possible if the FAS 157 modifications are accepted, banks will be able to write up previous write-downs tied to market fluctuations in distressed markets (though not the losses tied to true credit deterioration). This could mean the incentive for banks to sell troubled assets (the objective of the Public-Private Investment Program) largely goes away. Banks would be much less inclined to sell legacy assets to the government program, since that locks in losses that otherwise wouldn't be permanent under new FAS 157 guidelines.

Both the Treasury plan and FAS 157 proposals are good for stocks and warrant close monitoring in the weeks ahead. We wouldn't be surprised to see the Public-Private Investment Program evolve as participating banks and investors test the waters.