Toxic-Asset Plan: Bull in the Making

We have been waiting for significant news that reveals the conditions of the economy and the bailout to signal a legitimate rally. Other than a few things about home sales and oil, the economy has not had any terrible news lately. As a result we saw a stable rally over the past week and a half. The excellent news is that we now have some more details on the bailout and the toxic assets that are ruining balance sheets. This is why the market was up around 7% on the day and will continue to rise as the plan further unfolds and [hopefully] works.

Toxic assets, or legacy assets, are assets that have lost value and are on the verge of becoming liabilities. The legacy asset problem started initially with the housing bubble as standards became too lax and risks skyrocketed. As capital left these markets, these assets quickly lost liquidity. The proposed plan has both investors and the government injecting fresh capital into the system to get things running again. The mortgage sector is the primary problem that has to be corrected. Mortgages not paid led to foreclosures which led to assets that have lost value. The plan calls for private investors to team up with the government to inject liquidity into this market without the help of taxpayers through two different programs: legacy loans program and legacy securities program.

The legacy loan program calls for private investors to bid for assets. These assets will most likely be some kind of mortgage package from a bank. The private investor would split the equity portion with the Treasury 50/50 with the FDIC guaranteeing financing of the debt portion. The private investor would make all the calls with the FDIC closely supervising. This helps to rid banks of troubled assets and provide a more liquid balance sheet.

The legacy securities program combines financing from the Federal Reserve and the Treasury to allow private investors the chance to free up capital in order to stimulate fresh lending. The Treasury would provide a one-for-one match in equity plus additional leverage for the private investor to invest in these securities. This would free up capital and allow banks to lend to consumers again to help stimulate the economy.

These plans would not only help banks to rid itself of troubled assets, but it would allow balance sheets to become more liquidity and lending to flow again. This also allows private investors the chance to profit off these assets and taxpayers to dodge a bullet. As long as this plan works out the way its supposed to, the market should respond accordingly and give the rally a chance to continue making us cash money.