Investors ready, but banks continue to balk at toxic asset plan

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The Treasury Department has over 100 applications from would-be investment managers who want to buy toxic bank assets under the Public-Private Investment Program (PPIP). While that sounds promising for the success of the plan, banks actually don't want to sell their assets at the price investors are willing to pay. Also, some major investment groups just don't want to get involved in another government plan for fear they will be demonized for making big profits on the toxic assets they buy.

Yet these toxic assets continue to drain the health of big and small banks as the losses build and constrict their ability to lend. While big banks have raised $65 billion in new investor capital, smaller banks can't tap into that source of funds to prop up their balance sheets. Hundreds of smaller banks are sitting on commercial loans that have gone bad or soon will. But even the smaller banks don't want to sell the assets at bargain basement prices because it will hurt their balance sheets and dent their capital cushions.

Ever since the mortgage meltdown began, the government has tried to get toxic assets off banks' books, citing the success of the Resolution Trust Corp in the 1980s that helped to defuse the savings and loans crisis. But every plan so far has fizzled out and it looks like PPIP will as well. The first attempt was in 2007, when federal officials put together a plan for a bank-financed fund to buy securities held by bank investment funds. But that poorly designed plan quickly died. Then in 2008, the Bush administration established the $700 TARP bailout, but did a bait and switch and invested in banks through preferred shares rather than buy toxic assets. Banks can't wait to buy their way out of TARP, yet the toxic assets still weigh down on their ability to lend.

When PPIP was first announced, Wall Street loved it. The Dow jumped nearly 500 points, or 7 percent, on the day it was announced. But as the details filtered out, fewer and fewer banks wanted to take advantage of the program. Investors did surface to buy the toxic assets, but even small banks didn't want to accept the low prices they were being offered for the assets.

Small banks are particularly hard hit by the toxic assets because if just one or two large commercial loans go bad their portfolios' bad assets could swell quickly to 20 or 25 percent of their outstanding loans. In better times, the small bank might have been able to sell the undeveloped land or other real estate seized after a loan went bad, but in the current market, seized real estate just weighs down the banks assets, tying up money that might otherwise be used for new mortgages.

Since banks aren't jumping on board, the FDIC decided to use some of the PPIP funds to sell assets of banks that already have been seized under a program called the Legacy Loan Program. But until the FDIC figures out how to entice small banks into cleansing their balance sheets, we'll most likely see even more small banks fail under the weight of their bad loans.

Lita Epstein has written more than 25 books including Reading Financial Reports for Dummies and Trading for Dummies.
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