As this neat little flow chart from the US Treasury illustrates, the new arrangement isn't about new money; it is about taking some old TARP money and leveraging it up.
(click on the graphic for a sharper image).Geithner wants to take $75 to $100 billion in current TARP scheme, and add further capital from the FDIC and the Federal Reserve. In total, he thinks he can raise $500 billion. Then the scheme turns to the private sector, where Geithner hopes to raise an additional $500 million. One dollar of public money for one dollar of private money.
With a trillion dollars in their pockets, the managers of this scheme will go out and buy those toxic assets that have killed the US banking system. The participation of the private sector is supposed to align incentives. Investors won't want to buy overpriced assets and therefore this limits the potential hit to the taxpayer.
This scheme has a couple of advantages. First, Geithner doesn't have to go back to Congress, since he is using funds authorized under older schemes. Second, by co-opting the Fed, the FDIC and the private sector, he turns a modest amount of public money into a big toxic assets buy-out. Third, the price issue is resolved with private sector managers, who will do their best to turn a profit from this scheme.
The most immediate question is about the price of those toxic assets? If it is too low, banks will have to absorb large losses on their balance sheets. If the price is too high, and the scheme can not recover its initial investment, then the taxpayer, along with the scheme's new investors, will have to suck on a straw and slurp up a loss.
Ultimately, the price of these assets will determine the distributional question. Due to the housing crash, the banks have accumulated a massive loss, and it needs to be distributed somehow. Who will pay? Taxpayers? New investors? Bank shareholders? Only time will tell how this latest scheme resolves this question.
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