The toxic assets plan Tim Geithner previewed a month ago finally got fleshed out and rolled out today. Wall Street responded with a more than 400 point rally signaling that investors now feel the Obama administration is on the right track when it comes to healing the wounded banking industry.

Public Private Investment Program - Buying Toxic Assets

The idea here is to shore up the balance sheets of banks by removing the biggest negative through selling these “bad” or toxic assets to private investment firms using public funds. The hope is once these toxic assets are gone, banks will start lending again.

The Treasury will support their end of the deal with about $100 billion in capital and loans so these private partnerships can buy about $500 billion of bad bank assets. The reaction to the removal of these bad assets made up primarily of bad mortgages will spur investment back in bank stocks, as well as, instill confidence so borrowers can feel good about borrowing again.

Treasury Secretary Geithner parrots these conclusions by saying,

“Over time, by providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets,” Geithner wrote in an op-ed in the Wall Street Journal.”

Will This Work?

The short answer is “Nobody knows”. We have been burned before if we remember a few months back when we were told if we just injected billions into the banking sector we would solve the problem. Now we see that $700 Billion bank bailout did NOT work as we were told, so we are rightly skeptical of this new program.

Paul Krugman on said this:

“If you think that the banks really, really have made lousy investments, this won’t work at all; it will simply be a waste of taxpayer money,” New York Times columnist Paul Krugman wrote Saturday on his blog.

My feeling is if these toxic mortgages are as a whole completely worthless, Krugman is right. But we must remember even on the subprime mortgage pools, over 80% of those borrowers are paying as designed. That bodes well for the program since we know these subprime mortgage pools are clearly not “worthless”.

Buying Time - Toxic Assets

These private partnership are only using about $1 for every $6 of taxpayer money. So the risk to them is negligible. If 80% of the subprime borrowers are paying as agreed, this program is more about buying time than buying toxic assets.

These investors know they have little risk, so they must look to the reward to make their decisions. The reward is a huge upside as these “on time” paying borrowers will increase as the real estate market recovers. Time is on the side of this program. The better the housing market, the more borrowers who will stay paying rather than walk away.

This could spell a huge profit for these private partnerships as housing recovers and less and less borrowers slip into foreclosure.

Today we heard existing home sales rose 5.1% in February, showing at least a glimmer of hope for a housing market recovery sooner rather than later. This will encourage home owners on the edge to hang on as well.

So if these trends continue and the unemployment picture doesn’t explode, these private partnerships could prove a wise investment. Of course, that’s a big “if”.

Will it work…only time will tell. But the market just closed up now 500 points, so at least Wall Street believes it will.

Good Luck!

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