The U.S. Treasury Department released details Monday on its plan to help remove troubled assets from bank balance sheets in an effort to revive credit markets.

Despite extraordinary efforts to revive the US economy, “the financial system is still working against economic recovery,” Treasury says.

One major reason for this, it said, is the problem of troubled “legacy assets” on bank balance sheets, both loans and securities. “These assets create uncertainty around the balance sheets of these financial institutions, compromising their ability to raise capital and their willingness to increase lending,” it notes.

Various other market watchers, such as the IMF and the Institute of International Finance Inc., have also singled out the problem of toxic bank assets as the primary problem facing the financial system, and ultimately, the economy. The original Treasury bailout was supposed to target these asssets, but it went to recapitalize banks instead.

Now, the Treasury, along with the Federal Deposit Insurance Corporation and the Federal Reserve, has revealed the details of its latest plan to cleanse bank balance sheets, involving public money, but also inviting private investors to team up to buy these assets from banks. It imagines using US$75 to US$100 billion in TARP capital and capital from private investors to generate US$500 billion to buy legacy assets, with the potential to expand to US$1 trillion over time.

The hope is that the involvement of private investors will help establish fair prices for the assets, while the possibility of investing with FDIC-guaranteed leverage will enable investors to realize attractive returns on these assets. Critics of the approach still worry about the pricing mechanism, and whether banks will be induced to sell assets at a price that asset managers believe will give them a decent return.

“This approach is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly,” the Treasury asserts. “Simply hoping for banks to work legacy assets off over time risks prolonging a financial crisis, as in the case of the Japanese experience. But if the government acts alone in directly purchasing legacy assets, taxpayers will take on all the risk of such purchases — along with the additional risk that taxpayers will overpay if government employees are setting the price for those assets.”

Treasury is asking asset managers interested in participating in the program to submit an application by April 10, and it will be approving firms to participate by May 1.

In a research note Merrill Lynch analysts say that investor participation will be the key to the plan’s success.

“The structure of the plan is one designed to encourage private participation. However, this is the key area of uncertainty,” it notes, pointing out that other efforts to relieve the credit crunch, such as the Term Asset-Backed Securities Loan Facility (TALF), have only received limited interest from the private sector. “It is private interest that will determine whether this plan is ultimately successful,” Merrill observes.

IE