The market liked the idea that Gaithner HAD a plan.It will sink in that the plan has great difficulties before it can work& there will be 2nd thoughts

The market reacted favorably but second thoughts will inevitably appear. The toxic assets plan has to steer between Scylla and Charybdis of the higher prices needed by the present owners and the lower prices needed by the public-private partnership; it also needs to convince private institutional partners that the government can be trusted not to abrogate agreements after the fact, as they explicitly did last week ( albeit in a way that I would think, and hope, will be found unConstitutional ).) There is also the choice of the five managers ( and Maxine Waters laid siege to Goldman Sachs being one of them) with Blackstone and PIMCO being the only ones so far identified.

Reasonable people might question the premises of the testimony of both Bernanke and Geithner that AIG HAD to be bailed out because of the threat it posed to systemic risk and that it still poses such a threat ( and, therefore, will continue to require being bailed out.) If  the systemic risk exists on a global scale ( thereby presumably justifying taking money from American taxpayers to pay off the counterparties to AIG, among whom are Deustchebank, Societe Generale and Barclaysbank ), I would still have AIG go into bankruptcy and use US taxpayer funds to bail out the international  system...if necessary. It's often a matter of convenience, and what is habituation for bureaucrats, to maintain the status quo rather than consider the system being turned upside down ( and perhaps being improved.)

 

When the market realizes the problems ( they have to pick managers, they have to bid on the toxic assets, the bids have to be high enough to entice the present owners and yet low enough to produce a good chance of profit -- clearly a potentially conflicted and possibly impossible constraint-- and the private sector has to trust the government enough to get into bed with it -- which, after the vote to tax away the bonuses and violate contracts might not be a trivial trust to rebuild), it might reconsider the 500 point uptick of Monday.

The plan for toxic assets is fraught with uncertainty. There will be five managers appointed who will have their own (tiny) equity added to more equity from the public and  both supplemented by debt guaranteed by the government ( FDIC ) at an interest rate not yet determined and with NO RECOURSE if the equity portion goes sour ( i.e. if the underlying toxic asset is worth less than initially determined by the bidding managers. ).The taxpayers will therefore lend the equity holders about 5 or 6:1.  

One public version of the legislation has the seller of the toxic securities actually doing the lending with the government providing the guarantee but how this will help the capital position of the seller banks is totally unclear.

The five managers will bid for various kinds of toxic assets at some number of cents on the dollar. The problem for this being the wonderful "solution" that it appears to be on Monday will subsequently be realized to depend on what the managers bid for the assets. The assets are presently held by banks and other fiduciaries. The bid price has to fit into a narrow window that may not even be an open window.

It has to be high enough to encourage the banks to sell ( they might prefer to hold onto the assets to see if they will rise more than they will be offered; they also might not want to recognize the loss -- i.e. they KNOW they have a loss compared to the current illiquid market price but they need regulatory capital to stay in business and can't make loans if that is too low.) The bids have to be high enough to satisfy the present owners but low enough to make a profit for the buyers when the assets are ultimately sold or held to maturity ( with significant deterioration due to defaults ). We don't know who the managers will be ( although PIMCO and Blackstone are likely two among the five ), and they haven't had the auction yet. After the auction, the seller banks have some time to decide to accept the offer or decline and keep the assets themselves. 

Leverage ( the incentive provided by the FDIC ) only works if the deal makes sense in a simple way. There is the chance of a Groucho-Marx-type impass ( If the price is low enough for the buyers to want it, perhaps the sellers should keep it. If the price is high enough for the sellers to accept it, perhaps the buyers are paying more than they can make a profit from. )