In October, as the true extent of the financial crisis was being realized everywhere, former Federal Reserve Chair Alan Greenspan admitted that the crisis was “broader than anything I could have imagined.” And the Greenspan confession tour is evidently not over.

In a forthcoming CNBC documentary, Greenspan reportedly admits that he was “mystified” by the subprime mortgage market. As DealBook reported:

Alan Greenspan, the former chairman of the Federal Reserve, told CNBC in a documentary to be shown Thursday night that he did not fully understand the scope of the subprime mortgage market until well into 2005 and could not make sense of the complex derivative products created out of mortgages.

“So everybody in retrospect now knows that that boom was developing under the markets for quite a period of time, but nobody knew it,” Mr. Greenspan told CNBC’s David Faber. “In 2004, there was just no credible information on that. It wasn’t until we got well into 2005 that the first inklings that that was developing was emerging.“

In 2001, subprime mortgages accounted for 5 percent of mortgage originations, totaling $173.3 billion dollars. By 2005, that had grown to 20 percent, totaling $600 billion.

The impending American Recovery and Reinvestment Act is President Obama’s first step towards closing the current gap between what America is producing and what it could be producing. Without his recovery plan, CBO estimates that the United States’ GDP gap will yawn to $2.7 trillion from 2009 to 2011. That’s more than $8,800 in potential GDP for every man woman and child in America.

The ‘GDP gap‘ represents workers who want to work but can’t find a job, businesses who are reluctant to hire new employees, land being put to sub-optimal use, and banks and credit institutions who accumulate money instead of lending it out. It’s wages gone unearned, profits unmade and revenues uncollected.

The CBO projects that the above shortfall “would be the largest — in terms of both length and depth — since the Depression of the 1930s.” Read more

Testifying before the Senate Budget Committee yesterday, Treasury Secretary Timothy Geithner laid out the five facets of his revamped financial rescue plan. One of the less expected decisions by Geithner is the creation of a Public-Private Investment Fund that’s meant to deal with the toxic, mortgage-backed assets still clogging the books of financial institutions. As Geithner explained:

By providing the financing that the private markets cannot now provide, this will help start a market for the real estate-related assets that are at the center of this crisis. Our objective is to use private capital and private asset managers to help provide a market mechanism for valuing the assets. We are exploring a range of different structures for this program, and will seek input from this Committee as we design it.

The overarching goal of the plan is to figure out what the toxic assets are worth and get them out of the banks, by enticing private investors to buy them, with the government providing some kind of insurance against losses. Though it sounds like an odd approach, and is not as straightforward as nationalization or Geithner’s original “bad bank” plan, it just might work.

The way this could be successful is if the various entities Geithner is hoping will purchase the assets — private-equity firms and hedge funds and other distressed investors — wind up bidding against each other.

According to the Wall Street Journal, large private-equity funds such as Carlyle Group and Blackstone Group “are interested in buying the kinds of assets targeted by the new Treasury Department program.” If they end up in a bidding war, eventually one side will balk at going any higher (stopping when they no longer think they could eventually turn a profit), and the true price of the assets will be revealed.

At MarketWatch, Brian Olasov, managing director at McKenna Long & Aldridge LLP, argued that “the participating hedge funds and other new owners will do the due diligence to figure out the true value of the illiquid assets“:

It does provide price discovery, it moves the management of the assets into professional hands and by removing toxic assets and placing them into the hands of others, you now have a clean bank people will want to invest with.

There is risk to the taxpayer involved in the plan, and as Geithner solidifies more details he’ll need to work to minimize that risk. Also, there is a chance that this program will actually finish off some of the banks now teetering on the edge, if the price discovery reveals that the assets are worth far less than the level at which banks are currently estimating.

Of course, the real efficacy of the program will be decided by the details, but if Geithner can walk the fine line between enticing Wall St. into purchasing the assets and protecting the taxpayer from further losses, he just might find a way to clear the banking system of the ugly mess its in.