WASHINGTON DC – Noting that the U.S. financial system “is still working against economic recovery,” the Treasury Department Monday revealed details of its plan to address toxic assets weighing on banks’ balance sheets.

Treasury said one major reason the financial system is still facing challenges is because of “legacy assets” and securities that are compromising banks’ ability to raise capital and their willingness to boost lending. Under the new program — the Public-Private Investment Program — the Treasury Department, Federal Reserve and Federal Deposit Insurance Corp. plan to work with private investors to try to restart a market for these troubled assets, The Wall Street Journal reported.

The federal government will use as much as $100 billion in funds from the Troubled Asset Relief Program and capital from private investors in order to generate $500 billion in purchasing power to buy legacy assets, Treasury said in documents Monday. The department noted that the program could potentially expand to $1 trillion over time.

The program would address both the legacy loans banks are holding on their balance sheets and the legacy securities backed by mortgage-related debt that is clogging the balance sheets of financial firms. In an interview with The Wall Street Journal Sunday, Treasury Secretary Timothy Geithner said the only way to remove troubled assets from banks’ balance sheets is to work with the private sector, even at a time when Wall Street moneymakers are being vilified by the public and politicians.

“Our judgment is that the best way to get through this is if we can work with the markets,” he said. “We don’t want the government to assume all the risk. We want the private sector to work with us.”

Under the legacy-loan program, investment funds will be created to purchase pools of assets. Treasury will provide 50 percent of the equity capital for each fund while private managers retain control of asset management subject to FDIC oversight. Treasury said it will approve as many as five asset managers “with a demonstrated track record of purchasing legacy assets,” but it might consider adding more managers depending on the quality of applications received. To be pre-qualifed as a fund manager, the manager must submit an application to Treasury by April 10.

Banks will identify the assets they wish to sell. The FDIC will conduct an analysis to determine the amount of funding it is willing to guarantee. Leverage won’t exceed a 6-to-1 debt-to-equity ratio, said the Treasury Department. Meanwhile, the highest bidder will have access to the Public-Private Investment Program to fund 50 percent of the equity requirement of their purchase.

Eligible assets will be determined by banks, regulators, the FDIC and the Treasury Department.

“A broad array of investors are expected to participate in the Legacy Loans Program,” Treasury said in a fact sheet. “The participation of individual investors, pension plans, insurance companies and other long-term investors is particularly encouraged.”

Under the legacy-securities program, non-recourse loans will be made available to investors to fund purchases of legacy securitization assets. Eligible assets are expected to include certain non-agency residential mortgage-backed securities that were originally rated triple-A and outstanding commercial mortgage-backed securities and asset-backed securities that are rated triple-A.

Taxpayers stand to reap gains — alongside investors such as hedge funds and private-equity firms — if the investments ultimately prove profitable.

To encourage investor participation, the Treasury believes participants in the program shouldn’t be subject to executive-pay rules imposed by Congress. The law authorizing the $700 billion bailout and a provision in the $787 billion stimulus package impose tough pay restrictions on firms that receive government funds, including limits on bonuses.

The Obama administration believes those provisions shouldn’t apply to such broad programs, and an exception was made last month for participants in the Federal Reserve’s consumer-lending facility, which provides loans to investors who agree to buy certain asset-backed securities.

Administration officials are hoping the public will draw a distinction between financial firms that receive a government rescue, such as AIG, and those such as hedge funds and private-equity firms that participate as investors in broad government programs.

The Treasury plans to contribute between $75 billion and $100 billion from its $700 billion bailout to the programs to remove troubled real-estate-related assets from bank balance sheets, with the possibility of additional money in the future. The Fed and the Federal Deposit Insurance Corp. will provide other forms of financing, including low-risk loans.

Targeting mortgages that banks no longer want to hold, the Treasury and the FDIC will provide financing to buyers. The FDIC will auction off pools of loans that a bank wants to sell and will become a co-owner by forming a partnership with the highest bidder.

The partnership will then raise FDIC-guaranteed debt to finance a portion of the purchase price, with the Treasury willing to kick in between 50 percent and 80 percent of the equity needed to buy the assets. The Treasury will be an equal investor in the partnerships.

To tackle risky securities, such as those backed by mortgages, the Treasury will create several investment funds run by private investors who meet certain criteria, such as experience managing similar assets. Treasury again will act as a co-investor, in most cases contributing $1 for every $1 contributed by the private sector and sharing equally in any gains or losses.

Lastly, the government will expand the Fed’s Term Asset-Backed Securities Loan Facility, or TALF, to help absorb risky assets dating back several years.

In an op-ed piece in Monday’s Wall Street Journal, Geithner wrote that the efforts will help tackle the glut of assets clogging bank balance sheets and will help provide some kind of normal price for these assets, which the Treasury believes are currently undervalued.

a>>