Today’s Daily Angle comes from John Jagerson and his staff at LearningMarkets.com. You can read more on the Learning Markets Website.

The Treasury has released more details for its plan to relieve the banking system of the toxic assets clogging balance sheetsacross the financial sector. The plan is specific enough for traders to understand what the proposed process looks like and to begin understanding some of the risks. This is an important development and the success or failure of launching this plan could determine the likely direction for the financial markets over the intermediate term.

The plan essentially details an auction process for the toxic or “legacy” loans banks have frozen on their balance sheets. Integrated within the auction process are key financing components. The overall objectives of the auction and financing provisions are to attract private investors that will partner with the government in buying the assets so the public can share the risk and determine fair pricing for the assets themselves.

Fund managers like Bill Gross at PIMCO and Lawrence Fink at Blackrock have already expressed interest in participating in the plan. That is not a surprise considering that the bulk of the risk and financing responsibilities will still rest with the public’s side of the partnership. The real questions are not whether private funds are interested in the opportunity but whether the plan can be executed; whether market prices can be determined; and if the banks will accept the auction prices.

The Treasury’s website includes an example of how they foresee the auction and financing process to work. In the video, we will detail each component of that process. There are two key components within the process that could easily shift the plan’s direction from success to failure.

1. The assets that will be auctioned are selected by the banks.

Ultimately the auction prices will have to be acceptable to the banks. If prices are too low and the banks refuse to sell, the process could stall. Banks may refuse prices that are too low and would make them insolvent. This could help identify the so-called zombie banks and could lead to a selling frenzy in the market and collapse for many banks in the industry.

2. The majority of the financing for the high bidders in these auctions are subsidized and in some cases provided outright by the FDIC, Federal Reserve and Treasury

Some of the funds from will come from existing allocations, such as TARP, but the public side of the partnership has the ability to draw down almost unlimited funds if needed.

The financing provided by the public is highly leveraged and is therefore very risky. Because the financing is heavily subsidized it is very likely that the asset’s prices will be inflated and difficult to determine despite an auction process. Excessive leverage and mispriced assets was one of the primary causes behind the banking crisis in the first place. This makes the process very fragile.

Individual investors should make sure they are following the events of the next several weeks and months. There are positive signs but this plan represents a razor’s edge. On one side, successful execution could create a higher probability for economic recovery. However on the other side, if the plan’s problems and risks become systemic the entire banking system could slump back into the depths of the banking crisis.

As if this were not complicated enough, traders should remain alert for signs of inflation. The plan itself may push more than a trillion dollars into the banking system and the issuance of new FDIC insured debt could hurt the value of existing Treasury debt. This is what China and Japan have been worried about as they have urged the U.S. to honor their obligations.

The bottom line for individual investors is that there is a great deal of uncertainty and risk around the Treasury’s plan. That uncertainty will definitely translate into volatility in the capital markets. Stocks, the dollar, and bonds will all be very sensitive to changes in the plan and the progress (or lack thereof) of the auction process.