Obama's 'Bad Bank' Plan Is a Turning Point 22 comments
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There has been an important development. Let us try to state it as simply as possible.
There is a fundamental question about assets held by financial institutions. Some observers have concluded that these assets are worthless--overvalued on existing balance sheets.
Most of these pundits have no mode of analysis -- - they have only their own opinions. The pundits do share something else. They are all critics of modeling, and none of them have any experience in developing or testing models.
A New Era
Last night's reports suggest that the Obama Administration will propose a "bad bank" plan. Under this proposal the government would buy troubled assets from financial institutions. What would this accomplish?
- The most important impact would be an end to the death spiral, where every asset sale caused a decline in the holdings of other financial institutions. This could have been accomplished better and faster by a suspension of mark-to-market accounting. It could also have been accomplished by a price discovery mechanism for troubled assets. The proposal is inferior, but it reflects what might be politically palatable.
- It enables normal lending activity by financial institutions. They no longer must worry about artificial reductions in regulatory capital. It means "back to business."
What Price Will be Paid
We expect today's pundits to pounce on the prices paid and the methodology selected. The rumor is that the Administration will use a modeling technique to determine what assets might be worth. This technique would look at factors like how many of the underlying loans are performing, and what interest rate cost is required to carry the asset.
We expect the many loud pundits who have never created a model and know absolutely nothing about modeling to insist that this is the wrong approach. Who is right will be determined in a few years, as the assets pay out. Meanwhile, the thundering pundits will be shouting from the sidelines. This gives the intelligent investor some time to react.
This is big news. If implemented, it will get at the heart of the housing and lending issues -- both crucial to economic improvement.
While it might not be our favorite method of addressing this problem, it is a plan that can work.
We expect a significant rally in financial stocks. That is just the first salvo. As market participants realize the effect on lending, the market impact will be broader.
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2. The Seller will be the shareholders and the unsecued bondholders of the failing/failed institution.
3.The shareholders, are probably already wiped , or should be if the 'bad asset price' is anywhere near fmv,market value, independent valuation fron independent modeling.The bondholder will be large haircut.
4.The real beneficiary that Obama team, Paulson team and Bernanke are concerned about protecting are the 'unsecured bondholders' who were wiped at Lehman. This group is forign debt investors from Asia,Middke East, China, Japan and Europe. and money market fund industry.This group will be represented by Bank Management.
The buy side, American taxpayer will be represented by what fiduciary looking out for its interest? Bernanke, ha ha? Geitner or Sheila Bair? How about Pimco/Gross or Buffett. I think the taxpayer would be well served by hiring them.
5.If the taxpayer is represented by competent investment counsel, whose interest is in making good, sound prudent decision in fiduciary capacity for owner/principal/taxpay... the prices will be so low that Seller shareholders and unsecured bondholders big haircut.
6.Therefore, by definition, the process will be a farce, a political cover, to simply shift losses from Seller to Buyer.
7.If this is the goal, then state it bold and clear. Tell the public why it is so important to protect the unsecured bondholders. Go make the case to the people. It very well be in the country's best interest to do this, but make the case clear and part of the public discorse and record.
8.If not, then leave assets where hey are, we already have 'bad bank'structure, its C and BAC and others. Create new bank shell, have failed banks transfer their good assets and people and franchise, for a premium to a new shell, raise new capital that starts fresh and has no 'baggage'. This new bank will make loans which is what the economists/politicos say the solution is.
The only difference from creating a new 'good bank' and a new 'bad bank' is what the old shareholders and old unsecured creditors get.
However, let us not have any illusions about who gets screwed in this deal: the taxpayer and the saver.
The 'bad bank' will overpay for these assets, not just on a mark-to-market basis but by the actual return on these assets. Future generations of taxpayers will ultimately bear this cost.
The money that is created out of thin air to pay for these toxic assets, along with the dollars sitting on bank balance sheets, will very quickly produce consumer price inflation and those who think their savings are safe in a nice, low-interest bond, CD or savings account will watch their purchasing power evaporate.
As usual, this latest proposal for a bad bank minimizes accountability. So the connected can have all sorts of favors. A bad bank is what the U.K. has isn't it? How has that helped them? Plus, if Sarbanes-Oxley is the problem, the solution to Congress never includes admitting it's wrong, as usual.
On Jan 28 08:18 AM countrybanker wrote:
> 1.The buyer will be the taxpayer, the financing for the buyer will
> be the taxpayer, and the risk taker will be the taxpayer.
>
> 2. The Seller will be the shareholders and the unsecued bondholders
> of the failing/failed institution.
>
> 3.The shareholders, are probably already wiped , or should be if
> the 'bad asset price' is anywhere near fmv,market value, independent
> valuation fron independent modeling.The bondholder will be large
> haircut.
>
> 4.The real beneficiary that Obama team, Paulson team and Bernanke
> are concerned about protecting are the 'unsecured bondholders' who
> were wiped at Lehman. This group is forign debt investors from Asia,Middke
> East, China, Japan and Europe. and money market fund industry.This
> group will be represented by Bank Management.
>
> The buy side, American taxpayer will be represented by what fiduciary
> looking out for its interest? Bernanke, ha ha? Geitner or Sheila
> Bair? How about Pimco/Gross or Buffett. I think the taxpayer would
> be well served by hiring them.
>
> 5.If the taxpayer is represented by competent investment counsel,
> whose interest is in making good, sound prudent decision in fiduciary
> capacity for owner/principal/taxpay... the prices will be so low
> that Seller shareholders and unsecured bondholders big haircut.
>
>
> 6.Therefore, by definition, the process will be a farce, a political
> cover, to simply shift losses from Seller to Buyer.
>
> 7.If this is the goal, then state it bold and clear. Tell the public
> why it is so important to protect the unsecured bondholders. Go make
> the case to the people. It very well be in the country's best interest
> to do this, but make the case clear and part of the public discorse
> and record.
>
> 8.If not, then leave assets where hey are, we already have 'bad bank'structure,
> its C and BAC and others. Create new bank shell, have failed banks
> transfer their good assets and people and franchise, for a premium
> to a new shell, raise new capital that starts fresh and has no 'baggage'.
> This new bank will make loans which is what the economists/politicos
> say the solution is.
>
> The only difference from creating a new 'good bank' and a new 'bad
> bank' is what the old shareholders and old unsecured creditors get.
What will be interesting is what sorts of unintended feedback mechanisms creep into this, both positive and negative. The very act that the government is buying assets at some premium changes the market (as we are seeing on Wall Street at the moment). There will be unintended consequences some good and some bad.
This is indeed a game changer.
There are good and responsible banks already operating, and they should reap the rewards of prudence.
I am a modeler, a former banker, and a real estate developer. Modeling is not the issue. Everyone forgot that the fundamentals of the underlying asset are what matters, not the models, risk speads, average default rates, seniority tranche, etc. In the big runnup, deals were done by expert modelers, with no understanding of the underlying asset.
We already have a bad bank. It is called the FDIC. In the 80s, we had a bad bank called the FSLIC. It went bust, so we made the RTC. If the FDIC goes bust, we can make the FDIC Bad Bank. Fundamentally, failed decisons need to result in failure of the institution, not a bailout of the institution though an attempt at removing bad assets via a model created by another expert modeler with no understanding of the underlying asset.
When the FDIC takes over, you wipe out the stockholders, the bondhoders, the preferred, the TARP investment, Warren Buffett (who apparently has lost his touch), the Saudis, Singapore, and everyone else. At the end of the day, the taxpayer still pays, so lets wipe the slate clean, let people who understand underlying assets make the bids, and move on. Otherwise, we will end up like Japan, unable to get out of our own way for the next ten years.
> The fallacy in the sour comments about a "bad bank" is that all the
> "bad" assets are worthless, or nearly so. The problem is not that
> these assets are worthless, but that in frozen market conditions
> their value is impossible to determine. A contingency sale, as some
> have proposed, would not solve the balance sheet problem since it
> would be no easier to value than the assets now. A sale based on
> a reasonable and agreed-upon model, however, would both provide the
> banks with a clearer balance sheet, and give taxpayers a reasonable
> chance of getting their money back.
If you follow this line of reasoning, then the markets can't be trusted to allocate capital effectively, so we need to turn the entire financial system over to government bureaucrats.
I think we used to all agree that the market itself was the agreed-upon method for valuing assets. Frozen markets = worthless assets.
Bad banks = bad idea.
Dead banks = one potential outcome of capitalism.
Anyone know that 20% of the Federal Reserve family owners had money with Madoff? Or that the 5th largest shareholder in the Fed Resewrve is GOLDMAN SACHS?
Jim Cramer made the off-the-cuff comment the other night that he SAW THE CHECKS GOING TO EUROPEAN BANKS FROM AIG! (As secret payoff for CDSs, as AIG is just a "bad bank" being used to secretly payoff foreign holders!)
SO MUCH FOR TRANSPARENCY, folks!
I assume these assets have some kind of descriptive wrapper. In other words, they are not something akin to Monopoly money with a value printed on it. What information is included on the descriptive wrapper? For example, with a mortgage based derivative product, how much information is there with respect to linking the summary value of the batched group of assets to the underlying mortgages? A major part of the modelling task would be to discover what information is useful with respect to predicting value or risk.
So is it spin or is it doable? If it is doable, would the predictive accuracy be better than chance? I think BEFORE the government uses tax payer money to purchase these assets, they need to be more transparent to the tax payers with respect to their proposed asset valuation modelling approach and its predictive accuracy. Right now it seems they are just throwing out a catch phrase when in fact, they have no objective way to value the assets.
The banks DO NOT WANT price discovery. They know all these factors are stacked against them. They shouldn't have made or securitized these loans! They want to off-load them in the dark of night and nothing Obama has said yet convinces me he isn't bought and paid for as a puppet-enabler.
He said we needed 7,000 more troops in Afganistan, now its 30,000! He even has Martin Feldman guru saying DEFENSE SPENDING is the best bang for the buck!
And the American sheeple continue their pathetic apathy to these comments.
On Jan 28 11:30 AM Larrysyr wrote:
> On Jan 28 11:01 AM keithofrpi wrote:
> Just because a future value is unknowable doesn't mean that it's
> worthless. Consider the transactions on eBay. Do you own "frozen"
> morgage-backed securities? I would gladly buy them all for $1, even
> $100, and maybe more! Outside of such extremes, private parties want
> neither the risk of selling for too little, nor of buying for too
> much. But it is appropriate for the gov't to take on such risks,
> because its concerns go well beyond P&L.
I'm not claiming that the securities are worthless, but the "market" apparently is. The holders of the securities have no inherent right to a payout, other than from the securitized cash flow stream. If they can't sell, they have to hold and hope for the best.
I believe it is NOT appropriate for the government to relieve investors of the risks they willingly assumed. The government's appropriate role in markets is to assure honest disclosure and prosecute criminal behavior.
First, regarding the bad bank idea the devil - as we can see from just the comments made on this post - will be in the detail.
1. Valuation of the toxic stuff is not just an exercise in manipulating numbers, something which is difficult enough, it is also a highly political issue. Indeed, even defining what is to be encompassed will be an interesting exercise. Will the next wave of bad assets flowing out of the residential and commercial real estate markets be taken into account, or will the good banks be left with these - an early hit to their newly 'clean' balance sheets?
2. What are the international implications? Cross-border interbank flows could very well become tiered to distinguish between 'good' US banks and 'bad' European banks. More broadly, who would want Barclays or Deutsche Bank as a counterparty if they could instead have a freshly-minted BoA or Citi? Why would high net worth individuals leave money with UBS' wealth management people if deposits with a US bank become palpably more secure? This plan is, after all, a straightforward US taxpayer subsidy which many countries cannot afford to replicate because they don't print the world's reserve currency.
Second, the economy remains dire and whilst a properly-constituted bad bank plan should eventually ease the flow of credit, the Disney-esque turnaround so many people seem to be reaching for is in all likelihood still several quarters away. Maybe Friday will give us a feel for just how many quarters.
Third, if the market is so fundamentally cured, why is it still being manipulated? Looking at the timing of the after-hours GE and bad bank announcements yesterday, it sure seems as though somebody somewhere doesn't trust the market's 'foresight'.
Whilst it would be nice to think we've found our way onto the 'sunlit uplands', I personally will be more of a believer if and when we breach trendlines converging around the 920-930 level. Until then, 'buy the rumour, sell the news' could still be an adage worth bearing in mind. Back in the Dark Ages when TARP was originally unveiled last autumn, the Financial Times ran with the headline "The Market Roars Approval". Less than a week later the roar had turned to a whimper - long before we found out that the original purpose of TARP had been hijacked. This may indeed be a game-changer, but caution is still warranted.