Return to Aggbank

When someone proposes a strategy for dealing with the economic crisis, he undertakes a hard issue. There are many conflicting priorities:

• Don’t harm the taxpayer much.
• Arrest the decline in asset values.
• Protect the solvent banks.
• Increase the flow of credit to the rest of the economy.
• Prevent the contagion in credit uncertainty from spreading.
• Facilitate price discovery on illiquid assets.
• And more, depending upon the most recent disaster.

The recent talk in Washington is over guarantees, Bad Banks, and more. I’m a skeptic on all of these, because you can’t get something for nothing. Now, it is not as if I haven’t made my own series of proposals:

• Aggbank
• Against Bank Nationalization
• What I Would Do
• A New Goal For TARP Money: Create Mutual Banks
• And more, if you are willing to dig further back into my archives.

But others have proposals as well:

• Bank Rescue Would Entail Triage for Troubled Assets
• An open letter to Tim Geithner
• Bad Bank/Worse Bank
• How to Value Toxic Bank Assets
• Bad Bank? Bad Idea
• Bank Rescue Would Entail Triage for Troubled Assets
• Beyond the age of leverage: new banks must arise

I’m going to modify my Aggbank piece, because it represents my best thoughts on what could be done to minimize the uncertainty to all parties involved, leading to a simpler, more transparent bailout.

Aggbank should solicit offers of assets, with prices. It should then publish that it will buy so much of assets that have been offered, so if anyone is willing to sell it cheaper, submit their offers.

The winning offers hand over the assets and receive cash in return. They also issue equity to Aggbank the difference between par and the price paid, in exchange for an equivalent equity stake in Aggbank. The Aggbank equity stake is reducible/increasible if the eventual value of the asset sold proves less or more than the price it was sold for. [Changes in Bold]

The main idea here is that the auctions should produce reasonably fair results, leading to price discovery. (Banks learn what their assets are worth.) The secondary idea is that any subsidy to banks should be limited. If an asset purchase price is high, they lend more money to the government, and give less stock, in exchange shares in Aggbank. Vice-versa if the purchase price is low.

Now, Aggbank shares are a high quality asset, given that it is a “full faith and credit” institution of the US Government. Capital charges on it would be low, as they are for FHLB common stock. The difference here is that the amount of Aggbank stock eventually received depends on the value of the assets purchased, when they are sold. Positive variances add to the number of shares, and negative variance decrease the number of shares, pro-rata.

The beauty of this idea is that the government does not have to be worried about whether the auctions are working perfectly right or not. The second step after the auctions trues things up, as Aggbank stakes are increased or reduced. Third, this allows banks taking losses to issue equity to the government, which will help them recover.

A proposal like this would give the banks time to heal, and would limit losses to the taxpayers. The eventual payout form the liquidation of Aggbank would approximately give each bank back its pro-rata portion of value contributed. It would give banks time, while facilitating price discovery in obscure structured lending markets.

Comments

[Mike in the...:]

David, why do you suppose a simpler, more equitable program has not been proposed by the new administration? This looks like more of the same from the govt/treasury. Are they blinded by their election mandate to the point where they assume anything they try will work? Or are they simply too close to the bank execs, whose jobs would likely be lost in the event of a total recapitalization? These people are smart enough, but I contend they cannot see the forest for the trees.

Feb 06 10:14 AM

[morph366:]

The awkward question for Tim Geithner next week in regard to a public underwriting of losses on toxic assets, a so-called insurance policy, is:
How much exposure does the taxpayer actually have in a worst case scenario?

He won’t answer that head on – politicians never do – but it could be because he either (a) doesn’t know or (b) the number would blow the bloody doors off.

Feb 06 10:19 AM

[Harry Tuttle:]

The problem is that at market prices several banks (including very large ones) have negative equity.

Feb 06 10:23 AM

[Unknown Inv...:]

Your suggestions doesn't incorporate a stick (Federal penalty/tax) to mandate that banks loan against these new auction sales. The final auction value will reflect a profitable rental only if an investor with 20-25% can get financing to complete the transaction.

With a 12 month supply of homes available in the US, the origination of notes to these new values is no small thing.

Feb 06 10:35 AM

[3 degrees o...:]

There is a REAL asset bubble, particularly in housing. This assset bubble must correct before asset prices can stabilize. Watever the banks mark these assets to has to properly reflect this correction. I'm afraid that will leave many banks insolvent and we should let them fail. If the taxpayers have to fund a rescue, lets fund good banks not bad banks. Let the bad banks investors take the hit, not the taxpayer.

Feb 06 10:50 AM