Proposed Solution for Toxic Assets Plaguing Banks 39 comments
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There is correctly much controversy over what to do with the toxic assets plaguing the banks. The famed Jim Rogers was on Bloomberg TV Saturday and he correctly brought up the issue of pricing the toxic assets that plague the banks. If the government takes the bad assets off of the balance sheet, what should the government pay? If the government pays too much, then the bankers will be making out. If the government pays too little then the banks will not sell.
Here is a potential solution: What if the government buys bad assets from an ailing bank at exactly what that bank has them marked at? A bank may ask why should it do that if the assets eventually go up in value? That would be a correct and logical answer by a bank. But if the government offered a profit-sharing arrangement for the assets that are bought, then the banks may participate.
It would work something like this: The bank in trouble sells the toxic asset marked-to-market at the mark-to-market value. The bank receives cash and the government receives the asset. Over time, the government will dispose of the asset with the intention of selling it at a minimum price, which would be the price it paid. In many cases, the assets over time will increase in value. The government then may be able to sell the assets at a profit.
This is the reason the banks do not want to part with the bad asset - the bank believes that with time the asset will be worth more. But what if the government offers the bank a profit sharing arrangement with a 50% - 50% split of the potential future profits? In that case, a bank may be more inclined to sell the toxic asset at the low marked-to-market fair value. So when the government later on sells the bad asset at a profit, it will then split the gain with the bank. The bank gets rid of the bad asset and then profits from an upside to that bad asset. The government does not overpay for bad assets and potentially gets a profit.
This seems like a win for all involved. For the bank it provides two things. First it allows the bank to shed bad assets, and then it provides a way for the bank to profit from the upside, if the toxic asset increases in value. For the government, it helps the bank by removing the bad assets, helps to restore credit flowing to the system, and gets its money back when the bad assets are sold and even potentially gets a profit. For the tax payer, it would help restore some lending, and it would not be on the hook for overpaying for toxic assets.
Maybe I am missing something and have oversimplified this but sometimes the best solutions are right in front of us. Also this would cost the government money up-front. But the TARP is there, it can be used for a purpose like this.
One last caveat: If the assets are sold to the government and the asset then drops in value, then the bank that sold the asset to the government would have to share in the loss with the government.
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This article has 39 comments:
A large segment of the indebtedness was created by the securitization
segment of the financial industry. Who in their right mind would believe a rating agency stamp of approval on a new "reformed" securitization segment ?
Therefore it is only "inflation" that can re-create valuations.
The point being is that there is no way that "those who do not owe" are not going to pay, whether it be through taxation or inflation.
At the moment, it is not politically possble to just tell the public that this is the inevitability.
Perhaps instead of being upfront, the "emotive public placebo" will be something along the lines of a new label for nationalism such as "The US Bank of The Future Program".
Your argument echoes mine that the only way to solve the issue is through a profit sharing agreement.
The securitization is the problem. The mass bundling creates a moving target. The history of poor original valuations begs revision anyway. The geographical diversity of the mortgages makes it almost impossible to gain final value as different local markets will "hit bottom and rebound" at different times.
All of this is hidden risk. SO the M2M value is accurate.
Break them up and sell them to regional or local thrifts at locally appraised discounts where the lenders have the ability to actually do case-by- case analysis instead of relying on the current pricing models made worthless now. To get out of this mess what is needed are "boots on the ground", in financial terms.
Break the contracts. Evaluate. Sell. Ban.
If not, bank A could easily have a bundle of troubled assets on the books for 65% of par while Bank B could have a simialar portfolio of assets valued at 40% of par. Under your proposal, this would obviously favor bank A.
I think before such a program could be implemented it would be essential for bank examiners and regulators to "stress test" all banks interested in your proposal to ensure a level playing field, inter-bank fairness and fairness to the taxpayer.
I do not think the federal government, in acting on behalf of the taxpayer, should overpay for troubled assets to avoid additional writedowns and to save existing share and bondholders.
I'd like to add an amendment to your suggestion, and it is to get (for free, for the good deed of purchasing these toxic assets) long term (say 5-7ears in term) warrants or options on a bank's equity. Sure that would dilute the bank's capital, but it would be needed now. And if the bank does become profitable, the government or resolution trust could sell the warrants or options (or exercise them), thereby increasing the bank's capital.
I do. The "market value" these "securities" were sold at and traded was something like ten times the total value of mortgage assets on the planet combined. It is fraud. The fact that they "blew out" was inevitable. No government has enough money to buy them nor should they. The banks that bought them deserve to fail, and should be allowed to do so. Unravel the fraud and distribute the losses and gains as they are evident.
Stop interfering with the process of capitalism.
"Break the contracts, evaluate, sell, ban."
But why restrict community banks to the toxic assets?
If the community banks buy the poisoned-apples, why not let the community banks also cherry-pick some of the good assets held by the loser banks.
I have 2 ammendments to your suggestion.
1. For any toxic asset a governemnt resolution trust buys from a bank, the bank should sweeten the pot by giving a fractional number of warrants or options that won't expire for some time (say 5 years), and which the trust can sell. Sure it would dilute shareholder value, but the rescur from bad management decisions should cost shareholders something.
2. For the banks being driven to perdition by bad liabilities, the resolution trust ought to evaluate the case by case situation, and then either (a) buy a special class of preferred shares which will help recapitalize the bank, or (b) change the bank's current operating mode to rehabilitation, thereby making bank shares essentially worthless, then giving each shareholders warrants in the post-rehabilitation institution. Certainly the warrants equal to the number of shares (1:1 old shares for new warrants) held by the now zeroed out shares outstanding would have an option value that could be traded immediately. Once the rehabilitated "Humongo Jumbo Big Bank" got back on its feet, the warrants would act like a new issue in a healthy huge interstate money-center bank and the warrants would provide additional primary capital to the rehabilitated monster!
What do you think?
Once a few are removed, the force of 'fluidity' returns the stream to normal. Not all toxic assets need be removed, but the flow must be primed in order to return.
The burden is half as big as we all are perceive it to be. As the market place slowly returns, the values will begin to rise, eventually 'normalizing' the valuation process (this does not mean a return to original value, but a return to a working market value)
I do agree with partnering in not allowing the sharing of future gains, but also future losses.
Additionally, for those toxic assets purchased, probably by deep discounts, the delinquent loans backing the toxic assets should be paired off from the pool.
The delinquent loans supporting that portion of the toxic assets then can be recast at discounted amounts, with sleeping seconds comprised of the default amount. Any increase in equity can be split 50/50 with the homeowner and the payoff of any sleeping seconds.
Its not necessary for regional or local thrifts to buy the assets, they just need to be contracted to appraise them. That's the first step towards dealing with the toxic asset problem, valuation. Now, separate the mortgage assets into groups based on risk assessment. Now open up bidding for these assets in the open market. Use the free market system to help us clean up this mess. At least it’s a start, and its an improvement over just giving these #^%$*#@ banks free tax payers money.
Paceman1947 says these asset bundles were purchased at values well in excess of the component mortgage valuations. That does not surprise me because that is how the market works. People don't purchase these types of investments on the basis of the underlying book value, they purchase on the idea that the stocks price will increase. When market values started to sharply drop in the US, investors started to question the value of asset bundles, and started to sell them if they could find buyers.
If this reasoning is correct, then toxic assets have at least two components. One component is the reduction in book value (Market - Mortgage Principal). The other could be called a speculative component. If the assets can be evaluated mortgage by mortgage, then it seems we could determine the valuation on those two components. Now we can separate loses due to securities speculation from the other loses. That leads to some interesting questions with respect to bail out programs.
Sorry for the long drawn out message… It's my way of thinking out loud, and trying to understand the problem.
IF the Govt. wants to get serious about freeing up funds, it can and should buy loan participations in NEW loans. That is simpler and more direct (Though a lot of Wall St./financiers get left with the garbage they were peddling before "the music stopped.")
The bad assets are one thing. The instruments attached to these assets are crippling these companies. MBS, CDO and CDS also have to be unwound and purged. They're also tearing apart anybody else who invested in these "risk free" assets.
Credit is out there. Credit worthy borrowers are not. So the net visible effect is that credit has dried up. The era of free credit is over for the next 80 years. By then, we'll have forgotten this mess and create another.
Get rid of all the adjustable nonsense. Banks will be busy refinancing, homeowners will have more money to spend, and the toxic housing assets will soon disappear.
I like to see Washington support a MAINSTREAM plan.
On Feb 15 08:18 AM CautiousInvestor wrote:
> My first thought after reading your proposal is that it, more or
> less, presupposes that banks have taken equal steps and used the
> same stadards and criteria to mark down assets.
>
> If not, bank A could easily have a bundle of troubled assets on the
> books for 65% of par while Bank B could have a simialar portfolio
> of assets valued at 40% of par. Under your proposal, this would obviously
> favor bank A.
>
> I think before such a program could be implemented it would be essential
> for bank examiners and regulators to "stress test" all banks interested
> in your proposal to ensure a level playing field, inter-bank fairness
> and fairness to the taxpayer.
>
> I do not think the federal government, in acting on behalf of the
> taxpayer, should overpay for troubled assets to avoid additional
> writedowns and to save existing share and bondholders.
>
This just gives the bank incentive to inflate the book value of the asset.
If bank assets are correctly valued today then we don't need to do anything as they are solven,so why transfer the assets?
The problem with bank valuations is that banks have consistently overvalued assets by making optimistic assumptions. This plan bets the taxpayers dollars that banks have finally become realitics.
I don't think so.
This little movie is absolutely incredible. If you are interested in gold and money you MUST learn about where money comes from!
video.google.com/video...
It starts out black but hang on to your seats!
then AFTER you see it ask yourself this:
Why not let the US Government buy into the banks big time then share the profits with the people? Right now Uncle Sam is not only stimulating but capitalizing the banks and getting lots and lots of shares in return. This is happening right now. Today the bank's stock values are lower than they have ever been. Let Uncle Sam BUY LOW. Grab the banks that are insolvent then add them to the banks that the US owns a high percentage of. Over time the people (Government), could own the banks and share the interest and profits with us (put it back in the treasury), so our kids can be taken out of debt (at least Government debt anyway), and the people that work in banks could keep their jobs.
I like the kind of bank shares our government is buying right now. They are preferred shares that pay 5% dividend. I wouldn't buy the old ones but I'd love to buy into the ones our government is getting. Maybe they could set up a huge mutual fund that we could participate in. In the end the people would own our banks and those terrible bankers would not.
This is the ideal time to do this. This movie needs to be seen by everyone then you will all agree with me!
Think about it. Uncle Sam capitalizes the banks and takes their shares. With the money the banks buy treasury bills so Uncle Sam can pay for this stimulus. if Uncle Sam owned the banks, then the interest and bank profits would be shared with the people since the interst payments would go back into the treasury, eventually so will the principle. The more money the banks loan to Uncle Sam the more money there is right now. If the banks charge high interest rates later rather than sooner, our government will be out of debt. Ask yourself, why are we paying interest to bankers when we could be paying it to ourselves?
But belive it or not: Uncle Sam's borrowing is the answer to the credit crunch. As long as it's from Government owned banks that is.
The idea of fixing mortages to 2% is a good one expect the banks would never ever go for that. But if Uncle Sam owned the banks he could say "2% sounds fine to me".
You will only understand how this is posible if you have seen this movie.
video.google.com/video...
If the FDIC bought ALL problem mortgages over the next 3 years before they entered the foreclosure process at 90% of face value with a limit of, say, a $70,000 cost per mortgage, it could then do two things. One, if a new mortgage could be crafted to keep a homeowner in their home, it would do this. The new mortgage would be for the original face value. The new mortgage could be for 30 years at an interest rate of, say, 5%. This would prevent foreclosure in many cases where resets at interest rates of 12% or more force the foreclosure. The FDIC would then bundle these "good" mortgages and sell them to Fannnie or Freddie or any other buyer. The FDIC would make back the 10% discount in value when it bought the mortgages and this would cover its transaction costs. This would set the value of all CDOs at 90% of face value, or more depending on the percentage of potential problem mortgages ubderlying the CDO.
Two, if the homeowner could not qualify for a new mortgage, the FDIC would initiate the foreclosure process and recover as much of the value that it could. Average house prices ran about $245,000 at the peak and have come down by somewhat over 20%, so far. Assume that the mortgage was for 100% of value. The FDIC would buy the mortgage for about $220,000. Suppose the amount recovered in foreclosure was 70% of face value, or about $170,000. The average net loss would be about $50,000, plus, say, $10,000 for transaction costs, or $60,000. If there were 1,000,000 such mortgages per year, the net annual cost would be $60 billion. This is peanuts to the sums being talked about these days. In any event, it would also value all mortgages at 90% of face value an dthis would stabilize ALL CDOs and bundles at 90% of their face value.
This plan would solve the mortgage problem worldwide and overnight when the program was announced. It would restore massive amounts of capital to banks balance sheets, instantly, and they could give back much or all of the TARP funds now being provided. All this for a cost of only $50 billion per year for the next 3 years, or a total of $150 billion. This should be compared to the costs to be incurred under the recently passed so-called stimulus bill for billion of dollars for things such as rapid transit from Los Angeles to Los Vegas.
Why the FDIC? Because it knows how to liquidate bank assets effectively and efficiently. This is its job and it knows what to do.
What is wrong with this idea?
chrjr
To further reply my position is that any insolvent bank should be put into receivership (nationalized) and ALL assets auctioned off. My point about local thrifts is that a major factor in pricing real estate tight now is the fact that securitization has wiped out local and regional market evaluations. The geographical spread of mortgage backed securities is a severe flaw in their design. Years from now (mark to market my words) some academic study will find that the rapid devaluation was at least in part caused by the inability o correlate data from so many varied markets. There is no doubt that Florida, Michigan, Arizona and California are warping the data on a massive scale. That these are the same states in various degrees of trouble (hurricanes, auto sector, no water, everything including hippies) is a sign that better controls for remedy lie locally, not nationally. Quarantine the problem geographically and better solutions will emerge. but to do that, you must break the contracts. So far, that is (sadly) not on the table.
On Feb 15 08:38 AM wcrxlp editorial collective wrote:
> Aristophanes gets my "thumbs up" for his proposal to use community
> banks to evaluate and manage the CMO run-off.
>
> "Break the contracts, evaluate, sell, ban."
>
> But why restrict community banks to the toxic assets?
>
> If the community banks buy the poisoned-apples, why not let the community
> banks also cherry-pick some of the good assets held by the loser
> banks.
>
>
Talk to a local realtor in some part of California, Florida, Maryland, and they'll tell you that some developments should never have been built, much less zoned for housing. Now they are festering exurbs full of weeds, fields, and non-serviced sewer pipes to nowhere. Their presence in the market is a drag on value. They add all sorts of other public sector servicing costs that are, rightly, a public good, overextended in a time when the nation needs to be thrifty.
Local governments should be given funds from the Feds to take land out of the housing sector. Local thrifts and realtors will nail the "where" factor very quickly. They're capitalists; it's in their best interests to have supply and demand balance out now that leverage is reduced. Developers and owners would probably appreciate some tax and trade credits for the land. Local zoning is an incredibly powerful tool to correct this problem and should be used. If cheap credit was the opiate of the masses in this run-up, cheap land in the exurbs was municipal heroin.
If they can do it with sugarcane in Florida to save the Everglades, they can do it in the Imperial Valley in California to save their housing sector.
On Feb 15 10:53 AM Bob Lunn wrote:
> I also like Aristophanes approach. It answers a question I have had
> about these assets all along. The identity of the component parts
> of the assets are apparently still present. That means you can break
> up the tranches and unravel the assets mortgage by mortgage.
>
> Its not necessary for regional or local thrifts to buy the assets,
> they just need to be contracted to appraise them.
There is no way the seller of this asset should share in the profits 50/50 with none of the risk. I would never support anything over 20% being returned to the enitity which was bailed out. The taxpayer has accepted 100% of the risk. If that company goes bellyup and the toxic asset is worthless who is going to reimburse the taxpayer? The answer is no one.
Furthermore, the assets are still devaluing as more homes go underwater and the homeowner defaults. Thus the hopes of any windfall is not what the banks are worried about. What they are worried about is selling overvalued assets at a premium to what they are booking the assets at already. Only in this way can they improve their balance sheet.
The bankers say their issue is they don't want to part with profits but what they mean is they want the government to eat all their loss.
And if they get to sell at an inflated price what will they do with that money you ask? Why to keep it in reserve to improve their balance sheet. Thus the value in investing in them to increase the money supply through a multiplier effect is rendered null.
These proposals on how to profit form from toxic debetappear to be
feasible under the 'right' conditions. But who is going to buy all this
stuff and when? When a soon to be devalued dollar begins its descent?
I don't think so.
The whole thing is a complicated mess - but probably not one that is insoluble. The key thing is to get the jobs market and the housing market stabilized so that there is some kind of floor under these assets that will enable investors - whether it's the banks as in your scenario, or some other investors - to have confidence they have some possibility of a real upside.
On Feb 15 08:10 AM Sean Hannon wrote:
> I agree - As I wrote in an article on this site on 2/13 (seekingalpha.com/artic...)
>
>
> Your argument echoes mine that the only way to solve the issue is
> through a profit sharing agreement.
On Feb 15 08:17 AM Aristophanes wrote:
> The only way to solve the mortgage- backed CDO issue (and therefore
> a large chunk of the CDS problem) is to break up the tranches and
> unravel the asset completely, mortgage-by-mortgage.
>
> The securitization is the problem. The mass bundling creates a moving
> target. The history of poor original valuations begs revision anyway.
> The geographical diversity of the mortgages makes it almost impossible
> to gain final value as different local markets will "hit bottom and
> rebound" at different times.
>
> All of this is hidden risk. SO the M2M value is accurate.
>
> Break them up and sell them to regional or local thrifts at locally
> appraised discounts where the lenders have the ability to actually
> do case-by- case analysis instead of relying on the current pricing
> models made worthless now. To get out of this mess what is needed
> are "boots on the ground", in financial terms.
>
> Break the contracts. Evaluate. Sell. Ban.
>
>
On Feb 15 08:18 AM CautiousInvestor wrote:
> My first thought after reading your proposal is that it, more or
> less, presupposes that banks have taken equal steps and used the
> same stadards and criteria to mark down assets.
>
> If not, bank A could easily have a bundle of troubled assets on the
> books for 65% of par while Bank B could have a simialar portfolio
> of assets valued at 40% of par. Under your proposal, this would obviously
> favor bank A.
>
> I think before such a program could be implemented it would be essential
> for bank examiners and regulators to "stress test" all banks interested
> in your proposal to ensure a level playing field, inter-bank fairness
> and fairness to the taxpayer.
>
> I do not think the federal government, in acting on behalf of the
> taxpayer, should overpay for troubled assets to avoid additional
> writedowns and to save existing share and bondholders.
>
On Feb 15 08:30 AM townncountry wrote:
> Tom -- Sure the government could do as you suggest, and put them
> into a resolution trust company for later disposal, but a big part
> of the bank's problems are it's contingent off-balance sheet liabilities;
> the toxic swaps that they created for counterparties or traded with
> other financial institutions. Those might just sink a bank (or insurance
> company, like AIG).
>
> I'd like to add an amendment to your suggestion, and it is to get
> (for free, for the good deed of purchasing these toxic assets) long
> term (say 5-7ears in term) warrants or options on a bank's equity.
> Sure that would dilute the bank's capital, but it would be needed
> now. And if the bank does become profitable, the government or resolution
> trust could sell the warrants or options (or exercise them), thereby
> increasing the bank's capital.
>
>
Writing helps me think the problem out too. Great stuff, thanks.
On Feb 15 10:53 AM Bob Lunn wrote:
> I also like Aristophanes approach. It answers a question I have had
> about these assets all along. The identity of the component parts
> of the assets are apparently still present. That means you can break
> up the tranches and unravel the assets mortgage by mortgage.
>
> Its not necessary for regional or local thrifts to buy the assets,
> they just need to be contracted to appraise them. That's the first
> step towards dealing with the toxic asset problem, valuation. Now,
> separate the mortgage assets into groups based on risk assessment.
> Now open up bidding for these assets in the open market. Use the
> free market system to help us clean up this mess. At least it’s a
> start, and its an improvement over just giving these #^%$*#@ banks
> free tax payers money.
>
> Paceman1947 says these asset bundles were purchased at values well
> in excess of the component mortgage valuations. That does not surprise
> me because that is how the market works. People don't purchase these
> types of investments on the basis of the underlying book value, they
> purchase on the idea that the stocks price will increase. When market
> values started to sharply drop in the US, investors started to question
> the value of asset bundles, and started to sell them if they could
> find buyers.
>
> If this reasoning is correct, then toxic assets have at least two
> components. One component is the reduction in book value (Market
> - Mortgage Principal). The other could be called a speculative component.
> If the assets can be evaluated mortgage by mortgage, then it seems
> we could determine the valuation on those two components. Now we
> can separate loses due to securities speculation from the other loses.
> That leads to some interesting questions with respect to bail out
> programs.
>
> Sorry for the long drawn out message… It's my way of thinking out
> loud, and trying to understand the problem.
Tom
This is in addition to the problem of figuring out the original amount to pay.