How Treasury's Bank Bailout Could Make Things Worse 29 comments
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An anonymous commenter makes an excellent point this morning about banks' willingness to participate in Treasury's bailout scheme:
Isn't the big hurdle getting the banks to offer up their assets to the auction process by FDIC? Once they do that, whether they accept the bid or not, it seems hard to imagine they would be able to value the assets very much above the highest bid offered. For example, if the assets are valued on their books at 50% of face value, they offer them in the auction process and the highest bid is 30%, I would think it would require a little chutzpah to decline the bid and go back to valuing these assets significantly above what has been shown as a market price.
To put it another way, far from making things better, the Geithner plan runs a serious risk of actually making them worse.
The status quo, absent any Treasury proposal, is basically the Hempton plan: let profitable-but-insolvent banks work their way slowly back to solvency by making large operating profits and not paying dividends. But the problem with the Hempton plan is that it only works on a kind of don't-ask-don't-tell basis: the banks can't be publicly insolvent, since then they need to be taken over by the government.
The minute the Treasury plan is put into action, we'll have a lot of public price discovery for the banks' bad assets. And if the prices don't clear -- if the minimum price the banks will accept is higher than the maximum price that the public-private partnerships are willing to pay -- then no one will any longer be able to perpetuate the fiction that America's banks are solvent. And without that fiction, the Hempton plan -- the muddle-through status quo -- is toast.
The big hope of the Treasury plan is that the private sector will be willing to pay a higher price for leveraged assets than it would for unleveraged assets. The returns on private capital are being leveraged by five or six to one in this scheme, if not more, which means a high chance of them making lots of money, and also a high chance of the capital being wiped out entirely. During boom years, that was a wager that many investors were willing to take. But now? I'm not sure. Chalk it up as yet another thing-which-has-to-go-right in order for this scheme to work. There are far too many of those for comfort.
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This article has 29 comments:
Constructe now know as Moon Kil Woong
Presently there is some spread between mark-to-market and what the assets could be worth if held to maturity. It is frequently argued that the latter could be significantly larger than the former and is the basis for revisions to mark-to-market which could produce a third data point.
And as Felix is suggesting, we will soon acquire a fourth data point arising from investor bids coming from partnerships funded by slightly more than 7% private equity and non-recourse, low interest federal loans. I'm certain that Treasury believes these favorable conditions will result in favorable bids.
If the auction bids, however, produce the lowest of the four valuation points it could become quite messy. In any event it will be interesting to see how all the valuations are reconciled.
This would be particularly true if there were no other moving parts in play here.
But that is not the case and there are all kinds of ways around that little issue. Ideally the "stress test" would be used to determine who was eligible, so you could be sure that any bad news during the auction could be borne by the bank. But that is a rosy scenario that assumes some sort of rational management. Snicker.
Then of course there could be an application of some helicopter money, or TARP funds or whatever sorts of other bailout that the fertile, creative minds of the nation's financial system could come up with. I mean there really is no particular belief on my part that there is any sort of restraint in operation in this category so the sky - (and by sky I don't mean the troposphere, I mean the the outer reaches of the exosphere) is the limit.
So I'd say that probably there will be some hiccups, but there will also be a fleet of helicopters at the ready, with a nice recording of "Ride of the Valkyries" on cue.
Lord have Mercy on us All.
I profit now and won't lose my "equity" until later. I've heard that a big hedge fund was masterful at using a similar technique to ensure that stupid CLOs and CDOs got done so they could short it. (no relation to Hank Paulson) They would supply the tiny slice of equity to make sure the deals got done, and then short the entire structure. What they lost on their equity was more than made up for the significant gains on shorting the rest of the capital structure.
This is what Geithner is suggesting. Let the wolves put in a few dollars, but how will he make sure they're not pulling in OPM in order to prop up toxic prices on their books?
You'd have to expect that they would have thought of this, right?
mmmm....not so much.
I'm looking at some bank own 4-plexes. The bank has them MLS'ed at $219,000 -- loan value. They were once nice but they have deteriorated recently. Those that have renters are renting for about $500 a month. At $2000 a month gross each, I need to pay somewhere around $60,000 for them each to turn a profit. I can assure you my little ole bank doesn't want to own up to that kind of loss.
Let's say I'm a bank with a $100 face value "Legacy" pool that I have dilligently and painfully written down to $50, even though the best tire-kicker bids I have received are at $30. I haven't accepted because I don't want to take another $20 haircut.
The FDIC decides I can get 6:1 debt:equity on this stuff. So I set up a PPIF and fund it with $5.00. Treasury throws in $5 and the PPIF issues $50 non-recourse debt guaranteed by the FDIC. The PPIF then buys my pool for $60 and presto! I have turned $30 worth of crap into $10 cash ($5 net) and $50 of FDIC guaranteed paper- I don't really care what happens to the PPIF. In the fullness of time it may or may not make money. If it does, I'll get 1/2 of the profits. But it probably won't, so the taxpayer will pick up the tab.
So what's to stop me from putting, say, $8 into the PPIF and bidding $96 for the pool? Treasury is in for $8 and the taxpayer is on the hook for $80 courtesy the FDIC. My bank ends up with $16 in cash ($8 net) and $80 worth of FDIC guaranteed paper and the PPIF can go get stuffed for all I care.
I'm laughing all the way to the bank. Wait, I AM the bank.
Today, Treasury announces plan to securitize and sell a bunch more mortgages languishing on the books of banks. Of course, this will likely drive up the rates of long term mortgages (more supply, lower price, higher rate).
Are these guys talking to each other?
am not sure why this plan matters since it still doesn't solve the problem. all this plan accomplishes is a bailout of overpaid wall street clowns ... provides those schmucks work for a few more months before reality sets back in ....
dow below 6k and S&P under 500 by year end ... don't take my word for it, go look at the credit markets and the spreads and draw your own conclusions.
And I thought the cronyism under Bush was bad . . . .
"I don't see this as a problem at all. In fact I see the opposite problem:
Let's say I'm a bank with a $100 face value "Legacy" pool that I have dilligently and painfully written down to $50, even though the best tire-kicker bids I have received are at $30. I haven't accepted because I don't want to take another $20 haircut.
The FDIC decides I can get 6:1 debt:equity on this stuff. So I set up a PPIF and fund it with $5.00. Treasury throws in $5 and the PPIF issues $50 non-recourse debt guaranteed by the FDIC. The PPIF then buys my pool for $60 and presto! I have turned $30 worth of crap into $10 cash ($5 net) and $50 of FDIC guaranteed paper- I don't really care what happens to the PPIF. In the fullness of time it may or may not make money. If it does, I'll get 1/2 of the profits. But it probably won't, so the taxpayer will pick up the tab.
So what's to stop me from putting, say, $8 into the PPIF and bidding $96 for the pool? Treasury is in for $8 and the taxpayer is on the hook for $80 courtesy the FDIC. My bank ends up with $16 in cash ($8 net) and $80 worth of FDIC guaranteed paper and the PPIF can go get stuffed for all I care.
I'm laughing all the way to the bank. Wait, I AM the bank."
I agree with Moon here. There are many ways to game this system, all resulting in ficticious accounting.
If this program works it will only be short term as follows: The banks and other lenders off-load some of their bad (toxic) assets to the Private Public Investment Program, they may begin to lend again to borrowers who are already over burdened with debt. These new loand will begin to default within 24 to 26 months of origination. The assets purchased by the PPIP will continue to default at increasing rates.
The economy will then have a new layer of non-performing debt instruments on top of the ones that were off-loaded in the PPIP. Society will be worse off than if the government had done nothing.
If you think it's hard to get a loan now, wait until 3 or 4 years from now. Today will look like salad days.
We cannot cure the problem with more of what caused the problem but only in D.C. where politicos who are ignorant of economics could this plan be believed in.
1. Transfer 93% of the downside risk they now own to the FDIC and Treasury.
2. Control the bidding process; ensuring bids are well above MTM.
3. Mark up remaining assets they will keep on their books.
In the near term, this will lead to a surge in the XLF and bank share prices, ensuring passage of the Tangible Common Equity “stress” test. In the longer term, the continued decline in employment and home prices, rising savings rates, and rising credit card, auto loan, student loan, and CMBS defaults, may lead to historic losses for the FDIC. Unfortunately, the FDIC’s Deposit Insurance Fund is already near zero. Should the FDIC become impaired in its new role as guarantor of bank assets, it risks failure in its original role as guarantor of bank liabilities, i.e. deposits. We will then be at risk of what we have so far managed to avoid – a good, old-fashioned Depression era bank run.
1. Transfer 93% of the downside risk they now own to the FDIC and Treasury.
2. Control the bidding process; ensuring bids are well above MTM.
3. Mark up remaining assets they will keep on their books.
In the near term, this will lead to a surge in the XLF and bank share prices, ensuring passage of the Tangible Common Equity “stress” test. In the longer term, the continued decline in employment and home prices, rising savings rates, and rising credit card, auto loan, student loan, and CMBS defaults, may lead to historic losses for the FDIC. Unfortunately, the FDIC’s Deposit Insurance Fund is already near zero. Should the FDIC become impaired in its new role as guarantor of bank assets, it risks failure in its original role as guarantor of bank liabilities, i.e. deposits. We will then be at risk of what we have so far managed to avoid – a good, old-fashioned Depression era bank run.
I just have a few more points to add.
1. The banks C, BAC, WFC, and GE (yes, GE is a financial), and possibly JPM are insolvent. If you don’t believe that, then I’ve go some mortgage backed securities to sell you!
2. How does our competent Treasury Secretary expect there to be ‘private sector participation’ when the country’s major money centers have no money?
3. From Bloomberg: “The plan is aimed at financing as much as $1 trillion in purchases of illiquid real-estate assets, using $75 billion to $100 billion of the Treasury’s remaining bank-rescue funds. The Public-Private Investment Program will also rely on Federal Reserve financing and Federal Deposit Insurance Corp. debt guarantees, the Treasury said in a statement in Washington.”
4. Let’s decode item 3 above into plain English. “The plan is aimed at financing as much as $1 trillion in purchases of illiquid real-estate assets”. 1Trillion dollars. Hey, what’s another trillion! No big deal! Continued…“using $75 billion to $100 billion of the Treasury’s remaining bank-rescue funds”. Let’s assume that there actually is 100Billion left from the original TARP. Where’s the other 900Billion going to come from? Oh…” The Public-Private Investment Program will also rely on Federal Reserve financing”. Translated…THE FED IS GOING TO PRINT 900b OUT OF THIN AIR. The Chinese have basically said that they are not buying any more of our bonds in diplomatic terms! Who out there is going to buy 900B of treasury bonds? And last…” and Federal Deposit Insurance Corp. debt guarantees”. The FDIC is almost broke as it is! How are they going to guarantee another 1 Trillion?
5. Now…go back and read JT77’s post again. The astute student will see the pure genius and eloquence of the post. It basically is describing how the private sector is going to participate in this process with OUR (the taxpayers money)! If you don’t believe it…just look at the market action today (23 March 2009). The S&P 500 up around 7%, with the financials leading the way with 10.2% gains on the day. Surprisingly…the NASDAQ (no financials) was just along for the ride, lagging the rest of the market (but still impressive gains).
6. One more thing. I have to give credit to the radio show host for saying this. This is very ENRON-esque. Didn’t ENRON move bad assets off of their balance sheet into other areas to hide losses? Wasn’t Ken Lay going to go to jail for this? Didn’t Bernie Ebbers go to Jail for this with world-com? But now it’s ok for the Banks (the most guilty mentioned above) to do this in the name of getting credit flowing again. What’s most sickening is that the Banks will get to do the same thing…the same thing that others are sitting in jail for…except they are moving their toxic assets to us, the taxpayer, with the help of the entity that is suppose to bring ‘…And Justice For All’.
What's the better solution? Bankruptcy. We've had it for years. Time to let the system work by rejecting the illness that's plaguing it. Allow private capital to set the terms for assets.
This "you take 7% of the capital risk, but you get 50% of the upside" is a bunch of crap. They get the upside in exchange for taking the risk. That's how the system works. Every time the Fed or the Treasury intentionally misprices risk, they break the system a little more.
This plan will essentially bail out the banks for the umpteenth time – and tax payers will be on the hook for all the toxic stuff. The intent of the plan (one of the many) is to get the assets priced by private parties – that is what will not happen. There will only be limited number of buyers 5 only at present – likely the politically connected cronies – PIMCO, Goldman, etc. In absence of unlimited buyers, price discovery will not happen. The private parties will be funded with a non-recourse loan – what incentive do they have to do proper due diligence – if it works out fine – else walk way – with so little at stake that would be an easy call for private funds.
And of course the possibility of double dealing – the sellers could show up as buyers and bid up the price – sell at inflated price –pass on 93% of the risk to the tax payer. This is what will happen.
Banks can arrogantly return the TARP money; go about their merry bonus ways, jets and all.
Stop Geithner, he is going to destroy what little is left of our financial system.
Ronald Reagan was right..."The nine most terrifying words in the English language are, 'I'm from the government and I'm here to help'."
>> "In a nut shell, the goal of this and all of the various solutions is to increase the level of debt in the economy so that businesses and consumers can continue to spend other people's money. The reason the credit markets are frozen, although I have doubts about that description, is that these markets need to re-adjust to the over leveraged status of borrowers and the level of total debt must be reduced" >>
Every financial crisis of the past century was caused by too much debt. All these gummint programs result in the creation of MORE debt. What is needed for recovery is LESS debt..
Gummint is incapable of understanding the concept of "unsustainable". The problem was the debt bubble popping. They're trying to reinflate it. The policy is futility.