The Geithner 'Some' Plan

Markets were higher yesterday on the announcement of the Geithner Toxic Asset Plan.

For now, let’s call it the Geithner SOME Plan in that it helps “some” institutions with “some” of their toxic assets.

It’s not all bad. It’s certainly not all good as it does nothing to address the value of the underlying assets. It provides liquidity and leverage but exposes only the taxpayer to losses. The particulars are important and disquieting.

Throughout the debate over the myriad of federal programs designed to address the global credit crisis, one theme has resounded. Wall Street has continually been accused of operating in a system where profit was privatized while risk was federally subsidized.

This concept was applied to Fannie Mae (FNM) and Freddie Mac (FRE). To AIG. Indeed to every institution that has now received federal support through Federal Reserve action, stimulus, TARP and TALF. The public has been told the federal government had to act, regardless of the moral hazard triggered by bankers or corporate leaders who sought profit knowing the taxpayer or the Federal Reserve would bail them out.

The question becomes, what’s changed with this plan? Very little.

The new plan calls for multiple public/private partnerships to assist in the transfer of both bank loans and securities. The public/private aspect is a “dollar-for-dollar” partnership between the government and a private investment group. However, the financing is classified as “non-recourse.” The simple definition is that if the underlying asset loses value, (as home prices or the economy continue to stagnate or drop,) the taxpayer is still exposed. The private entity in Geithner’s public/private partnership has the right to walk away from the transaction putting the losses back on the taxpayer.

If the underlying asset rises in value, the gain is shared 50/50 between the private investment group and the taxpayer. However, many observers still fear continued losses in the economy. Under Geithner, SOME those losses are still federally subsidized.

This plan also adds another $1.0 trillion in debt financing to advance considerable federal leverage into the equation. The market understands that the days of thirty times leverage are over. However, market leverage in Geithner’s SOME plan is the next best thing.

Consider funding for a $100 million dollar toxic asset package of residential mortgage backed securities (RMBS). Under Geithner SOME. Step one is to qualify the pool. Then a price is set. For the sake of argument, let’s make this simple and say it's eighty cents on the dollar. Under the plan the federal government and the private investor would put in less than $10 million each. The remaining leverage comes from a federal loan. The result is an asset transferred where the new private investor has risked less than $10 million to control an asset pool of $100 million; where the downside is absorbed by the taxpayer; and the upside is a 50/50 split. Who wouldn’t take that deal?

A few hours after the plan was announced, Bill Gross, the head of PIMCO, said that his firm will participate. I can understand why. It’s a great deal for PIMCO. Unfortunately, few others will be able to meet the criteria and size required by Treasury’s standards.

The Geithner SOME Plan should stand for…”SO OLIGOPOLISTS MIGHT EARN,” as the only beneficiaries of this public/private partnership will be a small sub-set of well known investment firms.

Comments

[morph366:]

Ultimately it's an ailing asset convalescence plan - if the patients (i.e. CDO's and CDO Squareds etc) recover Bill Gross and others will earn a very generous return on minimal outlay and risk. If the patients stay in rigor mortis then the taxpayer picks up the entire loss
That last bit sounds familar doesn't it?

Mar 24 09:18 AM

[TCE:]

Excellent article. What we have here are POLITICAL decisions masquerading as BUSINESS decisions. It will not work because the SOME plan fails to meet the objective criteria one would apply to a "good" business decision.

Furthermore, these toxic assets must be delt with one property at a time. The SOME plan does not provide a mechanism for doing this in a businesslike manner.

TCE

Mar 24 10:55 AM

[viewfromnyc:]

The whole plan is a massive transfer of wealth from the taxpayer to the equity and debt holders of the banks. In return for facilitating that transfer a few large investment firms will be given the opportunity to make incredible returns on equity capital with minimal risk.

If the premise is to save the banks, the best course of action for the American taxpayer is to separate the banking infrastructure (branches, managers, software and systems etc.) from the existing owners and creditors. The FDIC could seize the insolvent banks and the U.S. Treasury could recapitalize the skelton, leaving the losses with the stock and bond holders. The government would end up owning the financial assets as it eventaully will in the Public-Private Plan but it would own less of the loses. As taxpayers we would also own 100% of the potential upside.

In the Public-Private purchase plan the government is bearing substancially all the risk and giving the half the potential profits to a select group of large investment firms. The private partners in the plan are going to earn extraordinary returns on equity. First and foremost the private capital will have a earn a significant interest spread (6%-2.5% for 350 bps) between the cost of the guaranteed debt and the yield on the assets (levered 6x) . Why the government willing to give this away, for what essentially is private capital's advice on setting the price, is incredible. I predict private capital will earn back its investment in 18 month. If the govenment lets them extract those profits prior to the guaranteed debt being repaid, the private partners will have created a free call on the toxic assets with an ongoing income stream. As taxpayers we are giving up potentially half the upside for about 7% downside protection. That is a terrible risk reward ratio for our government and the American taxpayer.

Mar 24 10:56 AM

[Moon Kil Woong:]

The investors do have a down side. It is possible that the investors might not make money, however, I'm sure that will be offset by the fact their parent company will be able to mark to market their assets based on a taxpayer subsidized price for their bad assets.

High fives for Citibank and their ilk.

Mar 24 12:52 PM

[Leftfield:]

It's remarkable to see the negatives checked on truthtelling comments. I get the idea here some of the concentration of influence people who have vested interests bring to bear. Last week, mark to market was all over the place and scarcely debated on mainstream media. Plenty of it here with plenty of negatives for contrary opinion.

We are to believe that the Fed, Treasury, DC and Wall St. are all working for the common good. TARP was thrown at us posthaste: Quick, they need $1 trillion, don't ask questions. The insanity of it all is now commonplace. One trillion here, one there.....

Bill Gross is getting payback for pumping for TARP et al. The biggest insiders are getting their biggest score yet. Made of our misfortune. Disgusting.

Mar 24 02:05 PM

[retiredengi...:]

timmy's plan will be a bait and switch. it won't go for bad home debt, but for all the other credit card and toxic assets the banks are carrying. If congress approves this plan you can bet they will burnt again and again and again.

Mar 24 08:18 PM

[Ned S:]

The Americans have a plan to stabilise their banks. Only the Americans could create such a plan. Other countries say their banks have no money and the government takes control. But not America. America wants to save the banks that are not OK. But the American people must pay for it. I feel sorry for the American people. The American government loves the American banks. But it does not love the American people. It is very strange. But Americans are obviously very strange people.

Mar 25 05:05 AM

[Allan Frain:]

This is what happens when the Banks are allowed to write policy.

Mar 25 08:34 AM