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 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.
