Last September I had a conversation with someone knowledgeable about buying toxic assets. I figured if Morgan Stanley sold those assets at 22 cents on the dollar, well, there had to be bargains. He told me to forget about it. First, that 22 cents was for a CDO and the price that I had in my head was miles short of what the US Government "might" pay.
In December I saw him again and I asked, "So how come the few transactions that happened with AIG under the Maiden Lane program looked to be for about the price I was thinking about?"
I was told, "Well that was a forced sale, there was no option for AIG, and in any case that was just one government department buying something from another government department. Sure, if you could buy at that price, it would be a steal. But you can't."
So what's going on?
Transactions happen in markets when buyers and sellers agree on the value of things. The "problem" right now is that the owners of "toxic assets" think that these assets are worth more than their auditors, the bank regulators, and potential buyers think they are worth.
Another (linked but separate) problem is that until buyers and sellers reach an agreement on what is the right price, the economy will continue to suffer, because credit will not be available, and all economies need credit to work.
Of course that's not the only reason that the economy is suffering, the other reason is that in the not too distant past, a good proportion of Americans (and others) bought assets at twice the price they are worth today (or thereabouts). Many are now broke; many more are feeling sorry for themselves, ditto anyone who was foolish enough to lend money collateralized by those assets with the "L" in the LTV (then) worth more than the "V" (today) [LTV= Loan to Value]. But that's another story.
Mexican Standoff
For expediency, I call "the government" the whole infrastructure including the regulators and the auditors who work under the direction of "the government".
The state of play right now is that the "sellers" have been forced to write the assets down to a price that the government thinks is "fair".
This may or may not have been a good thing, but the result is that under the government's rules the sellers are now severely constrained in how much lending they can do, or in the case of companies with long obligations like AIG, how many assets they could snap up at bargain basement prices, which is what they would normally be doing now, if they weren't broke.
So whether it was "right" or not, on the surface that was counter-productive in that it moved the government further from it's goal rather than closer.
The important thing is that the "sellers" haven't got anything more to lose; some are bankrupt, some are partially (or effectively wholly), owned by the government, some are "technically" insolvent and hanging on by a thread. But the government has implicitly or explicitly guaranteed that so long as they pass a "stress test" they will be supported (and if they don't well they will be toast - game over).
So the sellers have as much time on their hands as a death row inmate - secure in the knowledge that you can't execute someone twice.
The government is not proposing to make the "sellers" write down their assets any more than they have already; and they (the sellers) are pretty sure than in a year or two, the assets in question will be worth more than the government has forced them to write them down to. (They may of course be wrong - they have been known to be wrong in the past).
The government does not have time however, at least if it wants the economy to recover any time this century.
So that's a Mexican Standoff, the sellers know that the potential buyers are running out of time, so they wait. That's normal.
What are the options?
OPTION 1: The government can put together a scheme where they pay too much.
That was the original idea behind TARP, which didn't work because there wasn't anything like enough money. The difference between that scheme and the new plan is that by bringing in the private sector and providing a structure where the private sector are guaranteed to make profits, and the government will effectively guarantee (a) any losses, plus (b) a healthy profit to the private investors, so there ought to be enough money, regardless of the price that is paid.
That makes some sort of sense, and there is a consistency in that approach. After all, governments always pay too much, from $30,000 screwdrivers; to $700 billion to find out that there were not any WMD in Iraq; to the settling up of AIG counter-parties where they paid 100 cents on the dollar when the counter-parties would have settled for 50.
And sure the politicians stand up and make a nuisance of themselves grandstanding about pennies, but once the money is out of the window, well, it's hard to get it back.
Whether it is a good idea to mortgage the future of the grandchildren of ordinary Americans to achieve this objective, is of course politics.
One argument for that idea is that the plan will be profitable to the government in the end, although sadly history does tend to show that if you pay too much for something you generally lose money in the end, and if you borrow to pay too much for something, you lose even more. But chance is a fine thing, and as they say, history doesn't always repeat.
A possible opportunity therefore is to "join" with the government and go shopping. So long as they are taking a good part of the risk, that's as big or a bigger opportunity as signing a cost-plus contract to provide military hardware.
The problem of course is that this great plan won't in fact achieve anything (for the government), although if they are handing out "get-rich-quick" passes, who cares?
The reason it won't work is because instead of the "ex-sellers" holding on to the assets and refusing to sell until someone pays too much, private investors will be holding on to them and refusing to sell until someone pays too much, plus of course a margin.
It's easy to forget that the objective was to re-start the market for those types of securities, but after the private investors have bought all those assets for too much, well who will they sell them too?
And there is another problem.
The reason that "toxic assets" were so popular in the first place was that they were worth much more for the calculation of capital adequacy or solvency under the government "rules" than a simple loan. The reason for that was that they were considered "liquid".
All you had to do the get the "stamp of liquidity" was to list the things on an exchange, and in that regard (a) that was a sham, the assets were hardly ever traded on the exchange, and in fact they were hardly ever traded at all (one reason for that is that they were all slightly different), (b) more important, now everyone knows that was a sham.
So the "value" of those instruments for padding up your capital adequacy is much less than it was. That brings you back to supply and demand - who actually wants to own a toxic asset unless the government pays you to own one?
So OK it could be an opportunity, if you are not too concerned about your exit, but whether it will re-start the secondary credit market is extremely debatable.
OPTION 2: The "government" (plus it's new-found partners) pays too little.
That's a good idea, except there is just one small problem, which is how do you get the people who own the assets to sell them too cheap?
It's one thing getting them to mark those assets down to some arbitrary number based on the assumption that the market is working when obviously it's not, the government has the power to do that.
But to force them to sell too cheap, the government will have to become the owners (like it did with AIG). Of course if that happens, then there is a clear opportunity to join in the game and basically asset-strip.
But it's hard to see how asset-stripping will make more credit available, although there again if that's the deal, who cares?
OPTION 3: The "government" holds on to its money (well actually it isn't its money, but that's just detail).
That would open up an opportunity for the private sector to buy toxic assets, without the sellers saying "Buzz Off - the US Government will pay twice that (one fine day)", which is basically what they have been saying for six months.
The opportunity there would be to be able to buy toxic assets with the knowledge that there might be a chance to sell them to someone else in the future. That's how markets start.
But doing nothing is the hardest thing to do.
Of course if the government was desperate to "do something", it could actually think about doing what it was set up to do, which was not actually to become the marketplace of last resort, it was to set up rules so that the economy works efficiently.
For example it could mandate that the toxic assets are valued by an independent valuation firm using International Valuation Standards to determine their "Other-than-market-value", and allow capital adequacy and solvency to be calculated based on that not mark-to-market.
And on that basis, guarantee to be the lender of last resort, which is what it is doing anyway, so its exposure wouldn't change.
The advantage of that approach is that the market would start up, credit would become available and the time before the market-value reflected the other-than-market-value, would be minimized. Also it wouldn't cost anything more than the government has already committed.
Which option will they chose?
Well there is no talk about doing nothing or mandating that assets be valued according to the only valuation standard that is approved by every valuation institute of any consequence in the world.
So I guess it will be (1) or (2). Which means that anyone with the right "connections" can get rich ripping off the government; which is nothing new.
