Let the TARP Games Begin

 |  Includes: C, XLF
by: Craig Brown

When Geithner announced his plan, which I refer to as TARP II, one of my earlier thoughts was that if I were the banks with the toxic assets, I would form a plan to bid on each other's paper. With the government taking 93% of the downside risk and only 50% of the upside, why not? So, you say, nonetheless, why would the banks do this and add on more toxic debts? Well, let's just run through a "hypothetical" example and see why.

Let's take a few made up institutions, such as GreedyGroup, Jumpin' at Morg Money, Watchoveryourmess and Pits Forgo. They each carry, in this hypo, their toxic assets at 50 cents on the dollar but they each know the assets are worth 25 cents on the dollar at best. Yet they agree amongst themselves to bid up the auction on each other's toxic debts to the point where whoever buys is paying 80 cents on the dollar. The government is paying most of this and the buyer only has a 7% risk of loss. Let's assume that each bank agrees to buy $100 billion in toxic assets from another of their brethren at 80 cents on the dollar. In theory they have each - as a seller - now gotten $80 billion in proceeds for assets booked at $50 billion but really only worth $25 billion. In other words a benefit of $55 billion overnight - not to mention the ability to falsely raise the market price of other toxic assets on their books and hopefully attract foolish buyers.

Now mind you, the selling bank also needs to be a buying bank from another bank. So they buy $80 billion and lose their entire investment, which is 7% of the investment, which is 7% of $80 billion - $5.6 billion. So the gain on the seller side is $55 billion and the loss on the buyer side is over 5.6 billion. Net gain - $49.4 billion. And they owe the U.S. government and taxpayers how much - $0. You can guess who gets the loss in this scenario.

Now obviously Geithner is too smart to let this happen (I hope) so they will do things to prevent it. Nonetheless, those very smart minds out there that figured out how to make money from increasingly sophisticated financial products that caused this mess are now actively figuring out ways to game the government's plans for a rescue. They are figuring loopholes to transfer massive taxpayer dollars from our pockets to their pockets. This truly makes me ill. Did I mention I do not like Geithner's Plan -or lack thereof. For multiple ways this system is being gamed, I refer you to this link. I say put all these companies under, sell the pieces off and hang the executives out to dry.

Nonetheless, despite the possibility of it being gamed, some who might have been interested in the Geithner plan are coming out squarely against it. They point out that the touted leverage may not be what was touted for private investors. As a taxpayer, I hope so.

Have We Hit The Bottom

I have been saying not, but for this post I will let you decide for yourself. Calculated Risk has been posting a Four Bad Bears chart on a regular basis. If you look at where things stood in The Great Depression about this point in the process, I am sure they were optimistic the worst was over. They had a nice bounce too.

Nonetheless, I have to admit, some of the key indicators are giving off better signals as of late. Credit markets in general seem to be better. After trillions in aid they should be. The question I have is "Do we need more credit?" Yes, certain corporations are desperate for credit just to continue normal operations. Plenty of businesses, even in good times, rely on credit as the lubrication that keeps the machine going, so we need that to be there for viable corporations. But beyond this, pretty much everyone else is in a position where they need to further deleverage. So, again, I ask, do we really need credit to save the day.

Banks Betting Against Themselves

So Citigroup (NYSE:C) says to avoid bank shares as they have peaked. This is bad news. But the the rules on them marking their debts to market are being greatly relaxed and the banks are having a nice boost. Suddenly the advice, from Citigroup, is wrong as the bank shares jump. But suddenly, we all have to be even more afraid as there is less transparency. Just when someone at Citigroup is saying not to buy their shares, news comes out that leads to people to foolishly want to buy them. Are the shares really any better off now with less transparency? Go figure.

You decide for yourself if the news is good or bad. I admit it is mixed. I did buy more put options today - though I was a bit hesitant in doing so. Signs are getting more mixed, which is a good thing overall.

Disclosures: None.