Cash for Trash: Better Never than Late

The U.S. government does few thing better than create debt. After a year of talking about it, the government is going to have the chance to throw their good debt, Treasury bills notes and bonds, after bad, non-performing toxic loans and securities. The Federal Deposit Insurance Corporation (FDIC) and the U.S. Treasury are going their separate ways on their cash for trash schemes at this point. Accountants and investors should be wary of the big prices they see coming from the FDIC’s auctions, but taxpayers should be afraid of the U.S. Treasury’s efforts to re-inflate the securitization bubble.

The FDIC is nearing the century mark of bank failures this year and it has a lot of bad assets to unload. On Tuesday, October 6, 2009, it announced that it sold a $4.5 billion, festering pool of condo loans from the failed lender Corus Bank. The last 10-Q for the failed Chicago lender said that it had $3.3 billion in non-performing loans with heavy concentrations in busted condo markets of Miami and Los Angeles. Yet zero-coupon, FDIC-guaranteed debt and a billion dollar line of credit led to the price of $2.8 billion. That price of about 60 percent of par seems rich when almost 70 percent of the loans are non-performing.

A few weeks earlier the FDIC did its first Legacy Loans Program auction. My paper, “Slicing the Toxic Pizza: An Analysis of FDIC’s Legacy Loan Program for Receivership Assets” (here), found that the nearly 6-to-1 government subsidized leverage in the first Legacy Loans Program sale boosted prices by over 20 percent. Yet the irony is that these subsidies don’t hurt the FDIC and ultimately taxpayers because the FDIC is offering cheap financing to sell assets it already owns. Any higher prices just offset the subsidized financing if the auctions are competitive. Yet any marks obtained from these auctions are certainly inflated.

The Legacy Securities Program run by the U.S. Treasury with an initial taxpayer outlay of $30 billion is set to launch soon. More asset managers are closing their investment funds every week. The problem with the Legacy Securities Program is that the government will probably use cheap leverage to finance the sale of trash assets that it does not already own. That means that the taxpayer subsidies are enjoyed by the banks selling the assets.

My research shows that the most troubled banks will be reluctant to part with their toxic securities. Yet, the healthy banks will be all too eager to unload those assets at inflated prices. Come Halloween the U.S. Treasury will be handing out the goodies. Unfortunately, taxpayers will be getting none of the treats but all of the cavities.

Comments

[john s. gordon:]

another taxpayer cash giveaway to the megabanks.
> jack

Oct 11 09:08 AM

[a. palmer jr.:]

We're going to have to start taking care of our financial system better. If America goes broke completely there will be no one to take care of our illegal immigrants. Who would take them, Canada?

Oct 11 10:28 AM

[Tradestar:]

Funny, Palmer. Thanks for the laugh. But the reality is that Obama will tax us to death, drive this economy into the ground, force socialism on us, and destroy the heritage of this great country.

Don't fear, though, his first priority will be for all money to go to illegals, the millions of non-citizens in endless Visa programs, and opening the border from the South to every citizen from Mexico. Wonderful Administration. Wonderful Democratic Congress. Wonderful slide down into hell.

Oct 11 11:43 PM

[Toeser:]

Actually Palmer, Canada may have to start watching it's southern border for American citizens. Canada is doing much better than the U.S., and after Pelosi, Reid, and Obama have destroyed our economy, we may all try to sneak into Canada.

Oct 12 08:03 AM

[User 312717:]

Actually everyday Canadians in a truly socialistic society fare much better than Americans in a society that believes in socialism for the rich but drives the rest of us into the ground with fewer and lower-paying jobs.

Oct 12 04:52 PM

[Linus Wilson:]

I forgot the disclosure... I only hold broad-based index funds.

Oct 12 06:11 PM

[User 443922:]

Political arguments with this kind of flawless logic, backed with solid evidence, are why I love the internet. Who says our education system is broken.

Oct 14 04:51 PM

[trekking1999:]

okayyyyyyyyyy... so what's the effect on HTS, AGNC, NLY and the other 20 tickers noted?

Oct 15 04:50 PM

[Linus Wilson:]

trekking1999: Those are commercial and residential mortgage REITs. Thus, the price of real estate loans, CMBS, and RMBS affects the valuation of those REITs.

Oct 16 09:56 PM