Used Bonds for Sale

by: David Bailey

When you buy a used car, one of the first questions you ask is: “Hey, if this car is such a honey, why do you want to get rid of it?” If the answer is: “I have too many cars” or “I want to get a new car” or even “Hey, I need the money” – that’s okay. But if the answer is: “I’d like somebody else to be driving it when it catches on fire” – that’s not so good.

So, with our Used Bond Buyer in Chief Geithner announcing his intention to get us some new, financial wheels with a big, big price tag, I’m taking time out of the great gold debate to ask readers a question to which I have yet to receive a satisfactory answer. Until it’s answered I will be very worried that if we do a deal with the banks, our nation’s financial wheels may fall off.

If the problem the banks have truly is that they hold assets with market prices that are very low but which assets will pay well in the future, why then is the following not possible for each and every bank?

1) Analyze the “underpriced” assets.

2) Calculate what they will pay.

3) Create an arm’s length trust to hold those assets and make those payments.

4) Transfer the assets and have the trust rated separately – with the help and insurance of the government if necessary.

5) Book the NPV of the payment stream at full value.

Why wouldn’t that be a logical step in any solution? And if the main problem really is the market price, why wouldn’t that solve a lot all on its own? It makes me VERY suspicious to note that the banks have taken no similar step themselves. Somehow, it seems really important to them not to have anybody do anything more than kick the tires of those bonds. I understand why he did it, but it seems to me that Chairman Bernanke has created a really terrible precedent by accepting questionably-rated assets for full represented value as collateral. It was wise at the time, but that’s because we were only renting them. Now they want us to buy.

“Stress test” the banks? Let’s stress test the junkers they want us to buy, first.

Now a lot of you may be saying: “Those ‘trusts’ he’s talking about are the same as SIVs.” Well, I was thinking of something you don’t rush past a rating agency and scuttle off to the Cayman Islands. I was thinking more of something you keep right here in America while the taxpayers have their mechanics take a long look under the hood. Let’s take a while to see whether those assets keep firing on all cylinders – or whether they even have all their cylinders. It seems to me that, at a minimum, the banks should be willing to set the trusts up and get ‘em up on the lift. Then, let’s see how those trusts run for a while and if they perform as advertised. I’m happy to see the banks get a fair price, but I’m in no rush to buy. If they need a down payment because of a cash crunch, we can talk about that. But let’s be very specific about what it’s a down payment on.

So, let’s not guess what the bonds are worth. Let’s certainly not take the banks’ word as to what they’re worth (after all, nobody else in the marketplace will). Let’s separate them out and see how they perform while they are on the books of the bank, not the taxpayer. Let the banks each put together their own “bad bank” and let’s see what those assets really do before we rush in and buy. If they’re telling the truth, fine. If not, let them keep those lemons.

I’d like my mechanic to drive those bonds around for a while before I buy what the “used bond dealers” are trying to sell me, thanks. Doesn’t that make sense?