Quick Hits: The Treasury's Toxic Asset Scheme

Includes: AIG, IYF, XLF
by: Markham Lee

Here are some quick hits on the Treasury's latest plan to rid the banks of the "toxic assets" infesting their balance sheets: first a fact sheet from the Treasury on the plan, coverage from the Financial Times, coverage from the WSJ and a WSJ Blog post on same.

As for my own opinion on the topic:

Buying up toxic assets wasn't a good idea under the original TARP program, so why is it a good idea now? Just think about it: one of the major problems the banks have is that they're levered up on the backs of these assets to the extreme, so removing bad collateral from their books won't erase their debt problems. If anything it's accounting chicanery of a sort because it's attempting to make the balance sheet look better, instead of fixing the business' core problems.

As for stimulating lending: the real story is that the banks lent too freely during the boom, and are now pulling back due to a combination of having to reset their lending standards, escalating loan losses, a worsening economy, the fact that many of them are losing money and the credit crunch.

At the end of the day the real problem is that we have undercapitalized banks (they were often substituting derivatives and esoteric securities for real capital) that are overleveraged, and are now functioning in both a difficult economy and frozen credit markets. Dumping their bad assets onto the backs of the taxpayer helps, but it doesn't resolve many of their other problems.

The most pernicious aspect of this plan is that it creates a "win/win" situation for the private investors and banks involved, whilst only partially solving the problems with the banking system and simultaneously exposing the taxpayer to 100s of billions worth of potential losses/liabilities. The way this fraud err plan is set-up the private investors stand to make a killing if things work out, and have very little downside exposure of things go badly. Considering that the banks are likely to sell their worst assets into this plan whilst simultaneously overcharging for same, it doesn't take a psychic to figure out that the taxpayer is going to left holding a bag for at least some of these asset sales.

It's highly disturbing that the Obama administration can have a tantrum over the AIG bonuses, and then hand Wall St. a gift like this.

Furthermore since many of the bank's problems will undoubtedly remain, we also get to look forward to another round of farcical congressional hearings into why bank lending hasn't increased as a result of the TALF. If saving our nation from having to watch another round of clowns err politicians railing at their co-conspirators err Bank CEOs isn't a reason not to execute this nonsensical plan, I don't know what is.

Finally I go back to my original question: doing this wasn't the best move when it was the original TARP, why is it suddenly a good idea now?

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.