It’s been over a week since Treasury Secretary Tim Geithner announced his Public-Private Partnership Investment Program designed to help the banks dump their “toxic assets”. As of late, the plan has received some much deserved criticism. Upon closer review, It’s my opinion that the plan won’t work in its current form because it fails to address one major question.

“What if the banks colluded to create a market price for these assets that is much higher than their actual value?”

Let’s not forget that we still have some very smart people working at this nation’s banks and they are working around the clock to find out the best way to take advantage of these new government programs. Although banks wont be allowed to bid on their own assets as part of the auctions, what is going prevent banks from setting up special entities to bid for them in the auctions or paying a hedge fun a “management fee” to bid for them on their behalf?

Let’s say that through this partnership a bank is able to sell an asset at 60 cents instead of the 30 cents that they probably are worth. If the bank only put up 5 cents worth of equity, the taxpayers would be on the hook for the remaining 25 cents of losses. If we didn’t have the partnership, and the government made the mistake of purchasing the assets at 40 cents, the taxpayer would only lose 10 cents.

Potentially, by using the “market” to price these assets, the taxpayer could stand to lose alot more money as opposed to a plan where the government would be the sole purchaser of the assets at “its” price. Its clear that the banks are incentivized to game the system to create a fake market for these assets.

The Financial Times reported yesterday that many banks that have received government aid are planning to participate in the auctions of each other’s assets.

The Khan Academy, a ‘not-for-profit organization, has posted the following great ‘chalkboard’ commentary on YouTube describing how the banks might game the system.

The fact that the banks are trying to purchase each others “toxic assets” is not surprising. None of them is going to write these assets down to their “real market value” which is why there has been little to no trading in the secondary market. If the banks were to sell or mark down their toxic assets to the “real market level”, many would be insolvent. In that scenario, the common shareholder is wiped out and those banks would have to be nationalized to prevent a collapse of the financial system — an area our government does not want to go.

So we are left with the Geithner plan, a plan that looks good on the outside but could have disastrous implications for taxpayers if these loopholes aren’t fixed. Until the govt is prepared to wipe out shareholders and nationalize the banks, the taxpayer is going to be holding the bag. Unfortunately, I don’t see any way around it.

Uncategorized banks, geithner, toxic assets

Today Secretary Geithner and Chairman Bernanke were busy testifying before the House Financial Services Committee regarding the AIG bonuses.  They really didn’t say anything new, and the most interesting part of the testimony is below:

Check Out The Protesters in the Back

On another note, it looks like 15 of the top 20 AIG execs have agreed to return the bonuses in full.  However, it looks like they were strongly coerced by the New York Attorney General who made the following statement:

“My intention today is if a person returns the money, I don’t believe there’s a public interest in releasing the names. People who do return the money, they would no longer be on our list”

-Andrew Cuomo, New York Attorney General

This almost seems like a form of blackmail — give back the bonus or we will release your name to the public.  No one wants to be handed up to the public given that they are currently an angry mob armed with pitchforks and torches.  CNBC is reporting something similar with an internal memo being circulated stating that names of bonus recipients will not be released if certain “performance targets” are met.

Not much else happening in the market as it seems tired after yesterday’s gains.

Uncategorized aig, bernanke, bonuses, geithner

Alas!, the details of the long awaited Public-Private Partnership Investment Program aka “Geithner bank bailout plan” were released today by the Treasury. Compared with the debacle a couple weeks back when Geithner first introduced the plan, but failed to provide any concrete details, the markets responded very well to this latest announcement with the major averages trading to their highest levels in more than a month. The Dow closed up almost 500 points!

The plan targets two types of impaired assets sitting on bank balance sheets: Legacy Loans and Legacy Securities. Through the use of FDIC debt guarantees, TARP money, and the Fed’s TALF program, the government intends to provide financing to private investors wishing to purchase these impaired assets from the banks. By allowing private investors to make use of leverage, the plan is likely to create higher prices for the assets. Assets would be sold to the highest bidder with the government and the private investor taking equal equity stakes and sharing in the returns.

The public-private partnership solves two pressing issues. First, it sets a “market price” for the assets through the auction mechanism. Second, as opposed to an RTC like entity, the taxpayer is not responsible for all the potential losses from the asset purchase.

In my mind, the plan faces two major hurdles. One is the willingness of Congress to go along with it. As we witnessed last week, Congress seems unwilling to support any actions where it feels taxpayers are bearing an undue share of the risk when compared with the potential upside. In this plan, the taxpayer only has 50% of the upside, but through FDIC debt guarantees, TARP funds, and the TALF, the taxpayer could be on the hook for a disproportionate share of the potential losses.

The second hurdle is the question of whether the banks will actually sell these impaired assets at the “market price”. Presumably investors will try to bid as low as possible to guarantee attractive returns, whereas many banks have not been very aggressive in writing down the value of these legacy assets. Selling the assets would lead to large realized losses and many banks may choose to hold onto the assets and sell them at higher prices in a few years. No one wants to be selling these assets at fire-sale prices if they can avoid it.

Regardless of the potential hurdles, the plan is unquestionably a good sign for the markets. The problem facing our banks is that there was no market for these toxic assets, and this plan creates one. Already some of this country’s largest bond managers Pimco and Blackrock have indicated their willingness to participate in the program. If everything moves forward smoothly, the auctions are likely to start in a couple of weeks. This is another important step on the road to economic recovery.

Uncategorized banks, geithner, rally, toxic assets