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

US Stock markets rallied Tuesday on the back of the release of an internal memo at Citigroup in which CEO Vikram Pandit is “upbeat” and argues that the current stock price of $1 does not reflect the company’s earning power and capital position. Further contributing to the rally were comments from Rep. Barney Frank (D., Mass.), Chairman House Services Committee, indicating that the often debated “uptick rule” may return in a month. Frank was quoted as saying “I am hopeful the uptick rule will be restored within a month”, according to CNBC.

Although these pieces of news are good reason for a rally, I think that the 6% rally that we’ve seen in the Dow & S&P 500 is a bit overdone. Its my suspicion that a good portion of the upswing that we’ve seen was driven by short covering in financial stocks which have been beaten down lately. Any sign of financials returning to profitability and/or rules hindering short sellers are good reasons to cover existing shorts.

Pandit’s memo is optimistic and details that Citigroup has been profitable over the first two months of the year. The market rallied on the back of this, which I think is overdone. Pandit’s statement comes as no surprise to me as banks have continued to make money throughout this crisis if we exclude the massive writedowns they have been taking on their “toxic assets”. The majority of these writedowns usually happen around quarter-end before a company releases earnings. Citigroup holds the largest amount of these “toxic assets” on their balance sheet when compared with other banks, so for me it’s going to be another month before we can pass judgment on if Citi is returning to profitability. For me its a crapshoot as the market for these “toxic assets” continues to deteroriate. Full text of the Pandit memo can be found here.

As for the return of the uptick rule, nothing is DEFINITE, but Barney Frank’s words are encouraging. I’m taking a wait and see attitude with this market and not getting too excited about the news.

Uncategorized citigroup, rally, stock market, toxic assets