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

I came across an interesting article in the New York Post about how Citigroup and Bank of America have been aggressively purchasing AAA mortgage-backed securities in the secondary market. Surely, its a bit bizarre that those banks that hold the largest amount of these securities and have taken the largest writedowns are back playing in the same market that hurt them so badly in the past.

“One Wall Street trader told The Post that what’s been most puzzling about the purchases is how aggressive both banks have been in their buying, sometimes paying higher prices than competing bidders are willing to pay.

Recently, securities rated AAA have changed hands for roughly 30 cents on the dollar, and most of the buyers have been hedge funds acting opportunistically on a bet that prices will rise over time. However, sources said Citi and BofA have trumped those bids.”

Both BoA and Citigroup were the recipients of $45 billion in TARP funds meant to to help prop up the economy and jumpstart the housing market.

Despite receiving the TARP funds, both BoA and Citigroup are positioned to take large writedowns if the market for AAA MBS deteriorates further.

“One source said that the banks’ purchases have helped to keep prices of these troubled securities higher than they would be otherwise”

Since trading is very light in these markets, it would be very easy to purchase up to $1 billion in assets at slightly inflated prices to prevent writedowns on the remaining $20 billion or so that they are likely to still have on their balance sheet.

I’m sure this won’t be the last time we hear about this…….

Uncategorized bofa, citigroup, mbs, toxic assets

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