We have a problem. Our problem is that Timothy Geithner is about to use our money to buy between $500 billion and $1 trillion “worth“ (more on that later) of toxic legacy assets. Our problem, put another way, is that we’re about to buy the financial equivalent of a whole lot of Kid Rock albums.
The short of it is that, as Geithner announced last Tuesday, Americans are going to give a few really rich guys (e.g. hedge funds and private equity firms) a crap load of money (between 67 percent and 93 percent of the total outlay) so that those really rich guys can give that crap load of money to some other really rich guys (e.g. Citi and Bank of America) so they can stay really rich (by removing toxic legacy assets from their balance sheets).
Despite the administration’s best attempts to convolute and obfuscate the plan in the hopes that Americans won’t be able to understand it, the Public-Private Investment Program (PPIP) is actually pretty simple.
The program dealing with toxic loans goes like this: The bank decides what assets it wants to auction, at which point the FDIC will provide “at most,“ i.e. “in practice,“ 6-to-1 debt-to-equity leverage for investors. Funny thing about the FDIC’s loan is that it’s non-recourse, so if the value tanks the investor just hands the FDIC the assets on their way out the door.
Anyhow, once the auction is completed and a price established, only then does the bank decide if it actually wants to sell. This is a put option, and it protects the bank from any uncomfortable write-downs by allowing it to set a minimum bid ex post. This is a big deal; if the spread between the winning bid and the bank‘s minimum sale price is too high, the whole plan crumbles.
But let’s assume the bank is willing to sell. The Treasury Department would then give the investor half of the cash it needs to cover the price after the FDIC leverage is applied. In theory, the treasury shares the gains and losses equally with the investor, but any further losses are all swallowed by the FDIC.
Ultimately, we’re on the hook for 93 percent of the cost of the asset purchase.
The program for securities, all those collateralized debt obligations backed by mortgage, auto and student loans and credit card debt, is the same in principle: minimal investor, uh, investment, and lots of taxpayer subsidy.
Now, the only way for this thing to work, and by work I mean remove between an eighth and a third of banks‘ toxic assets, is if Obama and Geithner can entice investors to intentionally overpay with taxpayer money. There is no other way for this to function. You know how I said that we would be buying between $500 billion and $1 trillion “worth“ of this shit? Well turns out the question of what this shit is “worth“ is about as open as Bristol Palin’s … well, anyway….
Banks are arguing that there just isn’t a market for toxic legacy assets; no one’s buying them because investors are irrationally panicked. The assets, they claim, are illiquid; there’s no pricing mechanism, and banks would be forced to take massive losses if they had to sell them or mark them on their balance sheets at market prices. Obama’s bought this garbage, and now he’s conjured a highly subsidized, highly rigged market to facilitate a gigantic transfer of wealth.
This is completely unnecessary, of course, because there actually is a market for toxic assets; but banks aren’t very keen on paying attention to it because the prices the assets are selling for would render them insolvent. Instead, banks prefer to just make something up; if they say an asset is worth face value, then damn it it’s worth face value.
“But wait!” you say. “Since Obama’s plan establishes a clear market price for the assets through the auction, shouldn’t the banks then have to mark to market, take write downs and risk insolvency?” Yes, they should. But no, they won’t.
Why? Because the Financial Accounting Standards Board has just decided that as of Apr. 2, mark to market is going the way of Marky Mark; under new rules pertaining to toxic legacy assets, a bank “would be required to assert that (a) it does not have the intent to sell the security and (b) it is more likely than not that it will not have to sell the security before recovery of its cost basis.“ As I said: If they say an asset is worth face value, then damn it it’s worth face value.
The argument for altering mark to market is that if a bank “does not have the intent“ to sell an asset, it shouldn’t have to value that asset at its sale price.
But how might a bank decide between holding an asset to maturity or selling it? Why, by determining what the market is willing to pay for it, of course! So the bank looks for buyers (thus marking the asset to market), freaks out because it’s not worth shit, and then claims “it does not have the intent“ to sell the asset and it will “more likely than not“ hold on to it.
This amounts to building a put option into the accounting rules, and will lead to a dangerously undercapitalized banking system.
Oh, and in case you had any doubt that these assets aren’t worth what banks say they are, the FDIC has just requested a $500 billion credit line to the Treasury; they know they’re going to take massive losses on the assets as a result of the PPIP, and they plan on borrowing from Treasury (i.e. us) to cover them.
Congratulations, we just became the bad bank.
Everyone involved in this charade, the banks, the hedge funds, the FDIC, the Treasury, the Fed, Obama himself, all know it’s a scam. Indeed, it must be for it to accomplish its goal.
But it gets worse.
The PPIP, assuming it “works,“ doesn’t do anything but return us to the status quo circa 2006; it leaves behind the same small number of the same large institutions run by the same people with far too much systemic risk, internal complexity and clout.
So to supplement the PPIP, Geithner made some suggestions for a systemwide regulator with a few new tricks. Some of his ideas make sense, but, as always, the fuck-you is in the fine print.
If you read it carefully, it becomes clear that Obama’s new regulatory scheme is designed to give the treasury broader powers to bail out the titans of finance; it creates, in essence, a permanent TARP, the very same program that’s allowing the PPIP to go forward in all its dubious glory.
But there is a glimmer of hope.
Maybe, just maybe, the PPIP is itself a ploy. The administration may actually be counting on the PPIP to fail, finally making it politically possible to do the only thing guaranteed to have worked from the beginning: taking the insolvent firms into receivership.
K.C. CODY hates all these acronyms. Commiserate with him at kccody@ucdavis.edu.
