Geithner's big plan for toxic assets

March 21, 3:37 PMProgressive Politics ExaminerJay McDonough

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Details are emerging of Treasury Secretary Tim Geithner's plan to address the estimated $2T of toxic mortgage assets held by the nations banks. 

The plan to be announced next week involves three separate approaches. In one, the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled assets that banks want to sell.

In the second, the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money.

In the third piece, the Treasury plans to expand lending through the Term Asset-Backed Securities Loan Facility, a joint venture with the Federal Reserve.

Feedback to the plan is fairly consistent.  And not favorable.

From Paul Krugman:

But it’s immediately obvious, if you think about it, that these funds will have skewed incentives. In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem.

From Calculated Risk:

With almost no skin in the game, these investors can pay a higher than market price for the toxic assets (since there is little downside risk). This amounts to a direct subsidy from the taxpayers to the banks.

From Naked Capitalism:

So presumably, the point of a competitive process (assuming enough parties show up to produce that result at any particular auction) is to elicit a high enough price that it might reach the bank's reserve, which would be the value on the bank's books now.

And notice the utter dishonesty: a competitive bidding process will protect taxpayers. Huh? A competitive bidding process will elicit a higher price which is BAD for taxpayers!

From James Galbraith:

Note that even a small loss of capital, relative to the purchase price, completely wipes out the interest earnings on the Treasury's loans, putting the government in a loss position and giving the banks a windfall.

If I'm right and the mortgages are largely trash, then the Geithner plan is a Rube Goldberg device for shifting inevitable losses from the banks to the Treasury, preserving the big banks and their incumbent management in all their dysfunctional glory. The cost will be continued vast over-capacity in banking, and a consequent weakening of the remaining, smaller, better- managed banks who didn't participate in the garbage-loan frenzy.

If I were a member of Congress, I would offer a resolution blocking Treasury from making the low-cost loans it expects to offer the PPIPs, until GAO or the FDIC has conducted an INDEPENDENT EXAMINATION OF THE LOAN TAPES underlying each class of securitized assets, and reported on the prevalence of missing documentation, misrepresentation, and signs of fraud. In the absence of a credible rating, this is the minimum due diligence that any private investor would require.

My meager knowledge of economics doesn't really allow for great understanding of all the details and nuance of the Geithner plan.  So, as with similar situations, I rely on folks whose opinion I trust.  That Paul Krugman, James Galbraith, et al. are skeptical (or scornful) of the plan is terribly concerning. 

But I do understand enough to know this is high stakes and it's damn important to get it right.  It also seems like alot of machinations just to avoid nationalizing banks.