Funny, I had started putting together a resume again. I was considering trying to work for FDIC – all this crisis of capitalism plus the Do Something Important wave I’m feeling from Obama, working for the government and trying to fix the banking sector issues struck me as a good use of a few years of my life.
But that was before I learned the Geithner Plan this morning. Holy Shit! FDIC is going to go from your friendly bank solvency center to ground zero of Wall Street firms raping and pillaging as much of the public commons as it can. It’s going to look like this:
Brad Delong gives a positive overview of the plan. The banks have giant pools of mortgages that they can only sell for 30cents on the dollar. On their books, they are valued at (much) more; they need to be valued at that rate for the bank to stay open. The plan will involve a private-public partnership that will bid on the mortgage pools, and then buy them at that rate; this rate will be more than the 30cents they could currently get from the market. As Delong points out, this partnership will not have the time frame or liquidity issues that the current frozen markets have which are causing the pools to be valued at much less than their actual worth (I think this is an important point – I can elaborate at length somewhere else),.
I think it is a shitty idea. My optimistic hope is that the stress tests are coming back even worse than they imagined, but that Obama realizes he can’t sell the nationalization of 30-50% of the banking sector for 5-7 years; so they do this, the mortgage pools sell for, say, 50 cents on the dollar to this public-private hedge fund, and citi and the other banks still aren’t capital solvent and have to collapse anyway. The banks needed them to be worth, say, 65 cents on the dollar, and even this private-public hedge fund giveaway plan couldn’t put humpty dumpty back together again.
So, what’s the problem? FDIC is leveraging up non-recourse money to insure this partnership. God bless the blogosphere – within 12 hours, I already know of two ways to game it so heads-you-win tails-FDIC-loses. Think of how hard that information would have taken to get public with generic newspapers?
Option 1: The Geithner Put
The FDIC provides 6:1 leverage to purchase each pool, and some investor (e.g., a private equity firm) takes them up on it, bidding $84 apiece. Between the FDIC leverage and the Treasury matching funds, the private equity firm thus offers $8400 for all 100 pools but only puts in $600 of its own money.
Half of the pools wind up worthless, so the investor loses $300 total on those. But the other half wind up worth $100 each for a $16 profit. $16 times 50 pools equals $800 total profit which is split 1:1 with the Treasury. So the investor gains $400 on these winning pools. A $400 gain plus a $300 loss equals a $100 net gain, so the investor risked $600 to make $100, a tidy 16.7% return.
The bank unloaded assets worth $5000 for $8400. So the private investor gained $100, the Treasury gained $100, and the bank gained $3400. Somebody must therefore have lost $3600…
…and that would be the FDIC, who was so foolish as to offer 6:1 leverage to purchase assets with a 50% chance of being worthless. But no worries. As long as the FDIC has more expertise in valuing toxic assets than the entire private equity and banking worlds combined, there is no way they could be taken to the cleaners like this. What could possibly go wrong?
If I, as a “financial institution” can participate as a bidder in these auctions [of my own assets] I can foist off my loss onto the taxpayer. Here is how I can rig the game so as to avoid an otherwise-inevitable loss:
– I become a “bidder” and “bid” on my own assets at 75 cents.
– I am providing 5 or 10% of the money. The rest is covered by Treasury, The Fed and the FDIC via guaranteed bond issuance.
– The loan, ex my contribution, is non-recourse. That is, I can lose 5 or 10% of the total portfolio purchased, but nothing more.
– Now the “assets” (a passel of CDOs?) turn out to be worthless. I lose 5% of $75 billion, or $3.75 billion that I put up, plus the other nickel on the original mark, but that’s all.
The taxpayer gets hosed for the remaining $71.25 billion dollars.
This can and will be done if the “sellers” of these assets are allowed to bid either directly or indirectly as it provides a means for banks to intentionally dump bad assets at a certain loss that is much smaller than their expected realized loss over time, shifting the rest of the loss to the taxpayer.
This program has the potential to shift literally $500 billion or more in losses onto the taxpayer, not through the operation of “bad luck” but rather through what amounts to a bid rigging operation.
Be aware that I, along with many others, have figured this out. Also be aware that as taxpayers and your ultimate boss, we do not intend to sit still and allow the public treasury to be looted in such a fashion.
The FDIC’s job is to prevent that sort of looting operation by prohibiting the sellers of these assets from having any financial interest in the bidding side of the equation, directly or indirectly, and I along with many others intend to hold you to that obligation.
Follow through the links – the first example can get complicated, but the second is obvious. If you put something for sale on ebay, and then you and someone else split the costs of bidding on it, you’ll bid it up high on the other person’s dime. It looks, from the original wording, that banks themselves will be in a position to bid on their own assets. With FDIC covering the dime. Financial Engineering at work!
There are a lot of reasons to nationalize, but one of the most obvious ones is that at this point, the incentives to build a healthy, well-functioning firm out of a currently defunct one in the financial sector is gone. With the fundamentals all destroyed, and the public coffer right there for the taking, a lot of man hours are going to be going into the act of “tunneling”, or theft, value into zombie non-productive activities, or outright ransom.