Can the Public-Private Plan Work?

Back in September, Simon and I wrote two op-eds on the governance and pricing challenges of buying toxic assets. As many people have noted, those problems have not gone away. The latter, in particular, represents a formidable barrier to Tim Geithner’s latest proposal to create a public-private partnership to relieve banks of their toxic assets. (In summary, the problem is that banks do not want to sell at the price the free market will offer, because (a) they think the assets will be worth more later and (b) doing so would force them to take writedowns that might make them insolvent.)

Lucian Bebchuk also wrote an op-ed on this topic in September, and to his credit he is still trying to turn “TARP II” into something feasible in his new paper, “How to Make Tarp II Work.” The paper has some good ideas but I’m not sure it solves the basic problem, which unfortunately has to do with the laws of arithmetic.

One of Bebchuk’s key points is that there should be multiple funds buying toxic assets rather than one super-aggregator fund, for the basic reason of price competition:

The existence of such a significant number of private buyers armed with substantial capital will produce a well-functioning market for troubled assets. This will be a market in which many potential sellers (banks) face a significant number of potential buyers (the funds). The profit share captured by the funds’ private managers will provide these managers with powerful incentive to avoid overpaying for troubled assets. At the same time, the profit motive of the selling banks, coupled with the presence of competition among the private funds, will make it difficult for funds to underpay for troubled assets. As a result, we can expect the market for troubled assets to function well, with prices set around the fundamental economic value of purchased troubled assets.

More on that last sentence later.

He also has a clever idea for how to create that competition: Have private-sector fund managers bid for government money (capital or loans – more on that in a second) by bidding the maximum percentage of capital they are willing to provide (the rest of the funding coming from the government). The fund managers willing to put up the most of their own money will get the government funding. This will use the market to minimize the amount of government money that has to be contributed.

Bebchuk also recommends lock-up provisions that ensure that investors – whether private or public – cannot withdraw money from the funds for at least three years. This will help fund managers focus on long-term value without having to worry about having to sell assets into an illiquid market in order to meet demands for redemptions.

These are good ideas. But I’m not sure they are enough to make the market work, and this is where the laws of arithmetic come in. In fact, here’s Bebchuk’s statement of the problem:

A well-functioning market will convert some of the troubled assets held by banks into cash and, perhaps more importantly, provide more reliable valuations for the troubled assets that banks will retain. While this might confirm the claims made by some banks about the value of their assets, it might lead to realization that some other banks are insolvent or inadequately capitalized, which would require infusions of additional capital. Thus, restarting the market for troubled assets might well be insufficient by itself to solve banks’ problems.

Even if you have multiple buyers willing to pay “economic value” for the assets, and multiple banks who want to sell them, you could still have a market failure; those banks could refuse to sell because it would force them to recognize losses that might make them insolvent (and no CEO wants to be CEO of an insolvent bank). In fact, this is what many people think is the case right now. All the people who might invest in a public-private partnership could buy those toxic assets right now, but they can’t agree on prices with the banks who hold those assets.

So if we want TARP II to work, it has to make it easier for buyers and sellers to agree on prices. Lock-up provisions could help, but presumably if there are private investors willing to agree to three-year lock-ups, then private fund managers could raise money from them right now. What is Geither’s public-private partnership going to change? In order to get to a price that buyers and sellers can agree on, buyers have to be willing to pay more than they are currently willing to pay (because the banks aren’t selling at their current willingness-to-pay). There’s only one way the government can do that: by sweetening the deal.

Here is Bebchuk’s example of how this might work:

Consider a $1 billion fund established with a $50 million equity investment contributed by the private manager and $950 million in debt financing from the government’s Investment Fund. In this case, while the private manager will be the first to bear any losses of the portfolio, the private manager’s potential loss from the fund’s $1 billion portfolio will be capped at $50 million. On the upside, however, the private manager will fully capture any profits that the government’s capital of $950 billion generates above the loan’s low interest.

Let’s say that I’m a fund manager, and without government money I’m willing to pay 30 cents for some asset.  That means that when I run my valuation models, there is some chance I will be able to sell it for more than 30 cents, and some chance that I will have to sell it for less, and those distributions balance each other. Government money doesn’t change that distribution of outcomes; it just changes the share of the gains or losses that I incur. In Bebchuk’s example, out of those 30 cents, only 1.5 cents (5%) are mine, so I don’t have to worry about the risk of the price falling below 28.5 cents. But I still get all of the upside. You can see how that shifts my expected outcome in my favor. Because my losses are capped at 5% of my purchase price, I might be willing to pay 40 cents intsead of 30 cents: even though my chances of making money are small (the distribution of eventual sale prices hasn’t changed), my losses are capped at 2 cents (5% of 40 cents), so I don’t need a lot of upside to compensate for my limited downside.

In short, the larger the proportion of government funding, the higher my willingness-to-pay. The purpose of Bebchuk’s auction is to find the fund managers willing to do the job with the least government funding.

This all makes sense, but here are the issues. First, the government financing in this example is a government subsidy. If the taxpayer is taking on the downside (after the first 5%), but none of the upside, and charging the fund manager a low interest rate, then that’s a losing proposition. Looked at from another perspective, if the fund manager’s expected take has gone up, then someone else’s expected take has gone down. Maybe it’s a subsidy we have to grant for the public interest, but there’s still no free lunch. (The government could contribute some capital instead of debt, but then the government’s capital has the same characteristics as the private capital, and the same amount of debt will be required to sweeten the deal sufficiently.)

Second, it still might not work. We don’t really know what the gap right now is between buyers’ willingness-to-pay and sellers’ reservation prices. A government sweetener will increase buyers’ willingness-to-pay, but there is a limit: if buyers think that an asset is worth 30 cents, and the chances of it ever being worth more than 50 cents are infinitesimal, then they will never pay more than 50 cents – and we don’t know if that’s enough to get the banks to sell. So it’s possible that we could set up the most efficient possible mechanism for distributing government financing to the most well-incented fund managers, and the market could still fail.

In the end, if Treasury is going to go down the public-private toxic-asset-purchasing path, then I think Bebchuk has some good suggestions. But there’s still no magic bullet here.

57 thoughts on “Can the Public-Private Plan Work?

  1. Simon & James : you need a catchy Tom Friedmanism about the banking oligarchs who are the eminences grise [ or should that be green? ] behind this crisis. Remember Friedman’s ‘Hamas rules’, ‘internet 2.0’ and ‘flat world’?

    Instead of ‘Banking Oligarch’, why not, ‘Bonkingarchs’? Not only is this a distillation of ‘banking oligarchs’, it also suggests bonking madness, and their penchant for trophy wives.

  2. Why hasn’t some expert commentator hammered home the point that suspension of the mark-to-market rules is a canard with respect to the banks? In other words, very few banks ARE marking their assets to the market as things now stand. If they were, they’d be insolvent. Although this may seem to be an obvious and, perhaps, insignificant issue, there is one main reason to bring the point home hard. We will finally be able to dismiss the mark-to-market matter from future discussions. Also, some people’s eyes will be opened to the fact that enormous games are being played by the banks, their auditors and the regulators to convince the public that we provided money under TARP to only “healthy” banks.

  3. Proposals of this kind have but one objective: The wellbeing of investors and the managers of financial institutions. That’s what “work” means in this context, not whether it will “work” for taxpayers, but whether it will “work” for those that sought to make sure with their contributions that the election of Obama and the subsequent appointment of the tax-challenged Geithner became nothing more than a quid pro quo for the protection of their long-term interests. And there will be no breaking of the death grip these vermin have on both our government and our economy until the banks are nationalized and prostitutes of the description of Obama and Geithner are literally driven from public service.

    How long are we prepared to endure the intellectualization of this problem, how long to “thoughtfully” examine this proposal or that? Either take the banks over or allow them to fail, and do one or the other right now!

  4. If you buy something at 30c on the dollar and you have 20 times leverage, then a 5% move on the price of that bond ( 1.5c) will WIPE YOU OUT!!!!!

    Your calculations and reasoning are totally wrong.

    The original buyers of these assets levered up like mad because they expected that the price volatility of their investment will be very low , lower than their capital buffer. But a buyer that buys at 30c does not need 20 times leverage. Already in the price there is an equity like return built-in.( assumimg that you think that not all the underlying collateral of your bonds will default).

  5. The public/private plan is so obviously corrupt, its astonishing that it is even being considered.

    Let’s see… the government is providing a “wink, wink” subsidy to private funds to invest in toxic assets. The funds have almost zero downside and substantial upside. These funds take 20% of profits, so basically the government is forking over $200 billion of tax payer money, at the very least, to private hedge funds for no particular reason other than that they are funds who specialize in the gambling of worthless paper assets.

    Care to guess who will get the biggest government funding? Yes, you got it. Goldman Sachs.

    I voted for Obama, but am completely dismayed and troubled by his continued support of these bailout schemes, which continue to enrich the same financial institutions which brought about this crisis.

    The whole bailout is corrupt and Obama’s stimulus plan is a nice morsel he is using to calm the middle class. He is giving $800 billion to 299.9 million people and $4 trillion to about 100K people.

    See any disparity here? What’s the debate? This is corruption at its highest level. No different than any third-world country.

  6. Ramesh Nair writes:

    Instead of ‘Banking Oligarch’, why not, ‘Bonkingarchs’? Not only is this a distillation of ‘banking oligarchs’, it also suggests bonking madness, and their penchant for trophy wives.

    There is such a word, already in circulation: banksters.

    As in “The Merry Banksters.”

    In long form: [Hank Paulson|Tim Geithner]’s golfing buddies.

  7. (a) Sam Foster — Well said!

    (b) I do not want Tarp II to work – I do not want Tarp II. I do not want Tarp II to be – in any way – or any hoo.

    ~~ my apology to Dr. Seuss

    (3) NObama & NObanksters 2012!
    (And yes, I voted for BHO in November, a decision I sorely regret.)

  8. Assume that the banks are valuing the assets at fair value (which could be above the “market price” if the market is illiquid.) Why would the private investor buy the asset if there is no prospect of making a profit? Why would the bank sell below the value they think they can get by holding on to the assets? And all this assume zero transaction cost.

    I prefer a solution that avoids the issue of asset pricing. Take $100 billion of TARP money, lever it up with loans from the Federal Reserve to an even $1 Trillion. Now execute intermediate term (1-3 year) repurchase agreements. The entity (lets call it Repo Bank) would buy the assets from the bank at the value currently on the books and at the same time, the bank would agree to buy back the same asset in two years time for 2% more (net any cash flows from the asset.)

    This removes the asset from the banks balance sheet and gives the bank cash which can be lent out. The key is that the repurchase agreement is guaranteed by the FDIC, so even if the bank failed, the Repo Bank would still get its money. The FDIC would get the asset but they would have gotten in anyway when the bank failed.

    If the value of the asset fell by the time the bank bought the asset back then the bank would have to write down the loss at that time. By spreading losses over several years, the bank would be able to apply their earnings against those losses. The assets sold don’t have to be toxic either. Good, illiquid assets could be sold to Repo Bank (such as Citibank’s Mexican operations.) If it sounds like a pawnbroker for the banks, that’s what it is, with extra protections for taxpayers.

  9. Rajesh –

    Either I am not following your train of thought, or you are nuts.

    You state, “The key is that the repurchase agreement is guaranteed by the FDIC, so even if the bank failed, the Repo Bank would still get its money. The FDIC would get the asset but they would have gotten in anyway when the bank failed.”

    Where do you come up with that the repurchase agreements are guaranteed by the FDIC? Clearly these toxic “assets” are valued far above depositor holdings (what is currently guaranteed).

    Is this FDIC guarantee you are referencing just a part of your/the plan? That is, just one more version of robbing taxpayers to pay the banksters?

    Those in academia, Washington, and corporate executive suits need to come down from the ivory towers and out of their marble offices and plant their feet on earth – preferably in deep, warm, organic earth.

  10. Sam Foster,

    “The public/private plan is so obviously corrupt, its astonishing that it is even being considered.”

    I think you have that one wrong, Sam. Its only because it’s corrupt that it can be considered.

  11. James Kwak writes, “In summary, the problem is that banks do not want to sell at the price the free market will offer, because (a) they think the assets will be worth more later and (b) doing so would force them to take write downs that might make them insolvent.” I would add one more point. (c) Much of the value of their stock is driven by the volatility of their toxic assets. Even if the banks are still solvent at market prices shareholders in distressed banks will see their stock price drop if the volatility of the banks’ assets is reduced. This is because shareholders are protected on the downside by a limited liability put option. Therefore, any buyer of toxic assets must buy the assets plus overpay the bank’s shareholders for the lost volatility. This is explained more fully in my paper “The Put Problem with Buying Toxic Assets” at

  12. Prof. Kwak —

    Your example can be made more clear by imagining not one asset worth 30 cents on average, but (say) 10 assets worth 30 cents on average.

    Suppose 9 of the 10 assets are expected to be worthless, but one of them is expected to be worth $3.00. (But we don’t know which is which; that is what it means for these assets to be worth 30 cents “on average”.)

    With the government-supplied 19:1 leverage in your example, the investor will make out like a bandit even if he buys all 10 assets for $1 apiece. That is because he only loses 5 cents on each of the 9 of the 10 that wind up worthless, but he gains $2 on the one that turns out to be worth $3. Meanwhile the taxpayers lose .95*9 = $8.55, most of which winds up in the hands of the bank that got to unload all those pieces of garbage for $1 each.

    non-recourse loans = insurance = gift to banks
    The only difference is that maybe the taxpayers might be fooled by the more complex arrangements.

  13. John Lowell,
    That gave me a good laugh. I’m definitely mixing up cause and effect when it comes to government policy. Much of my extended family is Brazilian, so I should be familiar with the fact that only corrupt policies can possibly be considered. Need to go back and read my Orwell for a good doublespeak lesson. What’s good is bad and what’s bad is good.

  14. Nemo,

    Thanks for the excellent example. But presumably, won’t the investor need to pay back the government’s initial loan of $9.50 from the gains? This would be too transparent as far as theft is concerned.

    Presumably, the way it will probably be set up is that there will be, let’s say, ten funds each getting $1 for each $0.05 they put in. 9 out of 10 of those funds will go to zero and one will double in value.

    The fraud will be that all ten funds will be owned by one big fund (e.g. Goldman Sachs) under ten different corporate names operating out of ten different countries.

    In this way they will easily cover up all their tracks, and proceed to steal huge piles of money. It’s very similar to former penny stock scams.

  15. The current banking model needs to be thrown out and we need to return to banks being the broker between lenders (depositors) and borrowers via the medium of exchange in fashion (my preference being currency backed by gold) with FULL reserves.

    Oh yes, this is old fashioned, and the wheelers and dealers won’t like it, because it turns makes “buggy whips” out of their antics – but this is what we need. And, yes, growth may be slowed, because leverage will be out the window, but growth ain’t all its cracked up to be.

    In my dream world there is no stock market, as there are no public companies…but I’m not go down that road this evening. If you’re in the mood for radical notions, read about Mondragon:

  16. Getting government intervention right is never easy. The best approach is one where there is real transparency and accountability … with money being tracked month by month and accounted for … not investigated five years later which is the standard government operating procedure.

    The economy needs investment to create jobs (build payrolls) and spending that improves productivity. Stimulating conspicuous consumption is not needed … but everyone should be able to get the basics, and the best way for this is jobs.

    Jobs are secure when companies are producing what the world needs and doing it productively. The USA (40 years ago) paid high wages, but was low cost because it was very productive … and had very low cost energy. But political and corporate leadership has not been very good … and US productivity is now nothing much to be proud of … and the infrastructure is old and decrepit.

    Upgrading the US people and the US infrastructure is essential and a huge challenge but if we can go to the moon we can do this. Success will not be achieved, however, if the US people merely wait in line for a hand-out or figure how best to steal the money.

  17. This is beginning to feel like The Twilight Zone. Submitted for our approval, TARP 2.

    Let’s see, in Sept. William Gross offered to buy Toxic Assets for free. The plan was to purchase the TAs cheaply, finance them cheaply, and then sell them someday for a profit. Sound familiar. Now, that plan can work, but it has some big problems:
    1) The price on the TAs will rise when the government gets in. There’s going to be a subsidy effect, no matter how hard to value, but it could be large. Or, the TAs will be purchased at a premium on purpose to transfer some of the losses from the people holding the TAs to the taxpayers. However you put it, it’s hard to see being able to actually prevent some kind of overpayment.
    2) Conflict of Interest. William Gross offered to work for free. Nothing against William Gross, since he’s one of the few financial figures I listen to. He might be my first choice. But there’s no way to get the feeling of collusion and conflict of interest out of this situation. As a few competitors of Gross said, Gross will work for free, but Pimco would do well somehow. After 8 years of crony capitalism, in a situation laden with possible conflict of interest, this seems like a deal-breaker. Imagine what will happen going forward if the purchase of the TAs is a big bust, but places like Pimco do very well. This is not a good bet.

    So, the plan could work, but the negatives are very real.

    As for TARP Recapitalization, that was a Hybrid, in which the government had different interests than the bank. The government saw the money as a kind of credit stimulus, the banks as a bridge loan until better times. It was worse than that, because the taxpayers also own stock, so the government was actually telling the banks to loan away but don’t lessen the value of our stock. Unreal. The problems with all hybrids are:
    1) Conflicting interests
    2) Subject to lobbying
    3) Hard to assess
    4) In reality, hellish to get out of, costly, and seen by the banks as insurance paid for by lobbying.
    Sounds like the GAO report.

    Many of us were for a version of the Swedish Plan ( Not an exact copy ) because:
    1) It was a model, and could be assessed
    2) It had worked
    3) It was harder to lobby against.
    4) It was cheaper and easier to get out, contra hybrids
    No one thought this was a perfect plan, but it was better than the alternatives.

    All of this was said in the first week of October. Do people really believe that the path taken has turned out to be better than what was just outlined?

  18. Sam Foster —

    No; that is what “non-recourse” means. The investors take out a *separate* loan for each asset they purchase, and if that loan goes bad, there is no “recourse” to any other asset the investor happens to own.

    Mark my words: This is how they intend to structure the arrangement so that the bail-out does not look so obvious.

    This is not just my opinion. See this analyst note from JPMorgan. (Search for “P-PIF” and read the paragraph carefully.)

  19. Basic question here that’s been bothering me:

    Given Bank A and Bank B, each of which has some amount of Toxic Asset X, is it safe to assume that the price at which Bank A can safely sell Toxic Asset X without becoming insolvent is the same price at which Bank B can sell without becoming insolvent?

    In other words, have the various banks written down similar assets to similar levels on their balance sheets? If not, how could any public-private market come up with an appropriate price for the assets?

  20. Hi Nemo,
    Thanks very much for the clarification. Even more corrupt than I thought. There isn’t even any need to set up different corporations as each loan will be segregated from the others. Very interesting.

    It’s doubtful the majority of the country will even understand what is going on here. Sad state of affairs.

  21. Why should ‘we the people” be on the hook for anything here? If 5% collateral is being suggested because 5% private parties plus 95% government funding is the only way to come up with enough capital to get the job done, then maybe. But, why should there be anymore backstops? If the government wants to own this stuff with the private sector, why not just have some shared interest for sale? If these products turn out to be faulty in terms of their original rating, then the parties that rated and sold the products may be liable for the damage, but of course, bankrupt entities have nothing to satisfy liabilities.

    In the meantime, if there are entities that would right now, be insolvent because they continue to hide in the shadows, the reality of their balance sheet, why should taxpayer money go to condone this behavior?

    And a bigger question here is, who would have ever agreed to allow the TARP I money go to prop up ANY insolvent institutions, and why isn’t anyone insisting on a retroactive valuation to September 15, 2008 in order to get an accurate view of the issues prior to the possible government infusion of funds into these entities through AIG and through the TARP 1 infusion?

    If these entities are insolvent, why should the public be deceived by continuing to allow their shares to trade for a price over pennies? In the same way, why did Bank of America buy Merrill Lynch for apx $29/ share if they were (or headed for) insolvent? $29/share is a hefty price for a company verging on insolvency, if that happened to be the case.

    I think the people of the US have already been prepared for “changes”. Maybe America is ready for a few “too big to fail” banks to have to be broken into smaller banks that can actually function without trillions of taxpayers dollars being taken, and possibly never returned?

  22. I wrote a little hypothetical piece about how the Treasury could leverage $50 billion into $500 billion in troubled asset purchases.

    The key idea is that a lot of assets have already been written down a lot from par. As long as they are not CDO’s of CDO’s, then the assets started with loans that should have had some subordination, if they are structured securities, they had additional subordination, and they have had writedowns.

    The central idea is that the government $50 billion would have to be a subsidy. Investors with cash are looking for 20% returns and the banks have assets that yield libor plus basis points at par. To bridge this gap, I’m suggesting that the investor take the first 20% of losses, the Treasury the next 30%, and the remainder could be financed at reasonable rates, providing leverage to make the deals work.

    Not saying that it would work, just that it could work.

    However, the only area with severely marked down assets are the investment banks with capital market units that own a bunch of structured finance products.

    Regular banks have whole loans that aren’t marked to market. This seems to be a point that few people have picked up on. Whole, vanilla loans were never supposed to be trading securities and were designed to be held to maturity using (mostly) FDIC insured deposits to fund the assets. The combination of guaranteed funding, reasonable capital ratios, regulation, simplicity [no need for calculus], provides a mechanism to carry loans of uncertain value until they either fail or amortize, and to fund losses on an ongoing basis as needed.

    Investment banks are lightly regulated, highly leveraged, and must use derivative accounting — aka m2m. Their traditional funding is not guaranteed and therefore subject to a “run” — which is exactly what happened. Unfortunately, investment banks have tried to queue up with traditional banks for federal money, and people are confused. No one in the local branch seems to be earning $500k/year, and a regular loan isn’t rocket science.

    Large portfolios of Alt A’s or similar weak credits don’t have the m2m pressures — they are just bad loans. Most banks are carrying loan loss reserves in the 3% range. Some of them have taken significant haircuts on certain portfolios, but nothing like the investment banks on structured securities.

  23. CapVandal,

    You are entirely correct. But, I am almost certain that what they plan to buy are CDO’s, CDO’s of CDO’s, CDS’s, CDS’s on CDS’s ad infinitum. 90% of these are worth $0 and 10% are worth something, as Nemo explained (could be 99% worth $0 and 1% worth something – just being conservative).

    If it was just regular loans, banks would not be insolvent, nor would there be a financial crisis.

    The point of buying structured securities, is because that’s where the real money is. As you say, you can’t make $500K a year giving out a real loan. But you can make millions slicing and dicing loans and selling phony paper.

    Since Geithner is out to save Wall Street, it’s certain his objective is to get the CDO and the other markets humming again. Problem is that it’s doubtful this will succeed, since everyone with any modicum of intelligence realizes this is an outright scam and therefore these Markets will remain cautious, since the bottom could collapse at any time.

    It’s a game of musical chairs, as Keynes once put it.

    Good night to all. Tomorrow the financial games begin again. Obama should rally the troops for a few days with his Housing plan, helping to deflect attention from Geithner’s $1 trillion heist.

  24. CapVandal,

    Your note may suggest that the first TARP money was distributed to save the old investment banks–a long shot from what the public was told about infusing cash into healthy institutions? I think most of the US population is paralyzed and pushed into membership of a GROUPTHINKTHINKTANK concept that if we don’t save AIG, the world will end as we know it!

    This is very disturbing.

  25. Sam Foster,

    Pleased I could inspire a laugh. Wish I could find something funny about the vermin the system manages to parade before us election after election. How anyone past the age of thiry – when the imbecile enthusiasms of youth begin to fade – can even bring themselves to vote, pretending in doing so that ours is a democracy in something but name and that the filth that run it are even close to being well intentioned, utterly escapes me. One hopes that what we are now witnessing is the death rattle of a 235 year old fraud, and in its aftermath the promise of a wholly new approach and a new Constitution. One as easily corrupted as the one we now have in place deserves an early interment.

  26. So, what is the real truth about the percent of income that the 300 private parties (if this is true that 300 private parties own shares that comprise the Federal Reserve Bank) that own the federal reserve keep before rebating the earnings back to the US Treasury? With all the conspiracy theories around about the establishment of the Federal Reserve Act, it is hard to even admit that i am intrigued by the issue. But, if anyone will put me to shame and tell me that the Federal Reserve Act is not somehow in conflict with our constitution or whatever it is that seems to be the issue for the conspiracy theorists, i would be grateful. And then i will be quiet.

  27. Sophie et. al –

    If you have not read Naomi Klein’s THE SHOCK DOCTRINE, you should add it to your reading list. All the crises are used as ways for the powers that be (some visible, some not) to get their way.

    On another note, recall there was a huge rally by the public against TARP I. That is why it was initally defeated in the House. But after seeing the banksters get their way, I think there is more a sense of hopeless outrage than apathy. Virtually nothing “gets through” to our representatives. Talk about GROUPTHINKTANK – that would be Washington. In addition, the lobbying forces have the upper hand.

    Change may not be imminent, but it IS a comin’ – and I fear it ain’t gonna be pretty unless Obama does an about-face with the bankster gang.

  28. Is anyone besides me wondering why, after realizing in late 2007 that bank’s debt holdings may be in trouble, not a single large bank has audited their debt holdings (or admitted to doing so)? Wouldn’t this be a great piece of information to base pricing these assets with?

    If the banks won’t do it, how about we stimulate the economy a little by contracting some auditors to take a look at these assets and see how risky these debts really are?

  29. Thank you b traven, i will read it soon.

    I guess people gravitate to what they understand, and while the banking questions that need to be investigated (did Lehman have to fail when they asked for a 6B bridge loan but were denied, even though a few days later AIG is given money which looks to be money that flowed right to the very entities (hundreds connected to maybe 2 companies) that were betting on Lehman going down…how is that, money for nothing thanks to free money from AIG/GOV; 350B TARP passed out to maybe save the 2 who benefited maybe most from the big passing out of money through AIG; and BAC bullied into paying $29/share for MER even though they were in deep trouble; 300B+backstops for Citi, adn on and on) are so vital, and it looks like our country is having it’s coffers taken right under our noses, all anyone wants to discuss is the stimulus plan. In my opinion, the stimulus package is another redherring, the same way that ‘the world will end if we don’t save AIG’ , was used to move forward support of this GROUPTHINKTHINKTANK concept that just happens to be protecting the interest of all the leaders of the firms that have much of their wealth invested in their own company’s stock options.

  30. James Kwak’s point remains….the banks remain unwilling to trade mortgage paper at the prices at which trades occur every day (yes, every day). Prime paper trades at 65-70, Alt-A at 50-ish and sub-prime at 35-ish. Most are carrying these “investments” 20-25 points higher. This was the WaMu scenario….toast at prevailing prices. They will hold on as long as they can…..why not?

    BTW….I am totally impressed with Citi’s 12%+ tier 1 ratio as its CEO defiantly pronounced at the House hearing…duh, we can all rest safely now.

  31. jaroslav Tyman: 10:45 HEAR-HEAR!!! and halleluiah to jaroslav Tyman if he can get it done!

    First you need a retroactive pricing on MS and GS on Sept 14, prior to Lehman failing and subsequent monies paid for bets on Lehman’s demise through the AIG/GOV payoffcreditdefaultswapsonlehman machine! (All you can find in the literature is the NET payments AIG made. And since MS and GS have hundreds of connected entities, it would be quite a feat to get the job done, but if you could do it, halleluiah to you!!!)

  32. So, Doesn’t this all boil down to the fact that the Deusche Bank Research Note might very well be right, and we’ll have to pay the highest price possible no matter what?

  33. It appears :

    – The house of cards was based on models (representations of reality)
    – There are ten opinions of what we face as reality for every 8 participants
    – That reality is what I will pay you for what you are selling
    – The most direct market mechanism possible is our only recource

  34. not a long narrative here……nationalize the big banks….the bait was thrown out there with the first of tarp and they reacted like immmature,money grubbing and childish behavior…..the time is now to rid ourselves of the criminals of the past….walstreet,,,,good luck….the country is calling….we need not you….the market is already tanked….just sickening what you did….

  35. Whenever I hear the term “public-private partnership,” I get a very sour taste in my mouth. Inevitably, in my experience, it means that the public takes on the risk and the private sector takes any profit. Could it be that that sour taste is why they call it “lemon socialism?” Or is it just that the taxpayers soon will be forced to buy the costliest “lemons” ever sold?

    Let’s not forget that Lehman Brothers, Goldman Sachs, JP Morgan Chase & Co., UBS and DLA Piper were among Obama’s top contributors, providing the early lead in the “money race” that made his candidacy viable — nor should we forget that Robert “Wrongbob” Rubin, Citibank director and slayer of Glass-Steagall, created the Obama economic team.

    Anybody who still believes in the “Change we can believe in” is extremely naive.

  36. A relatively simple means of handling so called toxic bank assets and keeping banks in business is a temporary suspension of applying mark-to-market to mortgaged-backed securities now on banks’ books, with conditions. I offered example conditions in an ill-fated post last evening that seems to have disappeared in cyber space. I’ll try to reconstruct them in a later post today. There would be no need for any additional TARP funds, at this time.

  37. So here is a question from what is perhaps a naive perspective. Anyone who has been paying any attention at all to Bailout Nation – and clearly there has been a lot of interest, based on the blogosphere – knows that the banksters are engineering a transfer of wealth from taxpayers pockets to theirs. It’s quite obvious and glaring. The question in my mind: is there a tipping point, and if there is, what does eventual real “change” look like? Is our system strong enough to clean up the inter-tangled mutant mess that is our political/economic elite without violence? Do we still have a system that at “some” point will respond to the growing outrage of the increasing numbers of people who see the truth of what is being done? Or is my naivete in believing that there are actually enough people in this country both educated enough and paying enough attention to begin working on a solution rather than the current protection of the highest-stakes gambling ring ever to go bust? We all know the problem – it’s quite clear and well-described at this point. I haven’t seen many solutions yet. If some of the very intelligent people here start putting forth real ideas of how to move past this particular “bankster” phase in our society (not the first of these phases, and it won’t be the last), there are a lot of us out here looking for solutions. Unfortunately, I haven’t figured out any answers yet (except the obvious short term fact that the banks must be allowed to “fail” – receivership, nationalization, whatever you want to call it). I’m hoping someone is ahead of me.

  38. A second question. Who are the “holders” of the stocks and bonds that form the “ownership” of the banks (as distinguished, to whatever slight extent, from the management)? In other words, when people talk about “wiping out the stock and bond holders, who are we really talking about wiping out? Are these banks held by a small group at the top, or is part of the problem that actually by wiping these groups out, we would be attacking even more the “little” guys whose 401Ks and pension funds are actually the owners of these companies? Any clarification of this question would be greatly appreciated. Thanks.

  39. See below for link to column in IHT on similar lines.
    My concern is that leverage will be used to artificially inflate a price for assets and provide a mark for others.

    LONDON: The plan for a public-private fund to buy up toxic assets in the United States is likely to amount to a fig leaf with which to hide subsidies to failing banks.

    It is also, inevitably, an entirely new subsidy to outside investors, who by definition will participate only if they get better terms than are now available in what we formerly thought of as the free market.

  40. Here’s another obvious reason why this scam from Geithner wont’ work: By the time it’s implemented the funds will have driven the Markets further into the ground and caused a massive state of panic.

    Why? Because if you know that the government is planning to give you a free $1 trillion with no strings attached to buy assets, you’ll want to make sure you get the lowest price possible for those assets to ensure a massive windfall.

    Basically, now the Funds know they are the strong party at the negotiating table. Geither is the weakling. The Funds can now make all sorts of demands, knowing that Geithner has no choice but to acquiesce.

    Terrible position to be in.

  41. Gee, I used to be able to read all the comments on this blog before posting (Curse You, Moyers!! ;-|)

    Bebchuk may be looking at the political reality that giving a handout to someone to clean up the banking mess for us might be more palatable than giving the handout to the bankers who caused the problem to begin with.

    Like Simon has grown fond of saying, use one faction of the financial community against the other.

  42. I don’t see how this makes insolvent banks solvent. If the government has to pump taxpayer money in to recapitalize them, it’s just another transfer from taxpayers to bank managers and investors. The zombie banks gets to blind the public with science again (my eyes glazed over reading the plan above), the sharp VC players (ex-investment bankers) get to make another killing in a financial shell game at taxpayer expense.

    The nation’s collective cognitive abilities are severely challenged right now. Clarity is called for. Write off the bad debt of the zombie banks, put them in receivorship, transfer control of marked-down assets and deposits to good banks. Keep it simple.

  43. “if buyers think that an asset is worth 30 cents, and the chances of it ever being worth more than 50 cents are infinitesimal, then they will never pay more than 50 cents – and we don’t know if that’s enough to get the banks to sell. So it’s possible that we could set up the most efficient possible mechanism for distributing government financing to the most well-incented fund managers, and the market could still fail.”

    Three words: chocolate-covered cotton.

    Yossarian pushed his hand away. “Give up, Milo. People can’t eat cotton.”

    Milo’s face narrowed cunningly. “It isn’t really cotton,” he coaxed. “I was joking. It’s really cotton candy, delicious cotton candy. Try it and see.”

    “Now you’re lying.”

    “I never lie!” Milo rejoindered with proud dignity.

    This is going to be a hopeless exercise until the powers that be finally face up to the reality that the vast chunks of the so-called “legacy” assets are completely WORTHLESS.

  44. Suspending mark-to-market. The following is meant only to encourage thinking of a third option to the current choice between nationalization and closure.

    We begin with the general proposition that time is not of the essence; that all the banks need is the time to earn enough money to write off/sell these toxic assets, and thereby keep $350 billion of taxpayer money for other good deeds. The world as we know it will not come to an end if we solve the toxic asset problem later, rather than sooner, so long as we all know what is going on and that the “what” sounds sensible.

    By way of example, lets have a well publicized plan that lets the banks try do do just that by the end of say, seven years. Banks can choose to enter the program. Those that do not will play according to all the asset-valuation and risk-based capital ratio computation rules currently in effect, and be closed, if necessary. Recall that closure wipes out shareholders, subjects uninsured depositors and bond holders to a financial haircut and senior officers and members of the board of directors to possible financial penalties and other indignities.

    At the beginning of the period, bank examiners at participating banks and their bank managers will agree on what assets to put in the pot and the value of those assets as then appearing on the books of the banks. Banks will then be obliged to reduce that total by sale or write-off by a minimum of 1/7 at the end of each calendar year. Banks must make a report, easily available to the public, on their progress or lack thereof annually, no later than 31 days after the close of each calendar year. The report must bear the attestation of the CEO and CFO as well as the appropriate member of the board of directors. Those filing a fraudulent report would be subject to severe financial and possibly other penalties. The reduction must be met before the banks can pay a dividend or, if members of a bank holding company, send any funds for any reason to the holding company parent or any of its subsidiaries. If the minimum is not reached, the bank will be subject risk-based ratio calculations applied to all assets, and be closed if warranted. (The plan may include some exceptions to this general rule.) Total current and future remuneration of all senior officers and all members of the board of directors will be made part of the report.

    At the end of the seven years, all surviving banks will be subject to risk based capital calculations in accordance with rules then in effect as applied to all assets. Federal regulators will then close, or permit to remain open, each bank in the program, as those calculations dictate. For banks designated for closure, the FDIC would perform its traditional role.

    Going forward all banks of a specified size or larger will be subject to a “to big to fail tax,” similar to the “luxury taxes” now found in some professional sports. The tax will be in the form of risk-based capital ratios well in access of those currently in effect and applied to smaller banking companies and be in addition to deposit insurance premia. Banks in this class will be subject to closure rules much more strict than those applied to smaller banks.

  45. Maybe I am being naive or over optimistic about Geithner’s political power, but I think that the problem of banks not willing or able to sell the bad assets can be resolved through the test strees/recapitalization. If the tests are conducted with very conservative (bearish) assumptions and with a reasonable amount of transparency of results, the banks and Washington will be forced to accept reality. How many days a bank can survive with a no confidence vote from regulatros? By forcing them to mark down, the Treasury can create the possibility of marking up once they sell the assets. And politicaly, this strategy avoids the difficult decision of explicitly opting for nationalizationi. The Treasury can say “I did not want to nationalize them, the problem was that they were insolvent”.

  46. Interesting article and discussion. Perhaps the Bebchuck public/private TA purchase plan could work, but maybe only in combination with and FDIC temporary takeover, to enable the pricing of the TA’s in an atmosphere without the existing bank ownership/managment feeling threatened. And, yes, we are all sick of “bailout fever” but what else is there to do. Don’t do any of it, and watch the world fall into complete economic chaos (Financial Armageddon).

    Additionally, I wish the talking heads would try harder to wrap there arms around the magnatude of the problem. I believe that if we don’t go into ultimate concern (panic) mode over the potential negative outcomes, we (the world as a whole) will come to regret it more than we can even imagine. This situation actually has the potential to become far worse than the Great Depression. If everyone of every political spectrum would just admit that they don’t have any real reliable answer to the incredible depth and complexity of the problem, we will continue to fiddle while Rome burns.

    Incidentally, it’s not just the banking/financial oligarchs that got us here, but also the health care oligarchs, and the energy oligarchs.

    Bottom line is that we should be having the most open conversation possible in the public venue, and resort to the most outrageously extreme options on a worldwide scale. Timidity is the enemy of success. Whatever we think is enough, multiply it by two and do it. We may all be destined to look like central Africa if we don’t.

    I will be fascinated to see how much will there is for the G20 to assemble a bold plan to resolve the issues. This is where the good will toward our President may make something bold and inovative possible. Keep your fingers, toes, arms, legs and wallets crossed.

  47. I am not a big fan of propping up insolvent banks. But if the government has to prop them up to maintain stability, they could allow banks to “smooth” the losses, not unlike Pension/Healthcare accounting under FAS 87 and FAS106. They could give banks some time to recognize these losses such that their earnings replenishes capital faster than losses deplete them. This way, toxic assets are off their books, arguably at fair market value (a price at which buyers are willing to buy)and banks balance sheet become “cleaner” (not withstanding off balance sheet losses, but this is far better situation that highly uncertain on balance sheet toxic assets).

  48. I am no expert in economics, but it seems to me that the goal of involving the private sector is to protect government money while efficiently and fairly manage the sale of hard-to-value assets. I am not sure if I am right in thinking that this mechanism creates a moral hazard from the banks point of view. The banks, as institutions, can simply unload the toxic assets to another entity. Also, the bank executives, as was mentioned in other places, can simply leave the bank to sink at any time after securing their escape. Maybe if banks and bank executives are tied to the deal by getting them to share some of the losses, this will give them incentive to sell the assets with minimum loss. Probably, the losses to the banks should be capped at some level so as not to jeopardize the bank solvency.
    Also, bank executives benefited generously during the boom years and it is only fair that they receive “negative bonuses”. This might be done in the form of raising their taxes or any other mean. so a structure like
    first 10-15% loss to banks
    next 5% loss to private shareholders
    next 5-10% personal loss to bankers
    then 70-80% loss to government

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