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Toxic banks or toxic assets?

by Brad Setser
February 10, 2009

Two weeks ago, George Soros memorably framed the core choice the US now faces as a choice between buying toxic assets or taking over toxic banks.

“The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets.”

There is perhaps a third option: handing the toxic assets over to the banks’ existing equity investors and the banks long-term unsecured creditors, assigning the deposits to the remaining “good” bank and recapitalizing the new bank with public funds.

Judging from this week’s press reports, Treasury Secretary Geithner didn’t like these options.

If Floyd Norris is right, the US Treasury will propose a fourth option: providing credit to private investors that are willing to buy the banks toxic assets.

Private investors then would have to figure out the right value of the banks existing toxic assets. In return, they would get all of the upside. They would also take some of the downside. But perhaps not all the downside.

If the government provided credit to private investors who put up cash to buy toxic asses, the private investors would take the first loss. That discourages overpayment. But with a non-recourse loan the government on the hook if the value of the toxic assets fell by too much. The private investors could extinguish its debt by handing the toxic assets it bought over to the government.

This seems like a transaction that requires the government take on additional risk. But that probably isn’t totally accurate, as the government already in some sense has most of this risk.

So long as the government is committed to protecting the banking system’s creditors – depositors, money market funds and bondholders – from losses, the government already has most of the downside risk on these toxic assets. There isn’t much bank equity left. As a result the government is already on the hook it the banks’ end up taking additional losses on their toxic assets. If the government provided financing to other actors willing to buy the banks bad assets, the government would have more exposure to those players’ toxic assets, but less to the banks’ toxic assets.

The plan Norris describes sounds a bit like the ideas some in the market were circulating a few days ago. The resulting “Geithner plan” also has some similarities to the Brady plan that helped to resolve the Latin debt crisis (really a banking crisis stemming from the banks’ overexposure to some large sovereign borrowers). Both Brady and Geithner seem to want to move bad assets from bank balance sheets to the market. And in both cases the government likely will facilitate the transaction in part by limiting the risks born by private investors. Brady bonds were collateralized by long-term Treasuries, assuring that investors would get their principal back.*

But it isn’t completely clear that Floyd Norris’ story has all the details right. The Wall Street Journal’s reporting suggests a somewhat different potential structure, one based on a public-private partnership. The FT suggests both approaches are under consideration. Krishna Guha:

“The exact details of how the private-public partnership will work are not known. One option discussed by policymakers is for the authorities to co-invest alongside private investors in a “bad bank” or “aggregator bank” that would purchase the toxic assets. Another version would involve the government sector providing non-recourse financing on a large scale for private buyers of toxic assets, possibly in conjunction with guarantees that explicitly limit loss on these assets. “

We will know later today.

The Treasury seems to have concluded that it was impossible for the government to figure out what price it should pay the banks – really the banks existing owners – for their toxic assets. There is a reason why bad bank – like the RTC– generally were created after a bank had already failed and their equity investors have been wiped out. If the government already owns the banks assets (as a result of its guarantee of the banks’ liabilities) it doesn’t really matter what price it pays the “good” bank for the assets of the “bad” bank.

But providing other parts of the financial system – including parts of the shadow financial system — with credit to help it buy the banks bad assets isn’t a perfect solution either.

Implicitly, Geithner and his colleagues seem to have concluded that the “great unwind” has limited the private sector’s ability to absorb the banks troubled assets. Key players no longer can borrow the funds needed to make large bets on troubled mortgage-backed securities. By providing credit to those willing to buy bad assets, the US government hopes to push up their market price up, and in the process induce the banks now holding these assets to sell. The US government in effect is providing the financial system with leverage to facilitate – one hopes – a transition to a less leveraged financial system. The amount that private investors have to put down – relative to the amount they are spending – is a key detail.

And it is quite possible that the market by be suffering as much from a sellers’ strike as much as a shortage of credit. Yves Smith is characteristically direct:

“The elephant in the room is how do we solve the heretofore insurmountable problem that the market price of the bad assets is well below what the banks are willing to sell them for”

So long as a bank can rely on the government to prevent a run (thanks to the government’s guarantee that creditors of large banks won’t take losses; i.e. “no more Lehman’s”) the banks current owners may prefer to sit on its toxic assets and hope the market recovers.

Finding private buyers doesn’t solve this problem. No bank has much incentive to sell its toxic assets at a price that would leave the bank bankrupt. Not selling is one way of gambling for redemption.

Breaking this logjam presumably is the purpose of another reported component of the reported Financial Stability Plan: a review of the balance sheets of large banks and, if needed, additional injections of equity capital into troubled banks. Here the Treasury seems to be moving away from former Secretary Paulson’s desire to put equity into all the banks, even relatively healthy banks, to avoid stigmatizing individual banks.

If the estimates of the banks’ total losses from Nouriel Roubini and Elisa Parisis-Capone are close to right – their estimated losses top those of the IMF, but the IMF’s estimates continue to be revised up – a lot of banks though won’t have any choice. Roubini and Parisi-Capone estimate that the US financial sector’s losses are close to its equity capital, something that no amount of regulatory forebearance can hide. …

It is consequently is likely that the government will end up with a large stake in some banks, even if key banks aren’t formally nationalized. That is fully appropriate. It is clear that the taxpayer is already on the hook for most of the banking sector’s downside. There simply isn’t enough equity left to offer the taxpayers much of a cushion against further losses (in world where the banks’ creditors are protected). If the taxpayer puts in new equity to allow the bank to remain adequately capitalized after the existing private equity is written down to cover past losses, the taxpayer should get a large share of the upside.

Will the Geithner plan work? I certainly don’t know.

Based on what I have read over the past two days, I have two main concerns.

The first is that the desire to avoid “nationalizing” key banks will soften the review of the banks balance sheet. I understand the desire to avoid nationalization. Once major banks are publicly owned, there would be pressure to lend for less-than-commercial purposes. But in some sense the substantive argument isn’t the crucial one. I testified before the Senate Budget Committee two weeks ago, along with Simon Johnson (if you aren’t reading the Baseline Scenario http://baselinescenario.com/, you should be) and Tim Adams. I got the sense that there isn’t currently political support for a step as significant as nationalizing the key banks. Economics bloggers – and Martin Wolf - aren’t in quite the same place as America’s elected representatives. The Senate wants the banks (meaning their equity investors and management) to pay a price for their mistakes and it wants the banks to remain in private hands. Alas, those two objectives are in tension …

The second is that need to stretch the $300 billion or so available under the existing TARP out may have triggered the push for options that have a limited upfront cost but ultimately pose large risks. The FT’s Guha reports:

“Rather than seek to solve all the problems by pouring vast amounts of public capital into the banking system, the plan hopes to crowd in private capital through guarantees and financing. This reflects financial and political constraints – the administration is having to work, at least for now, within the $350bn (€273bn, £238bn) second tranche of the troubled asset relief programme – as well as a desire not to expand government ownership of the financial sector any more than is absolutely necessary.”

David Brooks reports that the Treasury is shying away from guaranteeing a lot of the assets on the banks’ balance sheet for this reason.

There had been some talk about setting up an insurance program, with the government guaranteeing a low-end price on toxic assets. But Geithner doesn’t think that can work. “If you’re pricing a guarantee or pricing a purchase, you have the same basic problem: the absence of a market price,” he said. It’s better to create a market so prices can be set normally, not by fiat.

That is good.

But the reported plan does seem to involve rather extensive use of the Fed’s balance sheet.

Ultimately, the financial sector’s losses are bigger than can be absorbed by the portion of the $700 billion in TARP funds that has been injected into the banks and the banks pre-existing equity. Goldman estimated that there at least $3 to $4 trillion of “troubled” assets on the books of US banks. That is the stock of troubled, assets – not the losses. But even if the banks existing equity investors take a large share of the losses on these assets, I suspect that the US will be lucky if can escape from the current mess with a net cost (meaning the net loss once toxic assets and toxic banks have been sold off) to the taxpayer of less than 5% of GDP …

Systemic crises tend to be costly.

UPDATE: Geithner’s plan

* The Brady plan guaranteed full payment of principal on the bonds of troubled Latin borrowers, as the principal of Brady bonds was fully collateralized by Treasury bonds. Countries that participated in the Brady bond bought this collateral with loans made available from the IMF. In return for the government’s support for the restructuring process, the banks agreed to restructure (lower interest rates, reduced principal) their original loans. The overall effect was to take bank loans to troubled sovereign borrowers off the books of the banks and put them into a traded market …

111 Comments

  • Posted by cdr

    … in a world where some of the banks’ creditors have been protected ex post in a panic move with fiat insurance thus allowed to merge-in with the crowd and are now seemingly indistingushable from them, the abstract hedge fund gets its bail out also.

  • Posted by DJC.

    Banks Rescue Will ‘Make Things Worse’: Jim Rogers

    The new financial rescue plan will not work and could even make things worse because it plunges the US further into debt and it is designed by the same people who failed to forecast the crisis and take measures, legendary investor Jim Rogers told CNBC Tuesday.

    Jim Rogers said Geithner, who was president of the New York Federal Reserve Bank, “has been dead wrong about everything for 15 years in a row,” and so was President Barack Obama’s economic advisor Lawrence Summers, who acted as Treasury Secretary at the turn of the century.

    “It is mind-boggling to me,” Rogers told “Squawk Box Europe.” These guys have been wrong year after year after year consistently and here they are making the same mistakes again. This is not going to solve the problem, it’s going to make it worse.”

    http://www.cnbc.com/id/29114947

  • Posted by Albion

    There are many components intertwined and one matrix

    Assets prices with no market prices (present situation)
    Underlying and attached contra accounts (CDS..) to these assets
    Stock of assets to be sold

    Obviously one component is not going to move without moving the others (they may be more in the shadow banking stores)it may (worse case) create more capital shortage within the banking industry capital base. One may assume that the exercise only need to address the less genuine assets side of the balance sheet, when the others will be in the traditional classified to be classified assets inventory.

    The funding side is an ex post situation (in absence of market price) It is presumed that leverage financing should be provided to seed money. This is a necessary step in order to clarify the balance sheets of the banking industry and with no doubt they will not lend to each other before their balance sheet and PL is cleared.

  • Posted by Twofish

    I think that the resistance to nationalization comes from two factors

    1) it doesn’t change anything. OK, you’ve nationalized the banks, you still have to make the fifty decisions that you would have had to make without nationalization. The only thing that nationalization gets you is some more management control, but if you want to fire the board and CEO of a big bank, you can probably do with without nationalization, and if you fire everyone, who do you replace them with?

    2) You end up with more liability than you had before. Right now the government is on the hook for checking accounts, savings accounts, and money market accounts. If there is a nationalization, then the government is on the hook for everything. This can be extremely expensive as AIG illustrates.

  • Posted by credulous_prole

    There’s clearly little need to bother with economics anymore: baksheesh politics rule the day.

    Thank you, oligarchs, for turning academia into a cult of apologists and sycophants, too!

  • Posted by CouldMarxBeRight

    If the government provide enough financing, i.e. leverage to the private investors so that he can create a cheap call option on the toxic assets, than theoretically toxic assets can be taken off banks balance sheet at inflated prices, thereby accruing all the benefits to equity holders. Because we know that you can synthetically create put option with call options, if you know what I mean. It is nonetheless a windfall to the shareholders because it isn’t true that the government is completely on the hook for those toxic assets already. The shareholders need to share the burden too. And perhaps also the Tier 1 structures and the senior debt.

  • Posted by Twofish

    Also we have “Schrodinger’s bank” problem. Right now we don’t know if the banks are solvent or insolvent, alive or dead. The problem is interesting and somewhat amusing. It’s not that we don’t know what the banks own. It’s not that anyone is hiding information. It’s that the information to tell whether or not a bank is solvent or not does not exist.

    To value a mortgage security, you have to know basically one thing, the default rates over the next decade. That number is unknown. More interestingly, that number is *unknowable*. We’ll know what the default rates are in ten years, but because you cannot see into the future, you do not know who is going to default and who isn’t. It gets even weirder, because your actions influence the future. If you fix the banks, and get the economy moving again, then default rates will be low. If the banks stay broken and the economy is stuck, then the default rates will be high.

    A lot of what is going on is set up so that you can fix a price to these securities. At this point we really do have a “market failure” because the market cannot value these securities, because the value of these securities depends on information from the future that doesn’t exist.

    One way of thinking about it is. Suppose I give you a lottery ticket. How much is it worth?

  • Posted by GQ

    …i’m having some trouble understanding how guaranteeing (or providing credit) for the toxic assets does not expose taxpayers to more risk. if citi’s equity value is near negligible and only truly because of the geithner put, then yes, if the govt takes it over without wiping out shareholders, it risks losing that equity. however, guaranteeing losses on the toxic assets when these are valued to have significantly more downside (trillions) as opposed to the market cap of the banks (billions) seems like a riskier strategy by far, especially when the toxic assets are likely to be overpaid for given the govt distortion. am i not picking up on something?

    additionally, there is just an element of fairness involved with nationalizing the banks. you end up wiping out the existing shareholders, potentially convert bondholders into accepting warrants or converting to equity, and clean ranks at the executive level. without that, even in the rosiest scenarios where the guarantee/credit strategy marginally works, you end up with a scenario that has shareholders benefit, bondholders benefit, executive management benefit, private investors benefit and taxpayers potentially still losing…

  • Posted by DJC.

    From Cnnfn,

    Total cost of the US taxpayer bailout of Wall Street banks so far: $3.6 trillion

    http://money.cnn.com/news/specials/storysupplement/bailout_scorecard/

    More insanity prevails. Since the $3.6 trillion bailout by US taxpayers hasn’t worked, Timothy Geithner proposes to waste even more of the nation’s capital.

    Just how sane is it to attempt to “unfreeze” commercial, student, auto and credit card loans when unemployment is soaring, savings are at zero, and consumers are in debt up to their eyeballs?

    Just give every bank in the country $1 trillion and be done with it. But if you do, don’t expect any results, because it is still insane to lend when there are not any jobs.

    Nor will Timothy Geithner announce any plans to replace the management of virtually any of the troubled institutions, despite arguments by some to oust current management at the most troubled banks.

    We let executives rape the shareholders, pass out huge bonuses, use ridiculous amounts of leverage, get billions of US taxpayer dollars and we let them stay in charge.

  • Posted by DJC.

    Off-Topic:

    China’s auto market overtakes the United States for 1st time in January

    http://biz.yahoo.com/ap/090210/as_china_auto_sales.html

    SHANGHAI (AP) — China’s monthly vehicle sales surpassed those in the United States for the first time in January, moving this country closer to becoming the world’s biggest auto market, data released Tuesday showed.

    China’s ascent in the global auto market has been hastened by the plunge in U.S. auto sales, which tumbled 37 percent in January to a 26-year low of 656,976 units.

    Chinese vehicle sales also have cooled, but hardly as dramatically. In January, 735,000 vehicles were sold, down 14.4 percent from a monthly record 860,000 last January, the China Association of Automobile Manufacturers said.

  • Posted by Kafka

    The major banks are insolvent and already effectively nationalized. Enronesque accounting is being used to hide the true facts from the public. Too bad Skilling goes to jail for life but the government accountants using Enron style accounting are lauded as heroes. At this point good bank bad bank, it is all the same, it is just a shell game, can you figure out where the pea in the pod is? If you can find the pea, much profit will obtain. Buiter had the best solution but no one listens to him because he uses simple math and common sense, no Politico on the planet ever made dough for their special interest pals from that type of ananlysis.

  • Posted by Indian Investor

    Brad: Indian investor — china’s current account surplus is now arond $400b

    Me:
    It’s possible that I’m wrong.
    Since the total US trade deficit with China for 2001-2008 is 13.14% of the total US public debt, I’m still having difficulty following the theme, so it would be useful if you could clarify further.

    Here’re the numbers I’m looking at:

    2001-2008 US trade deficit with China:
    $1.41 trillion
    Brad’s estimate of China’s USD holdings: $1.45 trillion
    Total US public debt:
    $ 10.72 trillion
    ($ 10,717,280,371,345.89)
    Total US trade deficit 1992-2007
    FOR ALL COUNTRIES together

    $5.39 trillion

    Links are at my blog, unable to upload links here.

  • Posted by M.G. in Progress

    Toxic bank or toxic assets? No difference, they are part of the lemon banking. We have lemon banks and lemon products and we should get rid of them by creating “good banks”. There is no point to continue to insure or guarantee “lemons”, nobody wants them anymore. Would you buy a lemon?

  • Posted by psh

    You’re prodigiously lucky, or wise, not to be at Treasury with your mentor now. He’s going to be history’s poster boy for an epochal kleptocratic looting spree by the biggest, brokest banks.

  • Posted by babar

    @twofish it doesn’t change anything. OK, you’ve nationalized the banks, you still have to make the fifty decisions that you would have had to make without nationalization. The only thing that nationalization gets you is some more management control, but if you want to fire the board and CEO of a big bank, you can probably do with without nationalization, and if you fire everyone, who do you replace them with?

    not quite. partially, it comes down to a question of who takes the initial loss. if you nationalize and force equity holders to zero and some bond holders to < 100 you will get these stakeholders to pay rather than the govt. in addition you will not have to figure out market prices for assets up front as the fed is not required to mark to market.

    in short, at this point there is a strong incentive for the banks to try to sell to the govt for prices that are not believable (though i agree nobody knows what the real ‘price’ should be). that incentive would disappear under nationalization.

  • Posted by jonathan

    The sellers’ strike is a game theory problem. A review of balance sheets shouldn’t – in game theory – work that well, for the reasons you note plus some more, including timing. The usual approaches to break this kind of logjam is to offer incentives to move early, either by rewarding early action or punishing those late to the party. For example, solely using game theory, one would suggest a sliding scale for guarantee. That would move those who really need to act – assuming they have good information about their own condition – and would create a game among the sellers about their strategic choices (move, wait). I’m not saying this is the best approach just that this is how game theory would work it.

  • Posted by DJC.

    Hillary Clinton to travel to Beijing to “sledgehammer” the Chinese. LOL.

    http://www.bloomberg.com/apps/news?pid=20601039&sid=ad8oz4lIJLsk&refer=home

    Folks in Beijing have reason to be less enthusiastic: They will be on the hot seat.

    Officially, Clinton will focus on North Korea’s nuclear- arms program, the financial crisis, security and climate change. Yet Chinese leaders would be right to figure their currency and role in global imbalances will dominate her list of discussion points.

    Thorny topics likely to get more attention include China’s currency, labor standards and intellectual-property rights.

    China is clearly unnerved by the tone coming from Washington. One worry is many lawmakers think China bears primary responsibility for U.S. job losses. Another reflects concerns about U.S. protectionism, something fanned by the “Buy American” provisions in stimulus efforts. Geithner’s yuan- manipulation comments haven’t helped.

    Officials in Beijing also may sense a lack of contrition for the state of the global economy. In London earlier this month, Chinese Prime Minister Wen Jiabao criticized American- style capitalism and stressed “how dangerous a totally unregulated market can be.”

  • Posted by Cedric Regula

    Finally, our topic aligns with the days news.

    Here’s a peep what the new guys have in mind. TARP Part Two seems to be growing, 350B to a Trillion, and now we are worrying about commercial real estate loans too. (didn’t we used to have to vote on this? Did they disband the CBO?)

    So the combined Fed and Treasury efforts to repave the banking systems potholes in a nice new shade of green are increasing.

    Big 10y bond rally today. I thought it would go OK this go around, but still there is something spiritual about watching the Treasury re-fi an amount equal to a small EM’s GDP in one week, and see the market rally.

    +++++++++++++++++
    Geithner pledges forceful attack on banking crisis
    Tuesday February 10, 11:24 am ET
    By Martin Crutsinger, AP Economics Writer
    Geithner pledges forceful attack on banking crisis; Fed expands key program to $1 trillion

    WASHINGTON (AP) — Treasury Secretary Timothy Geithner says the new administration will wage an aggressive two-front battle against the worst financial crisis in seven decades, while the Federal Reserve expands a key lending program to up to $1 trillion.

    The efforts are part of the government’s major overhaul of the widely criticized financial rescue program.

    The Fed says it will expand the size of a key lending program to as much as $1 trillion from $200 billion. The program, which has yet to begin operations, is designed to boost resources for consumer credit and small business loans.

    The Fed says the program also is being expanded to cover the troubled commercial real estate market and certain residential mortgages.

  • Posted by Indian Investor

    @Cedric/anyone else:
    Is it posssible to explain the connection between trade deficits and external debt of the US, and the general case. It seems to me that central banks have a choice whether to intervene in the currency market or not. A country’s citizens could export, and the central bank may not intervene, making the local currency stronger. When a country’s citizens import, is it absolutely neccessary for the central bank to intervene, or for the govt. to incur and external debt because of the trade deficit?
    In case of a non reserve currency country, if the imports are conducted in the absence of sufficient reserves, the local currency collapses in the market, making it impossible to continue with imports. How does this apply to the US?

  • Posted by Indian Investor

    Cedric: TARP Part Two seems to be growing, 350B to a Trillion

    From the news item it seems to me what’s growing is the Fed credit program. I thought TARP was the one that the Treasury itself has, from which it can buy equity in banks.

  • Posted by Cedric Regula

    indian:

    I think the simple macro answer is that since the dollar is the world reserve currency, we can finance external CA deficits in dollars, provided that external creditors are willing to lend.

  • Posted by Kafka

    Is Summers up to his old tricks, manipulating the markets for his hedge fund buddies? Markets down so float the aggregator bank rumor which drives markets up then pull the carpet out from under the markets (which apparently think an aggregator bank is the answer). This is just too easy.

  • Posted by RebelEconomist

    Brad,

    If you want to refer to a good bank plan, please refer to mine, which as far as I know was the original, at least in suggesting a good bank spin-off as a solution to the problem of dealing with hard-to-value assets. Buiter’s latest post – “no-brainer”, “obvious”, etc – seems to be a response to my complaint that he had not acknowledged the contribution of comments on his blog to his thinking, which seems to have changed completely since his rather arrogant presentation at Jackson Hole in August, in which he asserted that the problem of valuing troubled assets could be easily solved by reverse auction.

  • Posted by Cedric Regula

    indian:”From the news item it seems to me what’s growing is the Fed credit program”

    That’s the way I read it too, but the article is a bit fuzzy. I sincerely hope that Ben isn’t serious about making $650B in consumer credit loans. I know a made a post a while back that we should nationalize Master Card, but I was just kidding.

    TG’s announcement today was supposed to be about TARP Part TWO.

  • Posted by glory

    hey OT (i know! :) but something i’ve been kinda thinking about — like if and when the fed starts buying LT treasuries, wouldn’t that be the signal for china (and everyone else) to start selling them theirs?

  • Posted by Offtopic

    Offtopic. We’re all consumed with the banking crisis, but make a quick note and double check the stimulus bill. Check this:

    The stimulus bill will affect every part of health care, from medical and nursing education, to how patients are treated and how much hospitals get paid. The bill allocates more funding for this bureaucracy than for the Army, Navy, Marines, and Air Force combined (90-92, 174-177, 181).

    Hiding health legislation in a stimulus bill is intentional. Daschle supported the Clinton administration’s health-care overhaul in 1994, and attributed its failure to debate and delay. A year ago, Daschle wrote that the next president should act quickly before critics mount an opposition. “If that means attaching a health-care plan to the federal budget, so be it,” he said. “The issue is too important to be stalled by Senate protocol.”

    ~~~~~~~~WOW~~~~~~~

  • Posted by Cedric Regula

    2fish: Re:”Schrodinger’s bank”

    The interesting thing about Schrodinger is that after grappling with his “Schrodinger’s Cat” thought experiment for a while, he concluded that Quantum Theory is no good.

    So that leads me to believe that if he were alive today he would be either an Austrian Economist, or a Marxist.

    That’s my intellectual input for today.

  • Posted by wally

    Do countries ever walk into a depression or do they always stumble in, backward?

    I think I know.

  • Posted by artichoke

    “Because we know that you can synthetically create put option with call options, if you know what I mean.”

    Actually I don’t and I work in options. One can create a stock out of its call and put options. One create quite a few things, but I don’t know how to create a long put option position out of long call options. The delta has the wrong sign!

    Also some people have said that the toxic waste has no price. I believe that is generally false. It has a price and is traded. But marking to those prices would expose insolvency in the banks. So they lie.

  • Posted by artichoke

    Ahem even to create the stock the put has to be short!

  • Posted by Albion

    artichoke
    When reading carefully this post I do not see any comments regarding a toxic asset price , the closest comment would be an asset going through markets price.
    Quoted is meaningless when going through unregulated exchanges
    Level 2 3 of banks have prices the main issue are they accurate? auction process could confirm

  • Posted by Twofish

    Albion: When reading carefully this post I do not see any comments regarding a toxic asset price , the closest comment would be an asset going through markets price.

    It’s really hard to get a market price when there is no market. A lot of what Geither is doing is trying to put a market so that we can have a market price.

    Albion: Level 2 3 of banks have prices the main issue are they accurate? auction process could confirm.

    They again maybe not. In order to get a market, you need someone willing to buy and someone willing to sell. The prices at which people are willing to buy and sell at are so different, that basically nothing is being bought or sold.

    One problem is that if you hold an asset, and selling that asset would establish that you are bankrupt and as a result you will lose your job, this gives you a big incentive not to sell at any price.

  • Posted by Twofish

    artichoke: Also some people have said that the toxic waste has no price. I believe that is generally false. It has a price and is traded.

    There is a price at which assets are traded, but the trouble with that price is that if you calculate the value of that asset based on the future cash flows, you would have to assume that the a great depression to get current market values.

    At that point you won’t sell, because if you do sell and there is no great depression, you go broke and lose lots of money. If you don’t sell and there is a great depression, then it doesn’t matter anyway.

    I do think that there will be a really big stink in about two years when it turns out that lots of people made lots of money buying assets that were supposedly worthless.

    But marking to those prices would expose insolvency in the banks. So they lie.

  • Posted by Cedric Regula

    Well, 10y bond rally continues, dollar fans take the dollar index up 1.26%, but goldbugs still winning in there little corner at 1.95%.

    I get the feeling something magical is happening. I just can’t figure out what it is.

  • Posted by Indian Investor

    Re Toxic banks, toxic assets, etc: Calculated risk has a blog post titled “Bank Failure Haiku” in which he records three US bank failures, all on the same day; Feb 06 2009. Geithner’s plan is now quite clear. Don’t expect an IMF-style “orderly resolution” of “insolvent banks” for the big Four. The small unheard of ones that are ‘too small to survive’ will be the ones that fail the Geithner-led ‘stress-test’. The former IMF people are experts at the art of conditional lending with an objective to make usurious profits.
    Geithner has also made a few small but important changes. If the remaining $350 billion in the TARP were to be used to directly infuse capital or buy bad assets, whatever – as you might be aware that can’t be done without full disclosure. Geithner will now pass on $100 billion to the now infamous ‘Fed balance sheet’. All the bailout activities to lend money across to buy toxic assets, etc will happen behind the black Pardah of the Federal Reserve Bank’s courtyard. No prizes for guessing who’s going to get that leveraged $1 trillion more from the Fed.
    Read the rest of the news with an understanding that the primary objective is to consolidate the ownership of the US banking industry. The objective is the same as what former IMF people can easily recognize as having been adopted in emerging markets around the world, on average once every year. The process is slightly different, though. After all, this is America. This new plan is for the people, by the people, of the people, whatever …

  • Posted by Cedric Regula

    Ok. The synopsis on TG and Tarp Part 2 is that TG is a newer, fresher, more transparent Paulson, re-incarnated in TG’s body. Furthermore transparency is of the delayed variety as TG is not providing much detail as to what the plan is that was announced today. I read some mumbles about $500B to finance private buyers of junk. That is probably what Brad was talking about above.

    So that question is settled.

    On towards stimulus. There will be stimulus. About $823B of it.

    Moving forward to Ben and the gang at the Fed. They be helping too.

    “The new Fed program to provide up to $1 trillion in lending, including loans for small businesses and for student, auto and other consumer loans, would be partially supported by a $100 billion contribution from the Treasury.”

    So it looks like around another $2.25T or 2.75T(if we add the 500B loans for junk program LFJP) in off budget spending.

    Granted, it may happen over two years. But then again we may find out we need to bail out the banking system sometime later on this year.

  • Posted by Glen M

    I like the idea of a national bank. Not nationalizing any of the existing ones. In fact I think that there should be two. One can operate as suggested by Nassim Nicholas Taleb*. The other as a ‘Bad Bank’.

    In so far as how a bad bank should price the assets it acquires, I think it should do so by auctioning money for assets in an open bidding process.

    *Nationalise the banks, limit the rewards to those who work in what he calls the “utility” part of the system and have a completely uninsured second leg that can take all the risks it wants and lose its shirt

    http://blogs.reuters.com/jim-saft/2009/01/30/save-capitalism-from-the-banks-nassim-taleb/?p=46?tempedition=debatehub

  • Posted by RebelEconomist

    I think that the low value of the troubled assets probably is realistic. One reason that structured products exist is that they could be sold with such a large mark-up, and even before the economic downturn gathered pace, they were going to generate serious losses for their holders. But now, I suspect that the low values are discounting not only the deteriorating economy, but the danger of an unprecented change in borrower behaviour. That is that borrowers are less restrained by the shame of default so that they are more liable to exercise their option to walk away from a non-recourse mortgage worth more than the value of their house.

  • Posted by Cedric Regula

    Just thought of another future blog topic idea for Brad. We should probably look over the Fed balance sheet sometime in the coming weeks or months.

  • Posted by Offtopic

    Geithner dodged the question “are banks insolvent”….he is very AWARE that some banks are insolvent, but believes mentioning banks are insolvent adds risk=this is total giveaway to investors that BANKS=insolvent.

    ~~~~~~WOW~~~~~

  • Posted by Cedric Regula

    rebel:

    I’ve got a worse case data point on salvage value of “assets”.

    Been tracking median prices of houses in South-Central Los Angeles. This is the home of the Rodney King riots, Watts riots and other anti-thesi of location, location, location….

    They peaked at $400K, 3Q 08 were at $150K, and are probably worth somewhere between 0 and maybe $50K.

    I tend to pick on SCLA, but other people probably can think of similar real estate in their cities.

  • Posted by Rien Huizer

    I think that the first step needs to be to agree on an official way of valuing these assets. That there is no market is due to several reasons, and the lack of a market does not mean that these things are worthless, or that they are all worthless.

    One problem is that the valuation expertise is closely held and perhaps he government should acquire (or seize) the valuation models used by Goldmann et al. Then the gvt could simulate the scenarios that it tries to realize (growth, employment, interest rates etc) and value portfolios based on its own assumptions re important parameters. That should result in prices at which existing investors could sell or mark if they want to hold. Probably a functioning market would follow soon after that.

    What the gvt then does (set up a bad bank, use F&F, wipe out&recapitalize etc) is a matter for politics and may have an impact of the shape and scope of the recovery (will housing recover or not? etc) but economically, it does matter less who holds these securities than that the uncertainty about their market value ends.

    Of course the process as such matters to people like Soros too, because it may offer abundant opportunities, but that is a matter for people like Soros. His wise adminishments should never be taken in isolation from commercial interest.

    A totally different issue of course is to what extent the Us would be able to deal with a partially nationalized banking ssytem. Most likely, most banks are in reasonable shape, for a country in recession. The minority that has large stocks of toxic assets might be nationalized, shareholders wiped out, etc. As the European experience shows so far, nationalizing banks requires a government strategy about how these banks should operate once nationalized. In a depressed economy there will be losses, unrelated to the reasons why they were nationalized, but politicians, untrained in the business may have a useless tolerance for losses (i.e. one day too small and the next too large). But, if he state acts in a completely hands off manner, some incumbent managements may become reckless (or too conservative). The UK gvt is now trying to make RBS, an almost nationalized very large bank, to extend an additional GBP 6 bn of credit to the UK market, following certain guidelines. The recived wisdom has been, for a long time, that gvts could not direct lending without all kinds of problems (corruption, cronyism, picking winners, moral hazard, etc). This will shed some light on the question if a private, but strictly regulated FI would produce different outcomes than a public, but managed using private sector criteria one. However, and a big however, this may work in countries where banks have very large market shares of 20% or more (bank strategy may shape macroeconomic conditions in such a way that bank stays out of trouble but economy as a whole performs suboptimally). I think it is impossible to operate say a dozen large state-owned banks side by side over 4000 ones that are still privately owned, much smaller and usually serving a local customer base. This will give rise to a very different type of conflicts than the situation in the UK where two of the clearers are still private (but maybe on the brink) and three de facto nationalized. Especially since the two private ones have much of heir business outside the market controlled by the gvt. In my opinion Geithner is right. This is not a simple problem requiring only cookie-cutter solutions.

  • Posted by Cedric Regula

    I know I’m posting too much, but I can’t help it.

    It really bothers me that Ben seems so hellbent to get into the banking biz. That is NOT the Fed charter. In fact it seems to me that it should be illegal, and maybe it even is?

    After all we already found out that it’s a bad idea for Sallie Mae to be making student loans, so why should we allow Ben to do it?

    And whatever happened to that little law we had about requiring Congress to vote up the national debt cap? It was at 11.4T, which they had increased to accommodate both halves of TARP. But now it looks like they need to take it up another 2 Trillion.

    Does anyone here have any legal insights to whether Ben can just decree on his own that he is a commercial bank?

  • Posted by M.G. in Progress

    The FINANCIAL STABILITY PLAN said “THIS BANK IS A LEMON”. Actually the plan is dealing with “The market of lemons” . If one cuts and pastes sentences on the blog sphere, including one or two from me (see my blog for example), you could get the same plan…

  • Posted by jtbar

    Why can’t they just set up 6 new regional quasi-nationalized banks…give them each 50 billion in capital…mandate transparency and conservative banking standards, start lending or buying assets on the cheap, allow private investors to invest via equity giving more capital to the banks to lend out…voila, new banks with unencumbered balance sheets…????????????

  • Posted by Indian Investor

    @Cedric: As far as I know, the Fed is empowered by its statutes to extend credit to just any institution or person that it deems to be systemically important.The Fed isn’t obligated to provide public accountability for its credit and regulatory decisions. It does go through an audit by certain Govt. agencies and there’s a testimony to the Senate Banking Committee and the Fed can’t be questioned by anybody unless there is a major ghotala or scam involved in its books, or something like that.
    By self definition, the Fed is an independent agency within the Government that isn’t actually ‘owned’ by anybody.

    But I think the plan you’re referring to is part of something like an asset-backed security loan from the Fed. i.e. a bank would have to bring a student loan loan asset backed secy. to the Fed. and the Fed will extend credit against that to promote lending to students.

    PS: I continue to be bullish on the market. I expect the big four banks to be functional pretty soon.

  • Posted by Twofish

    jtbar: Why can’t they just set up 6 new regional quasi-nationalized banks…give them each 50 billion in capital…mandate transparency and conservative banking standards, start lending or buying assets on the cheap, allow private investors to invest via equity giving more capital to the banks to lend out…voila, new banks with unencumbered balance sheets…????????????

    You might be able to do that, but even in the best of times it would take a year to do something like that.

    Also, you have to figure out what to do with the old banks.

    Shut them down? Maybe. But then you leave behind this huge mess that you have to deal with. One of the few places that is hiring on Wall Street is Lehman Brothers. They have a staff of about 150 people that are winding down the assets, and it will take about another year and a half before they can shut the doors.

    It’s not a bailout. It’s a clean up.

  • Posted by Twofish

    Huizer: One problem is that the valuation expertise is closely held and perhaps he government should acquire (or seize) the valuation models used by Goldmann et al.

    There’s nothing particularly secret about any of these valuation models. You tell me what the default rate on various asset categories are, and I can tell you exactly how much these assets are worth.

    Don’t know? We’ll lets start with something more simple. If you tell me what the unemployment rate will be in 12/2009 to 12/2010, then I’ll tell you the price of these assets. This might be difficult since we really aren’t sure what the employment numbers for 12/2008 are yet.

    Now while you are at it, you might tell what the winning lottery number is for 12/1/2009, and you might also tell me whether I’ll be employed on 12/2009.

  • Posted by locococo

    Cedric he can t but he will to hide the hedge fund and the spv and the siv bail out from students while the robots continue to buy treasuries buy buy buy meaning renewed strenght bravo of the dollar on shooooulders of new secretary on top that be giveth away later in a hidden transparent manner to the first.

    Together they really rock tha globe, ain t em?

    loco in their coco

  • Posted by privateinvestor

    “Both Brady and Geithner seem to want to move bad assets from bank balance sheets to the market. And in both cases the government likely will facilitate the transaction in part by limiting the risks born by private investors.”

    Brad- any thought on who these “private investors” will be? Will be an open ETF on the market or likely a certain type of private investor.

    Thanks.

  • Posted by Cedric Regula

    indian:

    Yes, the Fed is supposed to be independent, but the thought in the USA that we used to have for that was that we needed to keep the printing press somewhat removed from Congress. Then the Fed did unpopular things like “take the punchbowl away just as the party gets going”, or have Volker kill inflation with interest rates, provide sagely oversight of banks, inject liquidity when needed, and be the only staunch defender of the dollar.

    But student loans and cars loans are systematically critical??? I’ve been to college and I know you could wipe out half the student body and the economy would never notice. And they would make lots more money going into skilled trades or nursing than they would ever see with the liberal arts degree.

    Your right about how the Fed program is supposed to work. Ben will buy existing loans for cash on the theory that banks will lend it. We’ve heard that before, but assuming it works, there is still another problem. We have a huge sub-prime car loan industry. That rings a little too familiar. So I think the Fed has camouflaged this program to suck more toxic waste on to the Fed balance sheet. Just a different flavor, and it has a even lower asset resale value. Like what can you sell half a liberal arts major for?

  • Posted by Cedric Regula

    privateinvestor

    Methinks PIMCO.

  • Posted by locococo

    basically the fed will finance the private part of this equity group, in which the taxpayer will partly (tho probably not voting vise can t have that) participate and take disproportionate losses, fully to leverage it out to the max and then …

    …well youl ll think of something until then it s complicated you know but you now promise to then post it on the inetrnet

    it s called efficient market theory in practice.

    they give prizes for that.

  • Posted by Twofish

    GQ: if citi’s equity value is near negligible and only truly because of the geithner put, then yes, if the govt takes it over without wiping out shareholders, it risks losing that equity.

    It also risks losing a lot more than equity stakes. Corporate shareholders have limited losses. Once you hit zero, you are out of the game. You can’t lose any more.

    However the trouble is that once a government nationalizes, then it has infinite pockets (since it can print money). At that point the government is liable for potentially all losses in the bank. Now the government can say that they will only guarantee up to $X billion and they they leave, but you run into the Freddie and Fannie problem that no one will believe that.

    GQ: however, guaranteeing losses on the toxic assets when these are valued to have significantly more downside (trillions) as opposed to the market cap of the banks (billions) seems like a riskier strategy by far, especially when the toxic assets are likely to be overpaid for given the govt distortion. am i not picking up on something?

    Once you’ve nationalized, then the government may end picking up the loss anyway. If the government can take over the assets and get rid of the liabilities of a bank, then fine. But *someone* is going to have to eat the liabilities. In the case of banks, much of the liability consists of money that it owes to depositors.

    GQ: additionally, there is just an element of fairness involved with nationalizing the banks. you end up wiping out the existing shareholders, potentially convert bondholders into accepting warrants or converting to equity, and clean ranks at the executive level.

    Two problems.

    1) There are people that will get very annoyed if you do a debt-equity swap on them. If I go to my local bank, ask for my money, and I get bank stocks instead of cash. I’m going to be rather annoyed. What’s worse, if I *think* that next month, I’m going to get bank stock instead of cash, I’m going to go to my local bank, and take out all my money.

    2) You have to fix the bus while it is moving. If I go to my local bank, and ask for my money, and the teller tells me that “I’m sorry we are trying to figure out how owes what to whom, come back in a week.” I’ll get annoyed especially since they’ve cancelled my all my credit. Now, if I *think* that this is going to happen next week, then I go to the bank, take out all my money now….

    To do a thought experiment. Suppose tomorrow we decided to close all of the banks next week, and everyone gets their FDIC insured accounts. FDIC insures $5 trillion. It has $50 billion. Even if you wanted to do this, Congress would have to appropriate $5 trillion to pay everyone, and then you ask pay them with what? I now have a nice check from the government. Who is going to cash it? All the banks are closed.

    GQ: even in the rosiest scenarios where the guarantee/credit strategy marginally works, you end up with a scenario that has shareholders benefit, bondholders benefit, executive management benefit, private investors benefit and taxpayers potentially still losing…

    I think that given a choice most people would prefer higher taxes than no bank account. What people don’t get is that *you* are a creditor to the bank. The bank owes *you* money.

    Something that you can do is to figure out which bank liabilities are “essential” (checking accounts to little old ladies) and which liabilities are “non-essential” (fat cat millionaire crazy stuff). You put the “essential” stuff in one bank, and let that continue. You move the “non-essential” stuff to another bank and you now have the option of letting that fall.

    That’s the good/bad bank idea.

    One thing that I don’t get is if people think that banks are so evil and socially valueless, then why do people insist on keeping their money in one.

  • Posted by Twofish

    privateinvestor: Brad- any thought on who these “private investors” will be? Will be an open ETF on the market or likely a certain type of private investor.

    Hedge funds and possibly mutual funds. I’ve been thinking a lot of the consequences and implications should this plan work, because the alternative is too depressing, and there are a lot of people thinking about the problems of failure, but no one thinking about the problems of success.

    Thinking about what happens if it does work is important, otherwise you end up in an Iraq situation where you win and then lose…..

  • Posted by Twofish

    lococco: basically the fed will finance the private part of this equity group, in which the taxpayer will partly (tho probably not voting vise can t have that) participate and take disproportionate losses.

    That’s really why it’s important to have equity participation be widespread. If the only investors are hedge funds for rich people, then if the plan works, there will be unending (and justified) screaming.

    If you can go out to the Treasury direct, Fidelity, and Vanguard website and buy a “bailout bond” and put it into your 401(k). Then the political dynamics changes. At that point if the government offers a guarantee, you can justify it as an apology for messing up people’s retirement savings.

    Well at least be thankful for one thing….

    we didn’t privatize social security a few years back.

  • Posted by privateinvestor

    Thanks twofish. i think that if it’s term “private investor”, then why not average joe or bob?

    why not give the guy next door the chance to buy some of this junk if they wish? something doesn’t add up…

  • Posted by Cedric Regula

    privateinvestor:”why not give the guy next door the chance to buy some of this junk if they wish? something doesn’t add up…”

    Ask and you shall receive. Search this site for mortgage bond funds. There’s a ton of them. Personally I’d go the foreclosure.com route, however. Could be a 15K tax credit in it too, if the senate stim plan holds.

    http://www.etfconnect.com

  • Posted by Cedric Regula

    The AP finally caught up with me and released a much more polished news wire than my post of earlier. So it looks like Brad got his wish that the USG spend a “bit” money.

    Congrats to all on our success.

    I’ve looked thru it all and yours truly isn’t slated for a penny of it. Thought I had a shot at the $500 tax rebate, but nope. Thru an incredible stroke of luck I exceeded the cap on that in 2008. Budgeting for poverty this year, however.

    =============================
    $3 trillion! — Senate, Fed, Treasury attack crisis
    http://biz.yahoo.com/ap/090210/economy_rdp.html

  • Posted by ReformerRay

    If all the toxic assets wind up being converted into the face amount of the assets, somebody is going to get rich. Isn’t the face amount so large that private banks cannot pay them?

    So money is being transferred from future taxpayers to somebody today. WHO IS GETTING THE REWARD TODAY?

  • Posted by Observer

    One half of the ‘rescue’ plan can be viewed as an attempted revival of the ‘shadow’ banking system (the Fed might become the largest SIV ever). The other half of the rescue plan is a bid to finance private buyers to compete for the same assets that have stabilized in value and will help generate positive cash flow for banks in the future. David Goldman has this one right: you just don’t know what’s going on inside Geithner’s head right now.

  • Posted by Indian Investor

    @Cedric:
    Overall, this is an excellent plan and there’s very little doubt in my mind that it will work.
    1) I’m doubtful whether the stress test is going to be done in a very public manner. The Fed will exercise its expertise to determine which banks do and which don’t have a good balance sheet.
    2) As I mentioned, Calculated Risk blog shows you 3 banks which were ‘taken over’ on the same day. So technically I guess those didn’t fail, and perhaps they’re not counted as failed banks in the FDIC books.
    3) The Fed would get $100 billion that can be leveraged up to $1 trillion as part of the plan to purchase doubtful assets. My guess is that a percentage of the market value of the doubtful asset would be paid to a fund (it might well be PIMCO, or anyone else) from the Fed’s lending program as a loan.
    The fund would receive the upside in case the receivables come through. In case they don’t the fund might get to ‘walk away’. When the fund walks away presumably it doesn’t owe the Fed’s loan back to the Fed.
    4) The plan still leaves $250 billion from the TARP money for a future equity injection to the banks.

    From 3) above, my conclusion is that a huge volume of doubtful assets can be sold to a pliable private investor against the Fed’s $ 1 trillion loan. That $ 1 trillion should port on the books of the sellers of the doubtful assets. Overall, the doubtful assets will be off the bank’s books and the good new credit from the Fed will be onto it. Once the doubtful asset is sold, liabilities against that asset also get taken down.
    The Fed’s maximum loss is limited to that $ 100 billion in this round, the remaining $900 billion comes from the Fed’s leveraged balance sheet, in this case.

    Net-net I would expect at least 4 large private sector banks to emerge from this plan. They will have much lower levels of doubtful assets on their books, much better new credit from the Fed. And they might receive an equity injection from the remaining TARP money, and any future Congressional appropriations that might be allocated to them for this.
    I support the student loans as a good move. Student loans are a priority segment for lending and the Fed taking an initiative to direct some credit at that segment is actually a positive move for the recovery to happen.

  • Posted by Indian Investor

    When the issues involved are as sensitive as they are now; when the amounts of money involved as so tremendous; when the political power and pressure available to the banking sector is at such a high level; I think this is probably a good effort.
    In my post above I did cast a few doubts about the transparency of the plans, but without directly accusing the administration of wrongdoing. I believe that when you accuse somebody of doing something wrong; if they actually didn’t do it; the moral effect is the same as you yourself having committed the wrongdoing that you alleged.
    At the same time a democracy can never work without the institutionalization of doubt. As long as the Fed’s lending activities are conducted in a non transparent manner, there should ideally be a doubt in the citizen’s mind about the honesty of the process. Having such a doubt is part of ensuring accountability; and it doesn’t imply that the administration is being accused.
    Revealing the criteria for the stress test and conducting a transparent and objective assessment of all banking institutions would go very far in ensuring public confidence in the financial system. Public faith in the Fed and Treasury is much more important than public faith in private sector banks, in the long run.

  • Posted by Twofish

    privateinvestor: Thanks twofish. i think that if it’s term “private investor”, then why not average joe or bob?

    Part of it is that events are moving so fast that public relations consultants haven’t had the chance to find the sell any ideas. In regular times, whenever there is a new plan, it comes out and people send it in front of focus groups. People haven’t had time to do it.

    Also the political landscape has changed over the last six months. Since Reagan people have used “save the taxpayer against greedy politicians” but “Joe the Plumber” tactics doesn’t work as well as it did once.

    Since Reagan, people have been on the side of the rich against the poor because they have imagined themselves rich since obviously the rich deserve to be rich and the poor deserve to be poor.

    That has changed and most people in the United States are coming to grips with the fact that they may end up poor out of nothing that they actually did.

    The notion of “bribing the middle class” isn’t a new one. Anytime someone talks about the “taxpayer” they don’t mention that really rich people pay most taxes and that tax cuts hardly benefit anyone that isn’t already rich.

    If you set up the bailout so that rich people get most of the benefit but middle class people get something, then you end up with the same sort of political dynamics as you did with invoking the “taxpayer.”

    Investor: 1) I’m doubtful whether the stress test is going to be done in a very public manner.

    It’s not a big secret which banks are in relatively good shape and which banks are in trouble. Look at balance sheets and read the Wall Street Journal and Financial Times.

  • Posted by Cedric Regula

    indian:

    You’re are entitled to your opinion as a non US taxpayer. But I have to add I think you’ve been toking on your hookah again.

    I don’t think the Fed can “leverage” 100B to 1T. The treasury has to provide it, or the Fed prints it.

    The recovery value on toxic consumer loans is as close to zero as you can get.

    I did a little programming work for the sub-prime car lending arm of Ford. They made 25% loans to people that shouldn’t get them and a repo rate of 40% was assumed in the biz plan. The repo’d cars went straight to auction. But nobody is buying cars nowadays and the Fed doesn’t have a parking lot.

    Old student loans will be what the Fed gets. The ones that go into default because the psych major lost his/her job at the 7-11.

    So this is a trillion dollar giveaway.

    People can go to school if they want. It already gets state tax money and there are scholarships. Football tickets are 40 bucks. Have schools lower there costs. They make too much.

    It’s well past time for people to start paying their own way in this country.

  • Posted by Twofish

    Investor: . As long as the Fed’s lending activities are conducted in a non transparent manner, there should ideally be a doubt in the citizen’s mind about the honesty of the process.

    I don’t think that most people really care whether the process is honest or not. What matters is at the end of the day, what do they get out of it. If people think that they are going to get money out of it, they will put up with a huge amount of corruption. If people think that they are going to get nothing, it doesn’t matter how honest the process is.

    There is also a thing as too much information. I can gave you truckloads of data, and if you don’t know what to look for and what any of it means, it’s useless. You can hire someone to look through the data. But how do you trust them?

    Investor: Revealing the criteria for the stress test and conducting a transparent and objective assessment of all banking institutions would go very far in ensuring public confidence in the financial system.

    No it won’t, because the public will end up thinking (perhaps correctly) that the objective criteria were set up to benefit one group rather than another.

    People will have more confidence in the financial system when they have more confidence in their future.

  • Posted by Twofish

    Cedric: The repo’d cars went straight to auction. But nobody is buying cars nowadays and the Fed doesn’t have a parking lot.

    No one is buying cars today. If people start buying cars a year from now, then those loans are going to be worth quite a bit. If you buy loans for 5 cents on the dollar and then you can sell them in a year for 20 cents, that’s a huge amount of money.

  • Posted by Cedric Regula

    2fish:

    You just reminded me of something I forgot to mention. The Fed has an even worse problem with valuing consumer loans than TG has with real estate loans.

    The Wave Equation will collapse with all the sub-prime stuff on the Fed’s doorstep.

  • Posted by Observer

    Why is the Fed providing financing for non-banking entities to compete for assets that have hit bottom in pricing and are going up? There should be a Federal investigation on whether Bill Gross paid off the Obama administration and Geither’s Treasury to provide him financing.

  • Posted by jimspassion

    Great post brad especially in ref to George Soros – Georges writings may have not been as technically based as some might want, but nevertheless his theory that the future can’t be forecast accurately because it depends on how we respond to it has merit especially in light of what we are going through now – if indeed the banks are insolvent as Nouriel Roubini suggests then Nationalization must be seriously considered – senior debt holders in generally don’t subscribe to a orgy in leverage as did the common in their quest for speculative profit and share price appreciation (ignorant as some may have been) thus unfortunately the common may have to take the brunt of Nationalization – if the investor loses confidence because rules may change because politically the tough decision is just too difficult then why be an Investor??? – Now that’s systemic

  • Posted by RebelEconomist

    Ray,

    Great question: WHO IS GETTING THE REWARD TODAY?

    Mainly the people who sold assets (elderly downsizers and middle aged inheritors selling houses) at silly prices to people who could not afford them, and potentially the people who could not afford them if they are not foreclosed (probably at bond holders’ and taxpayers’ expense). But there are many people in both categories, and they vote, so the bankers, who facilitated the transactions and took out hefty fees, get the blame.

    Estimates of losses to the banks are in the order of trillions. Bankers and bank shareholders took out hundreds of billions in bonuses and dividends at most. Ordinary people got the rest.

    No, I am not a banker!

  • Posted by babar

    > Great question: WHO IS GETTING THE REWARD TODAY?

    there are few people in this country who didn’t benefit or have a strong potential to benefit from the credit bubble. there are plenty of people who completely forget this fact on the way down.

  • Posted by Observer

    Bill Gross made a $2300 donation to “Obama for America”, made public calls for the Fed to boost asset prices, and now he’s getting financing from the Obama administration to purchase depressed assets? For the sake of public disclosure there has to be some kind of a Federal investigation into this.

  • Posted by tyaresun

    Here we go again:
    http://www.bloomberg.com/apps/news?pid=20601080&sid=a_dsDz145J_A&refer=asia

    Feb. 11 (Bloomberg) — China should seek guarantees that its $682 billion holdings of U.S. government debt won’t be eroded by “reckless policies,” said Yu Yongding, a former adviser to the central bank.

    The U.S. “should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way,” Yu, who now heads the World Economics and Politics Institute at the Chinese Academy of Social Sciences, said in response to e-mailed questions yesterday from Beijing. He declined to elaborate on the assurances needed by China, the biggest foreign holder of U.S. government debt.

  • Posted by Cedric Regula

    observer: re:pimco

    The PIMCO bond fund managers that manage long term funds were in the news a few weeks ago stating that they are rotating out of long treasuries and going into mortgage assets.

    They usually talk about what they are doing after they are done of course. So they sold 2.2% treasuries, and are probably cherry picking better mortgage stuff.

    But I haven’t heard what the junk portfolio managers are doing. Maybe nothing and just waiting for the price support guarantee to come thru?

    They have “loan participation” funds too. Those are holding all the stuff Ben wants to buy. But PIMCO isn’t a bank, so maybe Ben will steer clear of their holdings.

  • Posted by Cedric Regula

    observer:

    Oh yes, I forgot one more perfectly legal move.

    Bill Gross announced a couple days ago that mortgages are going to 4.5%.

    At the risk of making Bill Gross sound less than prescient, Congress already fixed F%F rates at 4.5%. And TG confirmed that he confirmed the move in his confirmation hearing.

    So Bill’s good bond managers probably knew how to sift thru all that alphabet soup paper out there and knew which ones were free money.

    But it does make you less impressed with how some people get rich.

  • Posted by Observer

    The problem is that by providing liquidity to non-banking entities, the Treasury deprives banks of the necessary depressed asset prices that they need to generate cash flow and recapitalize. The words coming out of Mr. Geithner’s mouth simply is not consistent with the implications of his policies.

    Here’s an excellent article on that subject.
    http://atimes.com/atimes/Global_Economy/KA24Dj02.html

  • Posted by Off the boil

    Roubini says NATIONALIZATION….so I doubt if there is anyother option that will work in these distressed time.

    We are all talking about Banks. My concern is on the Retail Broker Dealers and RIAs (Reg Investment Reps)… What is happening to them ? Account closures in a big way ?

  • Posted by Michael

    Twofish: If people start buying cars a year from now, then those loans are going to be worth quite a bit. If you buy loans for 5 cents on the dollar and then you can sell them in a year for 20 cents, that’s a huge amount of money. (I’m not saying you personally are promoting this view, I understand you provide it as an example of why someone might buy “toxic” assets).

    But, that kind of risk-taking speculative buying is exactly what has crashed, and why the market for toxic assets has gone missing. During a period of high growth in the financial industry, founded on a world-wide rapid expansion of credit (yes, China and the Fed played their part, but there were many, many players), along with a glorification of risk-taking – by academia as well as business and government – as the ultimate source of all prosperity, almost everyone got greedy.

    The essence of excessive risk-taking is to overemphasize the possible gains (like “buy at 5 cents, sell at 20 cents”) and underemphasize the possible losses (like “buy at 5 cents, get 0 cents”). The current Crisis of Confidence isn’t simply some obstacle to “recovery” of excessive-credit-driven marketing of junk assets; it’s an awakening from the drunken stupor of “risk has been conquered” mentality to a very sober “I can’t afford any more to try to get rich by gambling” mentality.

  • Posted by Cedric Regula

    observer:

    Ya, I read the article but…

    He makes it sound like the banks are awash in cash and could make a lot of cash buying up junk rated paper.

    My understanding was they bought AAA paper that got exposed as junk. And marking that to market is the problem they have now.

    He does mention that the banks seem to be coming into new money for a few various reasons.

    But my understanding of the USG objective is to get banks to resume traditional lending rather than become bond vultures.

    So I guess I’m confused about the article’s theory.

  • Posted by Observer

    The stuff that’s been wiped off, or selling at 2 cents on the dollar are the riskiest tranches. The tranches that is in focus here are the AAA stuff, which are protected from losses from the latter classes. According to a calculation that the author made, if every single home defaults, and the homes are recovered for 40% of their original value, plus a five perc. recovery cost, the banks would still break even on their holds of AAA MBS currently priced at around 35 on the dollar. And that’s assuming 100% default rate.

    I believe Mr. Goldman has made a couple of posts around here in the past too so maybe he’s elaborate a little more.

  • Posted by Cedric Regula

    observer:

    That does sound too good to be true. If that were the extent of the banking problem the USG has many different ways to make it go away. Like mark to model, buy the stuff, its a no lose deal for taxpayers, etc..,

    So I would like to think there is more to it than that. Otherwise we are getting royally screwed.

  • Posted by Observer

    Cedric,

    These securities do pay out couple. That’s real money right there. And if the cash streams of these securities are not impaired, when why force banks to register a loss?

    The artificial loss has to do with the fact that all the leverage fed to the Treasuries, and the decline in the ratings of these securities meant that capital requirements went up for their holds, and forces an artificial liquidation. The banks now finally have the leverage to hold them and earn enough money to offset losses, but Geithner decided to provide leverage to non-banking entities to compete for these assets. If Mr. Geithner really meant by what he said, which is to fix the banking system, then his actions are indeed contrary to his words.

  • Posted by Twofish

    Michael: But, that kind of risk-taking speculative buying is exactly what has crashed, and why the market for toxic assets has gone missing.

    Exactly. Right now you could put gold bars outside people’s office, and no one would touch them out of fear that they are bobby trapped.

    If you look at the prices of some of these assets, they are priced assuming that half of the companies in the NYSE will go bankrupt and you will have default rates worse than that of the Great Depression.

    People are afraid that that the world will end, and they might be *right* and the world will end. But *if* it doesn’t, then people are going to be making a ton of money.

    Michael: It’s an awakening from the drunken stupor of “risk has been conquered” mentality to a very sober “I can’t afford any more to try to get rich by gambling” mentality.

    With an overcorrection. But if history is any guide, we’ll be back to greed and then back to fear and then back to greed and so on. There is a wonderful book “Extraordinary Popular Delusions and the Madness of Crowds” but madness works both ways.

    The way to get rich is to buy when everyone else is selling and sell when everyone else is buying. Right now, everyone is selling. Now is the time to buy. Once everyone starts buying then sell.

  • Posted by Twofish

    Observer: he tranches that is in focus here are the AAA stuff, which are protected from losses from the latter classes. According to a calculation that the author made, if every single home defaults, and the homes are recovered for 40% of their original value, plus a five perc. recovery cost, the banks would still break even on their holds of AAA MBS currently priced at around 35 on the dollar. And that’s assuming 100% default rate.

    There are a number of problems:

    1) if you are a bank you can’t just break even. If you have depositors that want their money right now and lenders that want cash right now, in order to lend that cash, you need to sell your assets. If you have a CDO that has a predicted cash value of $1, and the market is paying 15 cents for it, then in order to make a cash loan or redeem a deposit, then you have to sell it for 15 cents.

    If you think that it is worth $1, then you aren’t going to sell that security. The consequence of this is that you aren’t going to be making any loans. You have the same problem in real estate. If everyone thinks that the house is worth $1, then all you have to do is offer $2 and it’s yours. The trouble is that people that own the houses are willing to hold on to the houses rather than take a loss.

    The problem with all of this is that it leads to the “Japan syndrome.” If all people are doing is holding on to their assets hoping that they will be worth something someday, then there is no cash for opening up new businesses, and the economy just stagnates.

    We need to open up the credit floodgates, not to preserve the old system but to destroy it.

    Observer: These securities do pay out couple. That’s real money right there. And if the cash streams of these securities are not impaired, when why force banks to register a loss?

    Because if the bank can’t monetize the security, it has no way of raising cash for new loans or to pay depositors. At which point the bank has to go to the Fed for a loan, the Fed has to figure out how much the securities are worth, and we are now where we are now.

    You really need to at least report mark to market numbers.

    Observer: The artificial loss has to do with the fact that all the leverage fed to the Treasuries, and the decline in the ratings of these securities meant that capital requirements went up for their holds, and forces an artificial liquidation.

    But that’s not the only problem. People hopes that it was the only problem three months ago, but the situation has gotten worse.

    The mortgage problem left the banks bloody but mostly alive. The problem is that unemployment is rapidly increasing and people are doing to be starting to default on credit cards, auto loans, consumer loans, prime mortgages, basically everything. You have lots of old business contracting, and no one is going to lend a cent to anyone starting up a new business right now.

    Once the you take this into account, then you have a huge problem, because banks need to keep cash to cover the new bad loans, and while everything falls apart they are not going to be loaning out money. At which point everything goes into deep freeze like it did in Japan.

  • Posted by Cedric Regula

    observer:
    “These securities do pay out couple. That’s real money right there. And if the cash streams of these securities are not impaired, when why force banks to register a loss?”

    That’s what I mean by to going to mark-to-model. Or Goldman mentioned in his article in the past the USG has suspended mark-to-market.

    The cash infusion from the USG helps plug some of the hole.

    So if everyone was sure the assets are worth more, regulators could safely suspend mark-to-model for some time and the problem is solved.

    But they didn’t, so I don’t understand why they don’t. I’ll give them the benefit of the doubt and assume there is more to it than that.

    What they are doing is providing more buyers for the assets so banks can offload them. But still it’s “only” 500B out of a 11T mortgage paper market.

    But since we are talking serious tax payer money, it seems we have the right to have the USG answer these questions. Don’t know how to get that to happen, though.

    Maybe Brad can ask next time he gets invited to the Senate?

  • Posted by Twofish

    Cedric: That does sound too good to be true. If that were the extent of the banking problem the USG has many different ways to make it go away. Like mark to model, buy the stuff, its a no lose deal for taxpayers, etc..,

    If we could make the problem go away through clever accounting then I’m all for clever accounting. If unemployment was stable then we might be able to pull it off, but with over 1.8 million jobs in three months and people who are going to very soon stop paying their mortgages and credit cards, it’s just not going to work.

    This is the problem. We are in this downward spiral with three major crises happening at the same time.

    We have a banking crisis at the same time we have an employment crisis at the same time we have a foreclosure crisis and this is also happening at the same time all over the world.

    If you look at just one of the crises, you haven’t seen the whole problem. One other thing Merrill-Lynch under John Thain saw the same thing that Dan Goldman did, he put his money where his mouth was, and got burned.

    The Chinese economy right now is doing very well comparative speaking. It has one massive economic crisis rather than the US economy which has three.

  • Posted by Cedric Regula

    2fish:

    Ya, feels like we are circling in the toilet bowl.

    Annoying thing is the default rate was 4% last year and projected at 15% this year. So if the USG just buys all the houses, 19% of 11T = $2T, and declares a rent holiday, we are all better off than we are now.

    So why do things stink this bad?

  • Posted by Twofish

    About MTM accounting.

    EESA gives the SEC authority to relax mark to market account, which they did. It didn’t help….

    http://fasb.org/pdf/fsp_fas157-3.pdf

  • Posted by Observer

    Twofish: If you have depositors that want their money right now and lenders that want cash right now, in order to lend that cash, you need to sell your assets.

    Loan are assets. Banks hold these assets to earn the underlying cash flow….

    Twofish: If you think that it is worth $1, then you aren’t going to sell that security.

    When you don’t have the leverage to hold an asset class on your balance sheet, it doesn’t matter what you think. And that’s what has happened.

    And Japan stagnated not just because a bunch of financial wizards couldn’t get their numbers right. The whole industrial policy broke down. Some can argue that the breakdown of this policy is what led to the monetary expansion in the first place.

    Twofish: Because if the bank can’t monetize the security, it has no way of raising cash for new loans or to pay depositors.

    Not sure what this means. First of all, if you got a piece of security in your hands that nets interest in the double digits, why would you want to ‘monetize’ it. Second of all, you are talking about a theoretical situation where there’s a run on bank deposits. That certainly can happen, but in this discussion of bank’s cash flow, that’s neither here nor there.

  • Posted by Observer

    2fish: If you look at just one of the crises, you haven’t seen the whole problem. One other thing Merrill-Lynch under John Thain saw the same thing that Dan Goldman did, he put his money where his mouth was, and got burned.

    ???

    If I’m not mistaken, Thain unloaded a lot of this stuff to private equity. So I’m confused by this statement. David Goldman doesn’t advocate everyone buying these assets, just those who have the stable financing and are not constrained by capital requirements. Now that these assets have hit a floor in pricing, and that banks have plenty of liquidity to releverage, it’s the perfect time to earn those cash flows.

  • Posted by Cedric Regula

    observer:Second of all, you are talking about a theoretical situation where there’s a run on bank deposits. That certainly can happen, but in this discussion of bank’s cash flow, that’s neither here nor there.

    Right on. FDIC raised insurance to 250K. Banks runs would be completely irrational. Where’s everyone gonna put the money? In their mattresses? HA! It’ll be gone in no time.

    My suspicion is the USG really wants the banks to make lots of new loans, rather than operate as a breathing zombie.

    I worry if they get too carried away with that and think we will re-flate back to the good ol’ days of 2006.

  • Posted by Observer

    “My suspicion is the USG really wants the banks to make lots of new loans, rather than operate as a breathing zombie.”

    TG and Bernanke must know that the banking system can not possibly leverage up to the point where they could make up for the collapse of the shadow banking system. That’s why you heard TG announcing the new Fed financing facility that will support up to a trillion dollars of loans. That makes sense because the financing of the shadow system have retreated to the Treasuries.

    If the government piles all that leverage onto the banks, there’s no way any bank shareholder would get a single penny back, and you would get instant collapse.

  • Posted by Cedric Regula

    observer:That’s why you heard TG announcing the new Fed financing facility that will support up to a trillion dollars of loans

    They shouldn’t even call buying impaired consumer debt a “loan”. Let’s be honest and just add it to M2 right now.

    And there is still the liquidity trap. But if banks loosen up consumer credit anymore, we can call them “soup kitchens”.

  • Posted by Cedric Regula

    Also, along those lines I’ve had the feeling that the USG is borrowing money to give to people so they can buy treasuries. Banks will probably do it too. They have the first shot at it, and the lowest cost of money.

  • Posted by Fabius Maximus

    Paul Krugman has already written the definitive analysis of the new plan:

    “An old joke from my younger days: What do you get when you cross a Godfather with a deconstructionist? Someone who makes you an offer you can’t understand.

    “I found myself remembering that joke when trying to make sense of the Geithner financial rescue plan.”

    http://krugman.blogs.nytimes.com/2009/02/10/the-rorschach-plan-wonkish-or-at-least-hard-to-read/

  • Posted by ndk

    psh wrote: You’re prodigiously lucky, or wise, not to be at Treasury with your mentor now. He’s going to be history’s poster boy for an epochal kleptocratic looting spree by the biggest, brokest banks.

    And as such, I have little else to say, other than “let the piteous debtors default already.”

  • Posted by cdr

    In a nutshell – “they” think that they need to prevent foreclosures (mainly by refinancing on the cheap) in order to hide the fact that the CDO s held around do in fact not exist at all (central to that point are credit default swaps) meaning they did not derive their value from any existing asset ever. Lost mortgage titles? Estimate: 80%. Ratio: +/- 1/5. There are people who advocate modifying mortgages in courts (complementary to refinancing) should yield monetary compensation to MBS holder. Now why is that so? Why is Not disturbing the cash flows at all so central here?

  • Posted by cdr

    Of course ending a scheme requires a certain circulatory speed to turn corner –which would inevitably further break the money market s back, so here I agree on monetizing something with a big carefully calculated bang. Once-off one. Money market for starters, possibly real estate. If done in such a way then someone will profit enormously from holding subprime that soon will be rated higher in fact than their Alt A cousins (original or fake). I propose this would be the taxpayer but we could leave a proportion (not disproportion) with debt of bad banks holders as compensation for deposit transfers (out) earlier and the hair cut that went along. I d make this an ex post profit sharing –if and when profits materialize- not an ex ante disproportioned rewards for financing ………… securities in the first place.

  • Posted by cdr

    To manipulate the rate of refinancing (while monetizing fiat insurance) you do actually NOT need to monetize the long bond! Especially not as it has been oversold heavily. The second error here being that outlawing naked short selling (Soros) would force the huge short accumulated in the long bond to turn long indeed (new huge issue needed here to satisfy all this ”demand”) thus allowing the US to refinance in the long bond(!) at the cheapest levels ever. Then we get some of these potentially bad tempered guys` potential anger directed on FEDs personnel if they miscalculate the big bang required. How s that for incentive?

  • Posted by cdr

    If not being a regular subscriber to the publicly pronounced assumptions then the true error becomes the inability to blow bogus securities out of their legal existence which would lead directly to disappearing the scope of the problem (remember 1/5) by unwinding instead of subscribing to ridiculous over-liquidity that ends up being parked in Treasuries (call it private or public) but at the same time lead to erosion off Basel II fantasy “capital” and collapsing of the US CA deficit e.g. the “equal trade” thing. The assumptionists think all hell will break loose if they do that. Me thinks it will not if you first transfer “normal” deposits to a good bank – everywhere not just in the US and approach this one with western globosphere at least consensus! Hence this being the crossroads.

  • Posted by Indian Investor

    My simple version is that if you’re holding very doubtful assets: you get a dummy private investor and agree on a value of say $500 billion for them; the private investor who will get a loan form the Feds, say $100 billion and buy the doubtful assets with the loan money.Suppose the $500 billion goes doubtful and doesn’t yield anything back; the private investor can walk away from it. Once the PI walks away, she owes nothing to the Feds.
    Suppose it gives back more than $500 billion, the private investor gets the profits and pays back the Fed.
    Overall, this plan is the same as nationalizing the whole doubtful assets pack of cards.
    I noticed Dr. Roubini and Dr. Taleb in an interview together where Dr. Roubini recommends nationalization. That’s what this is. It’s nationalization with a private investor name thrown in.
    As to why the market fell yesterday, that might be because of some oil geopolitics. The Kuwaiti price was talking about crashing the crude down prices further, so that the Russians and the Iranians can be scared out of their wits further. Maybe that’s why the market was reacting yesterday.

  • Posted by cdr

    And incidentally, “the box” is defined by Fed’s big hug over 4-6 terrified big boys. You do not have to end this love affaire to get out of the box. There’s more but I’ll stop.

  • Posted by toxic_employees

    Think we have a case of Toxic banks, Toxic assets and Toxic employees.

    Federal regulators should seize the assets of all the MD’s, Executives and CEO’s.

    A part of taxpayer money should be allocated to Trials and Indictments. Why is Stanley O’neal NOT INDICTED? Why is Dick Fuld NOT IN JAIL? Why is HERB GREENBERG not under ARREST?

    Why did some highly paid Bankers who sold and packaged MBS and CDO’s quit in 2007 and then with personal funds SHORT the FIRMS who bought them? Making more money on way DOWN than on the way UP!

    I’m appalled and disgusted with Wall Street. I will never invest a dime in U.S. financials and I’m sure I’m not alone. Majority of my neighborhood is just as outraged as myself.

    Thank you!

  • Posted by Ying

    “Toxic banks or toxic assets?”

    The question should be weather to do nationalization, government bailout of private firms or some sort of public private hybrid?

    For my understanding, a public private hybrid model has demonstrated tremendous problems in the past. Examples include Freddie and Fannie, rating agencies, to Public Private Partnership infrastructure model, Commercial banks (in some sense).
    It is extremely complicated to spell out the responsibilities of each partner. Lots of resources went to figure out what is the right amount of true asset value, who should get what etc.

    Government job is to maintain a healthy economy for Americans. Taxpayer’s money bailout of private firms is not justified.

    The only option left is nationalize its banking sector. Given the severity of the crisis, the speed and simplicity of the action will bring, this option should be seriously considered right now.

  • Posted by Karen

    Proper valuation is needed for toxic asset purchases or proper mortgage modifications. This platform addresses both and protects the taxpayer, and un-biased on valuation.

  • Posted by Karen

    The platform is called Mo Mod built by Smithfield and Wainwright

  • Posted by Twofish

    Observer: Loan are assets. Banks hold these assets to earn the underlying cash flow….

    But they are matched by short term deposits to provide money to buy the loans.

    Observer: First of all, if you got a piece of security in your hands that nets interest in the double digits, why would you want to ‘monetize’ it.

    Because you have lots of interest rate and default risk that you need to manage. One way of doing this that can be a lot safer than holding loans is to make money off origination and servicing fees. You immediately sell off the loans, make money from the origination and servicing fees and then use the cash to make new loans.

    If you aren’t reselling loans, then the loan volume goes way down, which is what has happened.

    Observer: Second of all, you are talking about a theoretical situation where there’s a run on bank deposits.

    It’s not a theoretical situation. There were massive bank runs on the investment banks and money market funds after Lehman, and a bank run is what killed Washington Mutual. Banks have very little cash on hand, and even a small drop in deposits can be a huge problem. Since now everything is FDIC insured, it’s not a huge problem for depositors, but it is one for the government.

    You haven’t seen people line up in front of banks demanding their money, but that’s because all of this is happening over the internet.

    Observer: That certainly can happen, but in this discussion of bank’s cash flow, that’s neither here nor there.

    It did happen. Bear-Stearns, Lehman, and Washington Mutual, and the investment banking model were all killed by bank runs.

    Banking would be easy if you didn’t have to worry about bank runs, but you do. Part of the reason that finance has changed so much is that a lot of “let’s not worry about these events” have actually happened.

    Observer: Now that these assets have hit a floor in pricing, and that banks have plenty of liquidity to releverage, it’s the perfect time to earn those cash flows.

    They haven’t hit a floor in pricing, and banks don’t have plenty of liquidity. If you can get a situation in which the unemployment rate stabilizes *then* people will start purchasing those assets, but until unemployment stabilizes, people aren’t going to be too interesting in buying.

  • Posted by Twofish

    Observer: If I’m not mistaken, Thain unloaded a lot of this stuff to private equity.

    He tried to. The trouble is that if things get worse, and private equity doesn’t buy, you are stuck with these assets. If you haven’t hedged them, then you have large problems.

    Observer: So I’m confused by this statement. David Goldman doesn’t advocate everyone buying these assets, just those who have the stable financing and are not constrained by capital requirements.

    Except that no one has stable financing and everyone has capital requirements.

    You have a chicken and egg problem here. Hedge funds and private equity need financing and loans from banks to buy these securities, but banks aren’t going to provide hedge funds and private equity with that financing because they have these assets on their books.

    Observer: Now that these assets have hit a floor in pricing, and that banks have plenty of liquidity to releverage, it’s the perfect time to earn those cash flows.

    It’s not a good time right now, while we have massive job losses each month. The assets haven’t hit bottom and banks don’t have plenty of liquidity.

    Karen: Proper valuation is needed for toxic asset purchases or proper mortgage modifications. This platform addresses both and protects the taxpayer, and un-biased on valuation.

    This sounds like a press release that got injected into the system, and it sounds pretty bogus to me.

    Valuation is essentially a very subjective process, and trying to pretend that it isn’t will get you into a lot of trouble.

    Ultimately a lot of finance depends on staring someone in the eye, and trying to figure out if you can trust them or not.

  • Posted by Michael Carroll

    The Treasury should force the auction of 0.1% of the non perfoming loans of every banks each week with an opening bid of one penny per nominal dollar value. At one penny on the dollar it will be hard not to make some money as some of the loans perform marginally and others are redeemed for collateral so overtime demand at the auctions will grow and the government coersion can be relaxed.

    Even if the banks make no money, writing off a 5.2 percent loss on this stuff over a year is well within the current scope of what we are facing and the banks actually have an incentive to make this work because it works like a loss leader to get the credit market moving again. Hell they should toss in some gold ticket assets randomly just to spice up the pot.

  • Posted by locococo

    “there are no assets”

    that s written on the piece of paper hidden in these toxic assets.

    They are not toxic but partially non-existing. There therefore are no toxic banks at all. All we can argue here about is their” existing” and “non-existing” part.

    Their value thus depends on probability that
    a) no one discovers that piece of paper
    b) we can overprint to such an extent that this vacuum gets refilled
    c) that b) can in fact not be done due to the current »environment« we find ourselves in
    d) we ll lock in the needed total amount of fresh greenbacks on a huge but partial but regular and sustainable quarterly basis through congress for years to come to keep up the cash flow required for that picture to emanate to sink in the bottomless pit called »banking« these days
    e) foreign CBs don t wake up as to what constitutes a “reserve” or can be scared/persuaded enough not to remember (e.g. appreciation)

    but not on
    a) any model even those not yet invented that derive their result (value) from the underlying asset “happening”

    We re ok at the a) and the e) for now tho shaky, c) then scratched b) away, d) might take its dive along somewhere. That s exactly what the markets have lately been trying to say here

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