This morning, the Treasury unveiled its plan to buy toxic assets from banks through a public-private partnership. First of all, the assets are being called “legacy” assets, instead of toxic. Nice spin. But euphemisms aside, are we just spinning our wheels?
Here’s the plan from the Treasury Department:
To start the process, banks will decide which assets – usually a pool of loans – they would like to sell. The FDIC will conduct an analysis to determine the amount of funding it is willing to guarantee. Leverage will not exceed a 6-to-1 debt-to-equity ratio. Assets eligible for purchase will be determined by the participating banks, their primary regulators, the FDIC and Treasury. Financial institutions of all sizes will be eligible to sell assets.
From a Tim Geithner Editorial in the Wall Street Journal:
We cannot solve this crisis without making it possible for investors to take risks. While this crisis was caused by banks taking too much risk, the danger now is that they will take too little. In working with Congress to put in place strong conditions to prevent misuse of taxpayer assistance, we need to be very careful not to discourage those investments the economy needs to recover from recession.
Apparently, bank investors think the plan might do something. Bank stocks are up, the Dow has gained 250 points, as I write this.
But there’s a lot of skepticism that a. private investors will wade in deep enough to make a difference b. that these assets are, in fact, the problem and c. that we are just rehashing the same plan over and over.
From Henry Blodget at Clusterstock: Tim Geithner’s Five Big Misconceptions
- The trouble with the economy is that the banks aren’t lending.
- The banks aren’t lending because their balance sheets are loaded with “bad assets” that the market has temporarily mispriced.
- Bad assets are “bad” because the market doesn’t understand how much they are really worth.
- Once we get the “bad assets” off bank balance sheets, the banks will start lending again.
- Once the banks start lending, the economy will recover.
From Paul Krugman, New York Times:
Yes, troubled assets may be somewhat undervalued. But the fact is that financial executives literally bet their banks on the belief that there was no housing bubble, and the related belief that unprecedented levels of household debt were no problem. They lost that bet. And no amount of financial hocus-pocus — for that is what the Geithner plan amounts to — will change that fact.
Felix Salmon at Portfolio — Geithner’s Doomed Bailout Plan
Private-sector investors want to pay as little as possible for these “legacy assets”, in order to maximize their returns. But the banks will not sell any of their legacy assets unless they can do so at a price close to the level to which they’ve already been marked down. Is there any reason to believe that there’s a private-sector bid out there for legacy assets at their current marks? Not really. But if there isn’t, the banks will simply refuse to sell, and there won’t be any money or assets changing hands at all.
An alternative plan from the Economist — If you could only hedge the government:
So just in case markets do not like this plan I have a cheaper suggestion. The government should create a market that allows firms to hedge one of the biggest outstanding sources of uncertainty–its own behaviour… For example, there could be a security that is in the money if say the government one day decides to write down all mortgages 30% and then refinances everyone at a 1% fixed rate. Banks were strong-armed into taking TARP money only to have Congress turn around and start dictating how they pay their employees. So to get firms to participate, how about offering a security in the money if the government starts meddling with firms who buy assets under this plan?
Interesting. The government needs to be kept in check here too. What troubles me about the Geithner plan is that it hinges on one solitary concept — that the financial system is actually fine. It just needs to clean up the garbage on its books. I believe that’s been the theory since Paulson announced the original plan to buy toxic assets last September.
But what if that theory is wrong?