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US: Cash for Trash
We are living in very strange times. Back in the day, as recounted in so many “B” movies, desperadoes would rob banks, since it was said, “that’s where the money was”.
To save ordinary depositors from being bilked of their hard earned savings, up would step the long arm of the law. All would end well: the bandits in jail and the citizens cheering the authorities.
The latest news from Washington, however, suggests that in this financial crisis, the tables may have been turned: the law is about to rob the ordinary citizen on behalf of the banks to the tune of hundreds of billions. The citizens are still expected to cheer the lawmen.
Since late 2007, US banks have practically stopped lending – especially to each other. They did so because the bottom had finally fallen out on the sub prime mortgage bubble.
Banks got stuck with fantastic amounts of “assets” (estimates hover around US$3.3 trillion) that they all knew were valued according to models that had no relation to reality. They were deemed “toxic” because if these assets were marked to their market value (there were now practically no markets) and the losses taken or reserves were provided for dealing with the same, most banks, particularly the largest ones, would have been exposed for what they were – insolvent.
Each bank knew what was in its vaults and assumed that its cohorts were all in the same fix – with good reason, since they were all exchanging the ethereal derivative assets freely during the bubble.
So all the banks have held on to the “toxic” assets at book value (remember this was always a fictitious value) leading to the present Mexican standoff. The previous and present administrations went along with the banker’s fiction that they merely had a “liquidity’ problem – not enough cash to lend.
In reality we were dealing with banks that were literally dead on their feet – “zombie banks”.
The US government has poured billions (TARP 1 – US$350 billions) into the banks but with no effect, since it did not address the fundamental problem of undercapitalisation. And now the Geithner reverse bank heist has been unveiled – partially, since there are several grey areas – the “public/private partnership investment programme”.
For starters, the plan would provide funds to purchase US$500 billion of “toxic” assets with a provision to escalate up to US$1 trillion. The devil, however – as always – lies in the details.
The private investors would invest only 7.1 per cent in equity while the Treasury would take a further 7.1 per cent and the remainder would be funded by the Federal Deposit Insurance Corporation (FDIC)-guaranteed loans.
The government then takes practically all the risks. The “public/private partnership” buys “toxic assets and knowing that it undertakes minimal risks will bid much closer to its book value than otherwise.
So the banks get what they always wanted – a minimal markdown based on a price not really set by the market.
Based on private estimates this in effect would amount to a transfer of at least US$300 billion to the banks on sales of US$1 trillion of toxic assets. And remember there are at least three times that amount of the latter goodies.
But the scam does not end there. The FDIC loans to the private investor (hedge funds) will be non-recourse, meaning that if the toxic assets purchased by private investors fall in value below the amount of the FDIC loans, the investment funds will default on the loans, and the FDIC (the taxpayers) will end up holding the bag of toxic assets.
Some suspect that the banks may even be so bold to do a “flip” – pick up the same assets later at bargain basement prices, while the hedge funds walk away with huge “transaction costs” fees.
We believe that the Geithner plan not only presents moral hazard issues but also delays the inevitable need for fundamental reform (analogous with our Government’s guarantee to CLICO policyholders). The “toxic assets” should be sold at market values and those banks that are exposed as insolvent should be capitalised by the government.
We do not wish to use the word “nationalise”. At least the ordinary US citizen will have some real “skin” in the game.
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