naked capitalism

Several alert readers caught the Financial Times story, “Wall St banks seek to ring-fence bad assets,” and I held off from posting on the assumption it would merit coverage in the Wall Street Journal or the New York Times. Not so.

The Financial Times article says that investment banks are seeking to put dodgy assets in a separate subsidiary, with the hopes of offloading it to over-eager bottom-fishing chumps investors. Or if that doesn’t work, to taxpayers:

According to people familiar with the matter, banks are discussing a joint proposal to regulators to set up a fund, which would absorb US subprime assets and other troubled securities, as a way of restoring confidence in the banking system and ending the pressure to recognise mark-to-market losses.

I don’t give this proposal any hope of seeing the light of day, at least in this form, although a huge number of permutations later, something that might have germinated with this idea could come to life.

The biggest obstacle is the idea that this facility would be organized by the industry and all would participate on the same terms. As we found with the stillborn SIV rescue plan and the “bail out the monolines” firedrill, getting consensus among a large number of disparate players is well-nigh impossible.

This effort is likely to founder over the same issue that killed the MLEC, the hoped-for SIV garbage dump, which is how to value the assets going into the new vehicle. Prices need to be set for the instruments that will be moved out of a bank; this stuff by definition doesn’t trade so how to price it is legitimately subject to debate. But that’s assuming it even got that far. For participants to have a down-and-dirty discussion, they’d wind up shedding light, if in a general way, on their exposures and how much they had marked them down. I doubt that the involved parties would risk revealing that much.

The FT points to problems along these lines:

However, bankers say the prospect of a co-ordinated solution remain remote because of the difficulties in getting banks to agree on the terms and the scope of a common fund.

John Thain had said of the vastly simpler (and still unsuccessful) mononline effort that it would not work on a group basis, but institution by institution. So let’s consider that case:

Under UBS’s scheme, the bad assets will remain on the bank’s balance sheet because the Swiss bank will initially retain full ownership of the new fund. However, UBS is expected to sell all or part of it to outside investors, or to spin it off, according to people familiar with its plan.

Um, this works only if the price to which you have marked the assets is lower than a third party is willing to pay. Otherwise, you wind up worse off. Simple example: you’ve written this garbage barge down to 25 cents on the dollar, convinced that that it extraordinarily cheap. But then you try getting bids, and all you get is 20 cents on the dollar, You’d have to take another 5 cents on the dollar loss to sell it, which is another hit to equity, which is precisely what you were trying to avoid.

Or just as bad, word gets out that you shopped your little nuclear waste subsidiary, but didn’t like the offers. Now guess what that will do to your stock price, your counterparties’ confidence, and CDS prices on your debt. You were better off having everyone believe, or pretend they believed, that your write-offs put all your problems behind you.

So this does not appear a bona fide notion to unload this stuff onto third parties, despite chatter of hedge funds and distressed investors out buying MBS and mortgages (that stuff is a walk in the park compared the complexity of some of these structures). And the volume that would be on offer is certain to swamp demand.

This effort, then, despite the brave talk (and perhaps a bit of self-delusion), is preparation to somehow dump these toxic assets on the laps of the Powers That Be. But the Resolution Trust Corporation created good banks and bad banks out of failed banks. It’s an amazing bit if hubris if the industry thinks it can shove these assets onto taxpayers and carry on unimpeded.

There is also a lack of historical memory. The RTC was extremely controversial; Congress was not happy about funding its sizeable working capital requirements. And in contrast with 1990-1991, there are calls for relief from a lot more quarters. Wall Street may find it tougher than it thought to get its hoped-for rescue operation.