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Guest Post: FDIC Won’t Rule Out Banks as Buyers of Toxic Assets

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Submitted by Rolfe Winkler, publisher OptionARMageddon

During a press conference today, FDIC Chairwoman Sheila Bair was asked about the Journal’s report that banks are lobbying to buy assets under Geithner’s toxic asset plan, the PPIP.

She says banks will not be able to bid on their own assets, but clearly leaves open the possibility that they’d be allowed to buy the assets of other banks.

This is highly problematic. If banks can act as buyers in any capacity, what’s to prevent collusion? With just a sliver of equity and a pile of non-recourse federal loans, Citigroup could fund a special purpose vehicle to overpay for BofA’s bad assets. In exchange BofA would overpay for Citi’s assets. The beauty of using non-recourse debt is that you can walk away from it. The lender, in this case the taxpayer, is stuck eating the loss on the bombed-out asset.

All banks stand to lose is their small equity investment. And even this amount could be offset if banks collude to overpay.

The ranking Republican member of the House Financial Services Committee, Spencer Bachus, previously expressed outrage that such collusion might be possible. He promised to introduce legislation to prevent it from happening. I’m not aware that he has and have a call in to the Financial Services Committee for comment.

Below, I’ve transcribed Bair’s full response to the question she was asked about PPIP….

No [banks] will not be able to bid on their own assets. I think there has been some confusion about that….There will be no structure where we would allow banks to bid on their own assets. I think there have been separate issues about whether banks can be buyers on other bank assets and I think that’s an issue that we continue to look at. There’s also a question of whether banks who come to the PPIP to sell assets, while they would not be involved in the bidding process—private investors would set the prices—whether part of the consideration they would take back once the price has been set by the private sector, would be in an equity piece in the PPIP. Those are things we’re actively discussing….

I think there are a couple of factors that are still at play here as we try to devlop this structure and look toward the launch of PPIP. One is we’re finding on both the buyer and the seller side there continues to be discomfort about Congress’s view of this program, whether the rules could potentially change. The Boxer/Ensign amendment I think is a good amendment…it addresses conflict of interest issues and we want that too. Nonetheless I think this has created some uncertainty about certain aspects of the Boxer/Ensign amendment and the Treasury will need to issue regulations I think to clarify those issues before we will have comfort by market participants.

Bair’s sentence beginning “nonetheless” was not clear. What I transcribed is what she said. It sounds as if she’s uncomfortable about the amendment (more below)…..she quickly changes the subject…..

Also the good news is banks have been able to raise a lot of new capital before taking more aggressive steps to cleanse their balance sheets. The incentives to sell [assets to the PPIP] may be less for good reasons because they’ve been able to raise new capital.

So there are still some issues we are working through…

She knows taxpayers are getting a raw deal, which is why it would be “good news” that banks’ have less incentive to sell assets to these vehicles. She also knows that banks are still swimming in so much toxic junk, it has to be flushed away somehow. But she’s apprehensive that the public might have a transparent view of the cleansing process.

Enter the Boxer/Ensign amendment, which is attached to S. 896. It reads:

To provide for oversight of a Public-Private Investment Program, and to authorize monies for the Special Inspector General for the Troubled Asset Relief Program to audit and investigate recipients of non-recourse Federal loans under the Public Private Investment Program and the Term Asset Loan Facility.

In other words, Senators Boxer and Ensign want to give Neil Barofsky oversight over PPIP in addition to TARP. Is Bair uncomfortable with this because she knows Barofsky would publicize some of the very abuses the administration is counting on to help banks push their losses onto taxpayers?

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14 comments

  1. joebhed

    I’ll be surprised at any substantive oversight that could affect the execution of the PPIP play.

    There is the matter of the maintenance of the status quo, which is carried out in the name of preserving private banking in this country, but in reality preserves the fractional-reserve debt-money-creation system of the private bankers of the Fed.

    There is always the threat of a credit downgrading in response to any government involvement that might somehow violate the sacred doctrine of independence, meaning total freedom to the Fed to do anything, in setting the nation’s monetary policies.

    The purpose of PPIP is to preserve the banks. They don’t want any interference.

    Major financial contributions to both parties is a powerful tool that ensures minimal real transparency and ineffective regulation, when it comes to banks and monetary policy.

    Greenbacks.
    It’s OUR money.

  2. Kid Dynamite

    I obviously agree that banks bidding on assets would be the ultimate in gaming the PPIP, but the argument against allowing them to bid is even simpler: the whole point of this plan is to get these “toxic assets” OFF of the bank balance sheets… thus, they should not be allowed to bid on the assets to ADD them to their balance sheets.

    Q.E.D.

  3. bobo bobo

    Yves: This is highly problematic. If banks can act as buyers in any capacity, what's to prevent collusion? With just a sliver of equity and a pile of non-recourse federal loans, Citigroup could fund a special purpose vehicle to overpay for BofA's bad assets. In exchange BofA would overpay for Citi's assets. The beauty of using non-recourse debt is that you can walk away from it. The lender, in this case the taxpayer, is stuck eating the loss on the bombed-out asset.

    I am glad that Yves has finally seen the light. Once upon a time, Yves claimed there was no benefit to allowing the banks to bid on each other's assets using non-recourse loans from the Fed/FDIC under the PPIP program.

    Anyway, no one should be surprised that Geithner wants to allow the banks to do cross-purchases of substantially identical assets. There is precedent. In 1980, the Federal Home Loan Board (FHLBB) issued Memorandum R-49, which allowed S&L's to do cross-purchases of "substantially identical" pools of mortgages purchase without recognizing losses for accounting purposes. The whole point of the FHLBB blessing these cross-purchases was to screw the IRS by letting the S&L's recognize tax losses by each S&L on its cross-sale, so for accounting purposes they pretend to sell each other pools of mortgages at book value to avoid having GAAP losses, but for tax purposes pretend to sell them at fair market value, and recognize tax losses equal to the spread between face and fair value.

    Obviously, it made no sense whatsover to respect these transactions as cross-sales for tax purposes because the S&L's were in the same position economically before and afterward. But the Supreme Court blessed these deals anyway. Now, the banks basically want Treasury to let them do asset swaps of substantially identical assets at inflated prices recognize tax losses and not recognize accounting losses, but they want to turbocharge the transactions by getting non-recourse loans from the Fed/FDIC under the PPIP program.

    If Geithner blesses these bogus valuation techniques, the tax shelter promoters might start trying to use Geithner's valuation strategies to justify them doing cross-purchases of assets at bogus prices with non-recourse notes so that parties can get depreciation deductions. And if the IRS challenges it, the tax shelter promoters can pull out valuation strategies approved by Geithner, Bair, and Bernanke to help them. I'd like to see a judge send taxpayers to jail for using Geithner's valuation strategies. That would be very funny.

  4. orderemerges

    This PPIP and all the other mumbo-jumbo government crap is why I am applying for permanent residency in Canada. At least the Canuck government will make good on its retirement payments.

  5. Rolfe Winkler

    Kid Dynamite, you’re missing the point. The PPIP structure uses non-recourse loans to literally remove the exposure from bank balance sheets. A bank that buys the bad assets can walk away from them. They aren’t on its balance sheet. They are on FDIC’s.

  6. Sion

    Kid Dynamites comment shows how easy it is to game the public. If a regular financial blog reader does not get it how can we expect a general audience or even the independent main stream media to do so?

    I find it incredible that western democratic society exists with a financial system so opaque that it is possible to con the majority of its stake holders so regularly and easily.

  7. Anders

    Typo/URL:
    Link to optionARMageddon contains too many “m”:s.

    bobo, “I am glad that Yves has finally seen the light. Once upon a time, Yves claimed there was no benefit to allowing the banks to bid on each other’s assets using non-recourse loans from the Fed/FDIC under the PPIP program.”
    Well, there isn’t any benefit to the system as a whole, is there? Did you misquote or misread the quote?

  8. bobo bobo

    Anders: Well, there isn’t any benefit to the system as a whole, is there? Did you misquote or misread the quote?

    ———-

    Yves once upon a time said cross-purchases would not help the banks. She was wrong then. And if she still believes that, she is still wrong. I wasn’t talking about “the system”, and neither was Yves.

  9. Yves Smith

    boo boo,

    I challenge you to find my saying that.

    I objected to the whole premise of the PPIP in general as an inefficient, opaque subsidy to the banks. I further objected to cross purchases as gaming the system. It makes a mockery of the powers that be’s efforts to legitimate the process and pretend that this is some sort of investment with an opportunity for taxpayers to profit.

    I never in a million years said this was NOT a subsidy, which is what your “help the banks” is tantamount to.

  10. Yves Smith

    boo boo,

    The government has no business “helping” banks. The government does not serve as a charity to profit motivated organizations. If it makes an investment, it should take a piece of the capital structure at a market price. The PPIP is a huge ruse to avoid doing that, because if the powers that be had been striking market price deals, we’d own a few of these banks, and the authorities are ideologically opposed to doing that.

    I suggest you read the Norges Bank paper on how Sweden, Finland, and Norway dealt with their banking crises. They most assuredly did not coddle or “help” their banks.

  11. bobo bobo

    Yves:

    Here is a link to your comment re the banks not having an incentive to trade amongs themselves:

    http://www.nakedcapitalism.com/2009/03/investor-on-private-public-partnership.html?showComment=1237685880000#c4337594634684808751

    “At this juncture, I don’t see the motivation for banks to trade paper among themselves (although the total return swap idea above is noteworthy). They could have done that before, to validate higher marks on their assets (indeed, some have claimed banks were doing that with collateralized loan obligations, but that stopped, maybe because it was exposed). And the FASB is on its way to further weakening mark to market.”

  12. bobo bobo

    Yves,

    My point was simply that you seemed to miss or ignore the benefit to the banks of doing cross-purchases.

    You are changing the subject, but regardless, I don’t agree with the government helping banks. I think all banks that cannot issue equity and debt without government support should be put into chapter 11 bankruptcy for restructuring or into receivership for resolving by the FDIC. I think Edward Harrison’s and David Goldman’s idea that bondholder haircuts (for bondholders of banks and insurance companies) in receivership or bankruptcy will cause systematic problems is uninformed nonsense. The goverment can put any entity into bankruptcy, and keep it operating with DIP financing and guarantees to protect transactions entered into after the bankruptcy filing. Maybe retail customers won’t buy a car from a bankrupt company, but a fund manager will happily trade with a bankrupt company if it is profitable.

    There are administrative difficulties, but laziness is no excuse for the terrible economics and horrible morality in bailing out bondholders and counterparties of banks and insurance companies.

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