Investor on Private Public Partnership: "One would have to be a criminal to participate in this"

Hoisted from comments:

Say I am SAC Capital. I get to be one of the bidders on bank assets covered by the program

Citi holds $100mm of face-value securities, carried at $80mm.

The market bid on these securities is $30mm. Say with perfect foresight the value of all cash flows is $50mm.

I bid Citi $75mm. I put up $2.25mm or 3%, Treasury funds the rest.

I then buy $10mm in CDS directly from Citi [or another participant (BOA, GS, etc)] on the bonds for a premium of $1mm.

In the fullness of time, we get the final outcome, the bonds are worth $50mm

SAC loses $2.25mm of principal, but gets $9mm net in CDS proceeds, so recovers $6.75mm on a $2.25mm investment. Profit is $4.5mm

Citi writes down $5mm from the initial sale of the securities, and a $9mm CDS loss. Total loss, $14mm (against a potential $30mm loss without the program)

U.S. Treasury loses $22.75mm

Great program.

It’s just a scheme to transfer losses from the bank to the taxpayer with an egregious payout to a middleman (SAC) to effectively money launder the transaction.

You’ve also transmuted a $30mm economic loss into a $36.75mm economic loss because of the laundering. So its incredibly inefficient.

How did fraud and money laundering become the national economic policy of the US?

One would have to be a criminal to participate in this.

Update: One Kid Dynamite in comments suggested the CDS proceeds were overstated. If we adjust for his assumption, the Citi loss is reduced ($9.5 million versus $14 million in example). The investor would also show no profit on a $2.25 million investment (note the quick and dirty analysis did not allow for time value of money, which means he loses money). If the investor anticipated that, it means he would not bit at all. So you need either overly optimistic investors or an even richer subsidy from Uncle Sam. And that’s before you get to the other two issues, first, that even this example has Citi showing a loss on sale of dud assets (which we don’t see happening, the whole point is for banks NOT to show losses). So the bid would have to be even higher, the full $80 million.

Second, if we further accept Kid Dynamite’s observation that the CDS would be more pricey (any input here?) that basically means there deal would produce an expected loss. Again, no trade unless investors are too optimistic. Think we have an excess of optimism in this environment?

But this little example does serve to illustrate that even if the investors understand and fully accept that the current market price is markedly below the “true” value of the toxic paper, the math to the investor still does not appear to work. That means the program will have to offer even richer subsidies or will elicit very few successful bids (and then only on the best of the dreck, where the “real” value of the paper appears to be not too horrifically below the level at which the bank is carrying it on its books). That’s a lot of cost and drama for perilous little benefit. Back to the original post:

Folks, this IS even worse than I thought, and you know I have a constitutional predisposition to take a dim view of things (although it was clear from the get-go that the introduction of private parties to give air cover to the Treasury would make the exercise more costly without adding any value).

I suggest you write/e-mail your Congressmen, and more important, any of you who have MSM media contacts, call this to their attention. There will no doubt be useful further grist on this thread and on the post on which this comment first appeared. But the analysis above is damning on its face. I’d like to have someone have Geithner try to explain why it WON”T work like that, and how this abortion solution is in our collective best interest.

AIG bonuses are a sideshow (as offensive as they are, don’t get me wrong on that one, the symbolism is awful). It is diverting attention from the real crimes and serving to get nay-sayers branded as populists, which is code for “jealous of their betters”.

But this sort of thing in reality, as Paul Krugman points out today, is not a class issue but a recognition that the program is so heinous that it represents a fundamental danger to an already damaged economy:

… that these funds will have skewed incentives. In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem.

Krugman’s comparison to the S&L crisis is actually too favorable. The losses then were only $100-$120 billion in total. The damage (as in losses to the taxpayer) on this one program are almost certain to be greater if the Administration gets its hoped-for take-up.

Now that level of loss (ex the unnecessary subsidy) might well be warranted IF it were putting the markets on a sound footing, by providing a backstop while investors did price discovery on bad assets. Price discovery is a necessary part of this process. One could argue the reason the offer in the illustration above is $80 million and the bid is only $30 million is that no one is interested in bidding when the sellers aren’t serious. If the banks really were to start unloading assets, the initial buyers would get a steal, but more capital would come forward. You might not see bids rising to the “fullness of time” $50 million level, but you would see bidding rise above the current level. (Note, however, that the banks simply are not willing to show more losses, which means, as in the S&L crisis, the bad assets need to come into government hands via institutions that are in the worst shape being declared insolvent and taken over, and the assets sold out of receivership. There is simply no sensible mechanism by which the government can provide these massive subsidies. We’ve now had three attempts at it, two under Paulson, and now the Geithner monstrosity. A bad idea is a bad idea. We need to move on to Plan B).

With price discovery (or the equivalent via more realistic marking of their books), some banks would be toast and need to be put in a form of receivership. But pretending these banks are viable, keeping the incumbents in place (who have incentives to take risk with taxpayer money, if nothing else so they can try to show profits and slip the leash) is the worst of all worlds. Some of the big banks already have been nationalized from an economic perspective, yet we keep alive the dangerous and costly fiction that they are functioning, private concerns. The Japanese did a variant of this program via letting zombie banks hold dead loans at grossly overvalued prices and pretend to be solvent, and look how well it served them. Oh, and in the end, the banks had to take the losses.

There may also be a Constitutional issue, as another reader alleged:

Geithner/Summers are willfully evading Congressional oversight. After the Tequila/Mexico financial crisis, the banks wanted 20 billion and Congress wouldn’t give it, so Summers/Geithner under Clinton evaded that buy misusing the government’s ESF, argually illegally. Now, given that Congress doesn’t want to authorize more money, Summers/Geithner are trying to misuse Fed/ DIC authority to hand out cash. This is illegal because the FDIC and Fed are authorized to lend, but not to hand out gifts/grants. Lending non-recourse undercollateralized is a gift/grant.

I know we are all suffering from outrage fatigue, but this is a worthy target for your ire. I hope you find a productive outlet for it.

PS No vigilante stuff or threats to preps or suspected perps, please. First, it’s counterproductive. It elicits sympathy and will lead the companies to hire bodyguards, which if they are on Federal life support, comes out of our collective hide. Second, it’s bad karma.

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  1. Kid Dynamite

    Yves, I agree this program is a scam, but i’m confused by some of the math in this post.

    1) in the example given, SAC only books a net $4mm gain on the CDS right? they pay $1mm, and they receive $5mm (50% on $10mm protection). The post said they book a $9mm gain.

    2) the CDS wouldn’t really cost $1mm per $10mm – it would cost more like $5mm per $10mm. simply, if the CDS is priced correctly, the CDS portion of the trade will be a wash – you’re operating under the assumption that we know the true value of the bonds.

    i think you can redo this post to make it more realistic, and offer a better proof of how much of a scam the TALF is at the taxpayers expense.

  2. Steve

    The CDS leg is unnecessary if the government loan to the purchaser is non-recourse. So the idea is to let the purchaser ride the spread while it’s good and then throw the loss to the taxpayer some years down the road when the cashflows fall below the financing cost. It’s a delaying tactic to make the future Joe Taxpayer eat the cost. But this isn’t going to work for a range of bad assets with distant cash flows. I doubt this program will remove more than a fraction of bad assets from the books of the idiots who bought or created them. This installment of Through the Looking Glass will only work for stuff with an artificially created positive carry.

    By the way, where exactly is FDIC getting the money for this program, and under what laws?

  3. dearieme

    As an example of change you can believe in, this is all rather Special Olympics.

    It would seem that you really have elected your third dud in a row.

  4. Anonymous

    Are you going to include a link for paypal (or similar) donation — either to yourself or a favorite charity. This has been one of my favorite and most helpful news sources since last year. I know papers are hurting, and low-cost bloggers aren’t really in need, but it wouldn’t hurt to offer the willing, the opportunity to get in the habit of paying for what they appreciate using.

  5. Neville

    Does anybody remember that the last people who brought in 3% equity partners to take control of an off-balance sheet hedge fund in a no-loss deal designed solely to absorb toxic assets at inflated prices, were sent to jail by the government for misleading the public? Their names were Andrew Fastow, Jeffrey Skilling and a raft of other managers, at Enron.

    The goal of their off balance sheet partnerships was to conceal where and when the real losses had occurred and thus who was responsible for them, until some later date when they could either be transferred back onto the public (Enron’s shareholders) in a way they would not notice, or at least after the Enron managers had a chance to unload their shares.

    Now we have a virtually identical scheme, but this time it’s being promoted jointly by the banks and the US Treasury. Once again the effort is to construct a vehicle into which toxic assets can be transferred at inflated prices, positioning the public to take the losses while disguising them in the short term, and giving the managers of our biggest banks a chance to both profit now and then sell out ahead of the public.

    Perhaps Lay, Skilling and Fastow should be hailed as innovators in the field of public finance.

  6. Anonymous

    Notice that TALF 2.0 will include “older, illiquid and lower-rated securities?” So, if US Treasure is overpaying at TALF, then investor can bid up the price of “troubled asset”, so long as they can sell them to TALF with a profit. So essentially, teh government can predetermine the price that they are willing to pay the banks to get their troubled asset off their balance sheet, with so called private investor bidding process, and transfer the loss to the tax payer.

  7. Anonymous

    SAC Dude: One would have to be a criminal to participate in this.

    If Geithner / Summers / Bernanke take illegal actions for private gains, they risk being treated like criminals by prosecutors and/or vigilantes.

  8. Anonymous

    Hopefully someone can enlighten me about this, but why isn’t there more work being done to figure out what these assets are and what their prices are? It would seem the U.S. economy is now hinging on them, and there is no shortage of out-of-work talent ready to discover, describe, and attempt to price assets. So why not spend a few billion untangling it all?

    It seems like everyone is content to call them toxic and value them at 0-100% of their face value.

  9. max

    1) in the example given, SAC only books a net $4mm gain on the CDS right? they pay $1mm, and they receive $5mm (50% on $10mm protection). The post said they book a $9mm gain.

    Depends on the terms. I would see that as a 100 basis point spread over 10 years. Since the 10mm should be written against the top end, and the difference between the recovered value and the price paid is larger than that, they should get it all back. Of course, they could just insure the entire thing, would would give them the diff between 75mm and 50mm, and the profit there would depend on the cost. Heh. If Citi wrote the swap, they could wind up paying off the diff between the the eventual sale value and the insurance value. Then Treasury pays the diff. More money for Citi.

    My expectation would be that Citi is carrying the entire thing at near face value tho. That way they can book a loss that Treasury pays off. Their issue is that with Treasury, they’re having to book the loss without anything to show for it, but if Treasury is paying, they should maybe want as much cash from Treasury as they can get.

    simply, if the CDS is priced correctly, the CDS portion of the trade will be a wash – you’re operating under the assumption that we know the true value of the bonds.

    Yes, but why would the CDS be priced correctly? It needs to be ‘free’ to the investor or they will not buy it. Citi wants to make some cash (if they write the CDS, which I’m guessing they will) inbetween unloading the thing and paying off the CDS with Treasury money. They could insure the thing for more than face value, in psuedo-expectation that the whole thing will profit over the face value held now… it’s just that er, um, Citi can’t hold onto it right now. Say. They could get someone to buy it for them, and the buy the investor out, and then double-book the loss.

    Man, there’s so many ways this could be gamed to help the bankers get paid twice. This is kinda fun.

    Geithner/Summers are willfully evading Congressional oversight. After the Tequila/Mexico financial crisis, the banks wanted 20 billion and Congress wouldn’t give it, so Summers/Geithner under Clinton evaded that buy misusing the government’s ESF, argually illegally. Now, given that Congress doesn’t want to authorize more money, Summers/Geithner are trying to misuse Fed/ DIC authority to hand out cash.

    I had completely forgotten about the Tequila doohickey. I only remembered the ‘fake unemployment stats’ thingy. Factor in the LTCM doohickey, and gee. Summers seems constitutionally incapable of playing it straight.

    [‘The error never seems to fall in favor of the American people.’]

  10. Anonymous

    Yves: You might not see bids rising to the “fullness of time” $50 million level, but you would see bidding rise above the current level.

    Prices for garbage assets will rise once the auction opens because banks will make inflated bids on each other’s assets by paying each other with the taxpayer’s money. To the extent the banks sell old assets, they get cash profits. To the extent they keep old assets, they get mark to market profits by marking up the price of old assets to auction prices. The mark to market profits are huge because buying a small amount of assets at an inflated prices allows a MTM profit on the much, much bigger amount of assets on the banks balance sheets (e.g., buy 1M of assets at an inflated price of 2Mto mark up 100M of old assets to the inflated price of 200M).

  11. Kid Dynamite

    I later had the same realization that Max illustrated above regarding CDS pricing: i think the point of the original commenter was that Citi would be incented to sell the CDS to the bond buyer at a discount – they can afford to do that and still end up better off than they would be if they market their crappy assets to market.

    of course, Timmy G never thought of this, and no one will think of it until after the fact when the participants in the TALF rape the taxpayer for hundreds of millions of dollars and we impose a 90% retroactive tax on them to get the money back.

  12. Anonymous


    Original poster here. Max and Kid Dynamite above make my point about the CDS much better than I could myself.

    The CDS contract will be priced/termed to induce participation in the transaction.

    Its not about obtaining theoretically correct probabilistic pricing.

    The key point is the bank can afford to take a loss on the CDS b/c of the materially larger transfer payment from taxpayers to the bank. The expected value to the bank (vs. a forced sale at market) is positive under all outcomes, and they can structure a transaction that results in positive expected value to the private partners. The only party with guaranteed negative expected value is the taxpayer.

    That’s why the program amounts to fraud.

    Finally, I’m not a representative of any of the parties in the example: SAC, C, BOA, GS. or It was a hypothetical collection of parties to illustrate a transaction.

    I don’t think this detracts from the analysis, and I hope it gets wide dissemination. I’m sorry, I should have made this point clearer.

    Thank you so much.

    Lawrence Zack Galler

  13. Anonymous

    you know what would be great? excel chart for public to try all outcome of Geithner stupid trick.

    maybe knowing total pile to be inputted is hard. but the basic structure of the deal (the math) seems straight forward enough for charting return in next 5 to 10 yrs.

    if somebody supply me with the equation. I’ll dump it in spreadsheet and make pretty charts. (I am no financiers, just science student.)

  14. Anonymous

    Dear Jesus,

    Please let there be a run on the big banks before the banks get to sell any assets.

  15. Anonymous

    The NYT describing the Geithner plan stated “In one, the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled assets that banks want to sell.

    In another article about the FDIC, the NYT writes: “there are growing questions about the adequacy of F.D.I.C.’s insurance fund, which guarantees repayment on deposit accounts of up to $100,000 when banks collapse. The fund dwindled to $45.2 billion during the second quarter, from $53 billion in the first quarter.

    To replenish its fund, the agency will probably have to raise the fees it charges banks by at least 14 cents for every $100 of deposits, according to estimates by analysts. “

    Am I the only one who has a problem with the FDIC doing the lending?

  16. Karl Smith

    If you are selling someone underpriced CDS so as to elicit an overpriced bid from an investment entity they control then this is a kickback and clearly illegal.

    I mean at that rate Citi could just give Geihtner $100 million directly in exchange for full government guarantee and be done with it.

    The problem with the SAC scam is that no one has an incentive to sell you CDS at a rate they will give you even an expected profit.

    The whole point is that you pay slightly higher than actuarially fair rates in order to reduce risk.

    Rather I think the real issue would be that potential investors will take too much risk if they have a non-recourse loan. I don’t understand why that part is involved.

    Why not just have the government as an equity partner. This makes more sense because in theory the government is risk neutral.

    As long as it doesn’t run into a risk loving equity partner it should be okay.

  17. Anonymous

    One of the nifty things about partnerships (will these be actual partnerships?) is the way the partners get to allocate losses for tax purposes. I wonder if there is the potential to game this for some serious tax deductions?

  18. JC

    Where are you getting the 3% private participation from? I agree with your example if the Govt money is in for 97%, but I was assuming it would be in the 60/40-70/30 range. If there is no private “real skin” in the game, then there is no point in having a partnership.

    See below for a thoughtful paper on how this can/should work.

  19. Srini

    The reason why there is only 90% punitive retroactive taxation is because then there will be 10% left over for the states!


  20. Anonymous

    I’m sorry if this is an unbelievably stupid question, but if the plan works the way you describe, wouldn’t bankers just trade portfolios with each other and pocket the taxpayer subsidy? In effect, they’d be getting paid to price the assets as they like.

    I’m sure that the plan can’t be this stupid, but I can’t see what prevents this at the moment.

    Thanks for any responses that don’t contain too many four-letter words directed at me :)

  21. Anonymous

    Steve is correct there is no need for any CDS.

    In the simplest version, some entity buys $100MM face MBS from BAC at price of 80%. 3% down, 97% financed means that they put down $2.4 million.

    BAC gets $80MM cash.

    The next day, BAC buys the structure back from the entity for $2.5 million (this can be done via total return swap, if needed).

    The entity has made $100K for a day’s work.

    BAC has an purchased an option on the spread between the income on the mortgages and the cost of financing.

    For $2.5 million, BAC has transferred all price risk to the taxpayer and taken out $80MM in cash.

    I’ll try to put together a website with Flash graphs to explain all this.

  22. Gentlemutt

    Yves, Can we build a simple model for a sensible alternative to this grotesque approach by Treasury?

    For example, how much taxpayer money would be required to buy all Level III assets from the 25 biggest TARP recipients, at 30,50, or 70 cents on the dollar? How much to buy all Level IIs?

    Suppose, for example, a Treasury with spine were to buy all Level IIIs at 50 cents. How much, if any, equity would remain in these banks? How much ‘new equity’ would each current bondholder get while losing their coupon income? What would this approach cost compared with the unconscionable give-away evidently proposed by Treasury?

    Has this been publicly laid out before? Perhaps I have just missed it, but it sure seems like our friends in D.C. could use a little educational prodding to supplement the disgust they sense.

    Surely, somewhere between your readers, Tyler Durdens, Mish’s, etc there is enough talent to make a sound counter-proposal that will teach Congress how to represent us more constructively with respect to legislative dealings with Treasury.

    I’m certainly not from the scorched earth crowd that says let it all burn down, but it is becoming clear that the very clumsiness of Admin/Treasury/Fed/FDIC is making this whole thing much, much, worse than it must be.

    Simple, game-proof counter-proposals, anyone?

  23. Anonymous

    The counterproposal is obvious but not popular:

    1) Terminate credit support programs to BAC, C, WFC, AIG

    2) If they banks can’t meet basic capital requirements, place them in receivership. Pay off depositors, derivatives counterparties, vendors, etc. Anything left over goes to bond holders, pref share holders, equity holders in that order

    3) Use taxpayer funds to pay off depsoitors and deriv counterparties if needed

    4)Sell deposits, loans, etc. to the highest bidder to recover expense in (3)

    Variation on above would involved not paying credit derivs counterparties in full

  24. Yves Smith

    Anon of 8:57 PM,

    The Treasury has been acting as if the “investors” are bona fide third parties, as in not affiliated with the sellers. Will need to see details to see if any back doors to the banks as postulated above.

    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.

    I think this is a pure and simple subsidy to the sick banks, done in a hugely complicated way because the Treasury department does not want to go back to Congress for more money (or via getting more money for the FDIC, saying its for one reason, to help depositors in failed banks, but using it primarily for other causes). Everything else is smokescreen

  25. Anonymous

    "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)."

    The banks will trade paper amongst themselves to recognize losses for tax purposes, without affecting their economic situation. They did this after the S&L crisis. The IRS attacked this as a sham, and the Supreme Court blessed the losses in the Cottage Savings case.

    This auction is basically the same thing, left pocket right pocket trades among banks that Treasury pretends are actual sales as an excuse to give the banks radically undercollateralized loans secured by the assets.

    People should write Senators and Congressman asking them to demand that the Treasury Inspector General, the CBO, and the GAO audit Geithner / Summers. This plan is arguably illegal as a usurpation of Congress' power to appropriate funds.

  26. Justin

    Wrote my senator tonight. Will be watching the CDS markets for 5 year T Bills.

    We’re on an icy road sliding towards a ditch, and we keep oversteering and heading towards the ditch on the other side of the road, hoping that we’ll end up miraculously recovering to drive onwards with a target inflation rate of 2%, and a nice commission for everyone in the financial industry.

    Either that or we’ve handing out parachutes to the people who decided to save money on plane maintenance as the plane goes down.

  27. David

    Here is an even simpler way of scamming the system. What is to stop Citi from making a no-recourse $2.25MM loan to this investor and letting them have a free shot at making a lot of money. The tax payer still ends up eating the loss. The point is that if no one is really risking much of their own capital, you are not getting real price discovery.

    I bet if we sat around, we could think up 100 ways to scam this system. What a joke all of this is!

  28. Anonymous

    “Here is an even simpler way of scamming the system. What is to stop Citi from making a no-recourse $2.25MM loan to this investor and letting them have a free shot at making a lot of money. The tax payer still ends up eating the loss. The point is that if no one is really risking much of their own capital, you are not getting real price discovery.”

    It is worse than lack of price discovery; it is brazen price manipulation. Entities holding junk paper are massively encouraged to overbid for each others junk assets because they are paying each other with the taxpayer’s money, and keep the optionality of upside.

    Banks don’t even need a straw purchaser to overbid, unless Geither insists to try to disguise things. And if straw purchasers are used, Geithner will allow loopholes for banks to bribe purchasers to overpay through side deals with the purchasers (minority stock, convertible equity, options, CDS, swaptions, etc, etc).

  29. Anonymous

    Does anyone else, see this, as a convergence of human activity’s to this point in time (are we (the human race a rolling series of bubbles). Is economics, the physics by which we define our activity’s and assign winners and losers, or who is given control over all of us rightly or wrongly.

    The win or lose construct is the real beast here, and as long as we make it the only avenue, enrichment in our activity’s, we will revisit our past mistakes until it kills us.

    Money does not kill or diminish, we do in our love of wealth as a tribal status vehicle. The rule of the day is to win at all costs, to extend the winners advantage over the rest of us in infinitude, and the bets just keep getting bigger all the time.

    Grosse Pointe….diminish meant and death are the out put of all of this.

  30. ruetheday

    Any asset purchase program, no matter how simple or how complex, regardless of who is buying the assets and how it’s being funded, can only achieve its desired effect if it results in overpayment for the assets. Period. End of story.

  31. Jim in MN

    Yves, I just posted this to Krugman’s blog…I think we are farther along here than he is. Maybe he needs some more real world logic…he thinks the Administration is foolish but I think they are in a straightjacket, but are not being honest about it.

    Anyway…thanks for helping us toward the truth.

    “I’m sorry but I have to disagree on a couple of points.

    First, though, let me agree that the situation is a disaster, that the Administration is not being honest about its plans, and that there will be no second chance (at honesty).

    On the plan itself, I disagree on your take on its premises in the Administration’s view, and on the prognosis you have presented.

    The premise is not that everything is fine except for a ‘mispricing’ of assets. The premise is that bondholders cannot take any kind of haircut. It doesn’t matter if the assets are sound, mispriced, or garbage. This rules out both bankrupcy and nationalization. Either would entail bond haircuts. Forget it. Not gonna happen. No Sweden here!

    The prognosis is, instead of your ‘disaster’ (whatever that is) for a protracted sapping of financial strength and economic growth. In fact all the bank bondholders can be made sound even if the assets are never sold or priced; all efforts in the accounting and market-making areas are interesting sideshows.

    The model is the derivative unwind: Just keep paying the invoices until everything expires.

    In other words, taxpayers fund the bond payments (and derivative exposures) for, say, thirty years, and ta-daaa!

    A Lost Generation, that’s all. No big deal.

    Paul, maybe you are missing the underlying simplicity because you have a different simplicity in mind. Maybe, instead of your read–the Administration doesn’t get it–the reality is that they completely get it.

    Bond haircuts take down life insurance, health insurance, the health care system, pensions, etc.

    That is all you need to know. No bankrupcies, no nationalization, no bond haircuts. Doesn’t matter for how long.

    Japan R USA!

    –Jim in MN”

  32. Anonymous


    There is a much simpler way to play this game than buying the CDS contract mentioned before.

    Let’s say ABC bank has $100m nominal value of debt that they have marked down to $90m on their books. But ABC knows it will really only net out to $60m if held to maturity. So they have another $30m in losses to recognize.

    The easy way to game the system is for ABC to coordinte with Hedge Fund XYZ and simply loan XYZ the 3% of the $90m, or $2.7m with a two year term. This allows XYZ to bid and win the debt at full book value. Of course the debt could be spinning off $4-$7m annually depending upon your assumptions.

    The bank beneifts in several ways: 1) they have a $2.7m risk-free loan that they know will be money good and paid in full in two years, ABC has a worst case loss of $2.7m instead of $30m. Of course the chances of losing anything are almost non-existent.
    2) Their capitalization ratios are repaired immediately.
    3) They don’t have to take an additional mark down and the associated hit to earnings.

    XYZ will get a healty portion of the spin off of cash in the mean time, that far exceeds the $2.7 million loan, and XYZ garners considerable goodwill with bank for future deals.

    Since the Treasury sponsored loan is non-recourse, XYZ gets to walk away free and clear. XYZ has a huge potential to make money and Treasury is left holding the bag for the $30m that doesn’t pay off.

    To make matters worse, it would be almost impossible to stop this sort of deal from occuring. Even if the program forbade the bank from financing the purchase of their own debt it would be difficult to discover an agreement between two banks to cross fund other investors. Not surprisingly the XYZ fund always wins the bid because he intentionally overbids.

    It is my guess that in the end this is the shell game that has been designed by the Fed, Banks, Treasury, Pension Funds, and Hedge Funds in order to hand the bill to the tax payer a piece at a time without them knowing it.


  33. Anonymous

    This is a fascinating discussion. From my very amateur point of view, I find the view of Anon 6:58 and 9:20 and others much more appealing as a scheme, compared to the complicated CDS example which I have difficulty understanding.

    Yves, you seemed skeptical about the idea of banks trading assets, but it seems so sensible to me. For a 3% fee, they get to participate in a transaction which allows them to mark up their toxic assets and show profits on the books, plus mark up other similar assets as well. If you fear a 50% loss on an asset, wouldn’t you jump on a plan that limits your loss to 3% and gives 47% to the taxpayer?

  34. Anonymous

    Let me just say this, if Geithner / Summers want to whine about Congress acting unconstitutionally with retroactive taxes on bonuses, Geithner / Summers should stop being hypocrites and get Congressional authorization for any bank bailouts. It is illegal for the Fed and FDIC to give grants to banks, and Geithner / Summers proposal to give grants to auction bidders in the form of fraudulent loans looks illegal and unconstitutional.

  35. john c. halasz

    Since I'm the one Lawrence Galler's original comment was responding to,- (and though I get why my math was wrong in attributing a $20 million rather than a $22.75 million loss to the U.S. gov., I'm not sure why the CDS in the example would be paying out at 100% rather than 50%),- my point was that some such quasi-illegal collusion to game the system might be possible, such that the U.S. government would end up paying a premium windfall profit to some "private investors" not to facilitate genuine price discovery, but to inhibit it, while laying off the lion's share of the loss on the U.S. gov. I don't imagine that any actual such scheme would involve a single CDS sold on a single MBS transaction, since that would obviously be too "transparent". My more general surmise though was that the relevant mega-banks and hedge funds could devise a sufficiently complex web of CDS transactions to be effectively untraceable, perhaps involving several CDS contracts at more marginal mis-pricings, (since there is a high degree of uncertainty involved anyway), which would net out to the same overall effect, and perhaps sweetheart trades between the various relevant parties to shuffle the deck and creating a behind-the-scenes de facto index on the sale of such securities to pool the risk and hidden self-dealing subsidy. These tower boys, after all, are highly intelligent functionally, if not so much morally, and I wouldn't put it past them to attempt to concoct such a scheme, without being so gauche as to leave behind a trail of incriminating e-mails, since the rich incentives are so obviously there, together with their Pavlovian reflexes. To be sure, there are game-theoretic action-coordination problems and the question of honor among thieves in divying up the loot, but it's not as if they're not past masters at finessing such matters, which is how they arrived at they grey eminence. It's not as if collusive oligopolistic price-fixing schemes are unheard-of, and as if they are not attempted inspite of the risks of criminal liability involved. (My favorite one, resulting in criminal prosecutions, was a price-fixing scheme for crushed ice, since who would have thought that something so plentiful and commonplace as crushed ice could yield monopoly rents?)

    More generally, anytime the government sets up such a bail-out scheme by offering enhanced incentives, the socio-paths and criminals crawl out of the wood-work to figure out how to turn it to their advantage. Back in the days of the S&L debacle, persons with prior fraud convictions and even Mob money were to be found in the thick of things. And, of course, the impending troubles with the S&Ls were already publicly visible in 1985-86, but a bought-off Congress dragged their heels in addressing the issue (and its budgetary embarrassment) until the issue mushroomed and extended its collateral damages into crazy CRE and junk bonds. (Remember Speaker Jim Wright?) IIRC, the RTC ended up costing $350-400 billion up front and $130 billion overall to the tax-payers. Why should this time be any different, save for an added zero or so? And it's mind-bobbling to think what additional collateral damages will be done to the real productive economy through its mal-investments as this is dragged out.

    It was obvious from the get-go that Obama was a center-right DLC neo-liberal, and, like all successful big league politicians, a more-or-less adroit conformist to the requirements of the status quo power structure. And it's just as obvious that he and his chosen Obamaniacs lack the depth of intelligence, strength and courage to prevent steering the country into a morass. (Not to mention that the Fed has just added maybe $150 billion onto the long-run U.S. gov. deficit, with probably 3 or 4 times that amount still to be so added, entirely by "stealth"). The bitter irony for us proles is that the adherence to "free market" ideology, as always promising greater efficiency through price-adjustment mechanisms, in contrast to the evils of government intervention, combined with the fear of political opposition through being branded with the tabooed term "socialism", will prevent the most functionally efficient solution to our troubles from being implemented: namely, the nationalization of insolvent banks and other financial "institutions" and the permanent down-sizing of "our" hyper-trophied financial sector. Even the most obvious solution of "restoring" the "market" value of MBS through addressing expenditures to insolvent mortgage borrowers is tabooed, in favor of "restoring" credit to the financial system. No, I suppose the greatest fear, which supposedly would end the whole American "experiment", is to recognize loss up-front, even if it amounts to "can-do" efficiency, since, as a little remarked comment by Hank Paulson last Sept. had it, when he was asked why he didn't just publicly re-capitalize banks, that would mean we're losers, whereas we're really successes!

  36. Tyler Durden

    Unfortunately the investment community is all too aware of the free delta hedge (taxpayer sponsored losses) in synthetics… and that was based merely on TALF 1.0… one can only imagine what will happen Monday when TALF 2.0 hits. Today I posted CMBX spreads (read the synthetic portion at the heart of the toxic asset cesspool) where in the past month spreads have doubled!

    This is an unprecedented move… Basically the artificially high bid in cash products is being gamed via synthetics in 500 billion notional CMBX market. Instead of selling the CMBS loans, knowing you can buy them at any price of one’s choosing, investors play this by buying CDS. This is akin to shorting stock ahead of knowing a company is filing a PIPE (for Mark Cuban fans).

    As one of the commentators here says there is nothing at this point to change the purpose and the roll out of TALF – funds will keep on printing money and selling loans into the TALF/buying CDS. However, the scary thing is that banks will have to take on massive write down on the CDS leg now (instead of the cash side)… THIS IS AIG REPEATING ITSELF. The recent CDS blow out in CMBX will result in tens of billions of writedowns in this quarter alone for banks that wrote the CMBX swaps.

    This is the real reason for the sprint to minimize MTM before March 31 as all banks now realize that based on the prior month’s CMBS move they are all f****d.

    Btw, did anyone see the WaMu FDIC fireworks? Will drop a post about it here shortly.

  37. David

    Tyler, love your blog. Didn’t someone just come out and say that commercial real estate losses would be in the Trilions? Was it Blackrock?

  38. David Rosen

    “Let’s say ABC bank has $100m nominal value of debt that they have marked down to $90m on their books. But ABC knows it will really only net out to $60m if held to maturity. So they have another $30m in losses to recognize.”

    I am a tax guy, so I am looking at this from a tax perspective. I thought I read they are structured as loans. So in our example, we put down $2.7M and borrow $87.3 on a nonrecourse basis. Are we making payments on this amount annually? Assuming a 5% rate at interest only, we are talking $4.365M per year. That means our $60M of assets are generating an annual 7.725% return (and a 5% return on the purchase price). If we are getting a 5% return, then we don’t need the treasury to make this deal – there would be a market. No, the expected return is much less, so I cannot imagine that we are actually making payments annually (since tax benefits do not outweigh cash).

    Is the deal instead that we make payments up to the amounts paid and the remainder is either forgiven or accrued. If accrued, this makes no sense because we will never recover our money. If forgiven, we still would probably lose our principal without ever getting annual payments above the interest payments.

    If we are not making payments annually, then this may be a good deal for an investor. In this manner, we are making profit each year since we are pocketing some return and making no payments. We would probably have to return the amount of profit received to the government, but we have used that money in the meantime and presumably made a solid return, which would hopefully more than recoup the loss principal (which will also provide a nice tax loss of $2.7M).

    If they held to maturity, I’m not certain they would be permitted to recognize the $30M loss, but only $2.7M plus any future profit (which would be minimal if we are making any payments). Presuming the investor is a partnership, it would have enough basis during the term of the loan to take losses annually (even for a non-recourse loan, I believe), but if the asset secured by the loan is held to maturity, and loan obligation is non-recourse, the obligation would expire and we could only take losses to the extent of our basis in the partnership interest (and in the event that we are taking profit each year, the loss will only offset the prior profits – which accelerated taxes – and is not desirable).

    So having approached this from another perspective, I am with the majority here and don’t believe that any straight deal in this manner makes sense. Assuming a hedge is prices correctly, it is profit neutral. Thus, the only way this makes sense for an investor is to play games (i.e., making a deal with the players involved).

  39. David Rosen

    One more followup to my earlier post, if the partnership was a dealer in securities and marked the asset to $60M, while this would create a book loss, I don’t think it would result in a tax loss until disposition – this is why we can’t take tax losses in securities obtained with non-recourse financing like we can with depreciable property. With depreciable property, the money is recouped upon disposition (even if sold at a loss).

  40. Nick

    There’s another major way for the banks to potentially pwn the taxpayer. However please feel free to point out any misses I may have made in logic.

    Say Bank A has already marked down a portfolio of toxic mortgage securities from its $100M face value down to $80M. Under TALF 2.0 provisions, Hedge Fund B buys this portfolio for $80M with a 3%, or $2.4M, equity stake. The rest comes in the form of non-recourse loans and “gifts” from the Treasury Dept. Bank A gets these toxic mortgage securities off the books and makes a cool $80M.

    In reality, on the open markets, a similar portfolio of mortgages recently sells for about 20% of face value. The execs at Bank A know this.

    The following week Bank A comes to Hedge Fund B and offers to buy the MBS portfolio from the hedge fund for $20M. Initially, the hedge fund’s 3% equity stake would now only be worth $600K. However Bank A offers to pay the hedge fund, say, a $3M “transaction fee” or some other shady payment/purchasing method to go through with the deal.

    Hedge Fund B’s equity stake is essentially bought for $3.6M ($600K+$3M). In only a week’s time, Hedge Fund B has made $1.2M on its initial $2.4M investment. It pays the Feds back the principal on the non-recourse loan it took out and has made more than enough $ to pay whatever miniscule amount it owes for a week’s worth of interest payments on the loan.

    Bank A has now not only bought back this MBS portfolio actually worth 20 cents on the dollar, it only had to pay $3.6 million or 3.6 cents on the dollar to Hedge Fund B to get it back. Bank A nets $16.4M dollars and has a sweet party. As an added bonus, Bank A believes the portfolio will in time be worth 50% of face value when it matures/the markets recover and makes Vegas money on that 30-point spread.

    Meanwhile, the taxpayer gets the epically-sized shaft. The Fed facilitates enormous losses for the taxpayer by making up the vast majority of the differences between current and/or eventual actual market prices and the paid fake/inflated auction price of 80% of face value–or approaching $60M for this portfolio. Add a whole lot of zeros to this number and that’s where taxpayers will be at when all is said and done. Meanwhile the banks make astonishing profits on what could become the greatest bait-n’-switch in modern history and taxpayers wonder why they have to pay $10 for a loaf of brad.

    On the plus side, I hear beachside huts in Palau are cheap these days.

  41. Doug

    James Galbraith makes an excellent suggestion in his comments on this plan:

    “If I were a member of Congress, I would offer a resolution blocking Treasury from making the low-cost loans it expects to offer the PPIPs, until GAO or the FDIC has conducted an INDEPENDENT EXAMINATION OF THE LOAN TAPES underlying each class of securitized assets, and reported on the prevalence of missing documentation, misrepresentation, and signs of fraud. In the absence of a credible rating, this is the minimum due diligence that any private investor would require.”

  42. Justin

    So I’m trying to understand how to couch some of the issues of the plan in sufficiently simple language to generate public interest.

    Complexity (either in finance or law) is a powerful tool for overriding checks and balances. Any sufficiently complicated scheme at best delays public understanding, at worst it remains opaque, giving the people who do understand it a power, an edge, and an ability to move the pendulum without it swinging back.

    It seems a lot of that understanding of power has migrated from Wall Street to the administration. Perhaps it’s always been there. I do not automatically ascribe malevolent or self-serving intentions to their efforts. It may just be “holy smokes, we have to try the best we can to fix this, but we’re pessimistic we can stop it crashing down, but announcing that would make things worse”. I’m hoping there’s a large percentage of noblesse oblige in the adminstration.

  43. mmdonner

    some miss the point also that the company selling the CDSs…AIG? will get bailed out for any loss on them as it will be deemed systemic in the end!!! this will help grease the skids as well.
    further, isn’t it still “legal” to sell CDSs even if one does not have an interest in the underlying bond/deal/whatever??? Lots of folks can benefit/steal from this one..especially when you figure in the time lags and change in adminsitrations to track it all over the next 5 + years!!
    the transfer of wealth continues unabated.

  44. Blissex

    «some miss the point also that the company selling the CDSs…AIG? will get bailed out for any loss on them as it will be deemed systemic in the end!!!»

    Well, that’s a fantastic idea — just to ensure that the scheme is successful, all the toxic assets bought should be insured by AIG. This would guarantee the profits of the hedge funds, and large bonuses for the AIG traders “finding” so much new business. Wouldn’t it be this like a cherry on top of the cake? :-)

  45. Blissex

    «Didn’t someone just come out and say that commercial real estate losses would be in the Trilions?»

    That is indeed part of the big deal behind all these scams.

    The big deal is that for 15-30 years there has been a global credit bubble (yen carry trade, dollar carry trade) feeding a series of asset bubbles in the USA, UK, … and investment and job bubbles in China and India.

    During these bubbles asset (dotcom shares, bonds, real estate, commodities, treasuries) prices in the USA, UK, … have grown much, much faster than trend and much, much faster than GDP.

    A large part of these paper capital gains have been actually monetized using various sorts of securitization.

    Now asset prices are snapping back towards trend, or lower, leaving large capital losses in the accounts of those who bought the securities embodying those capital gains.

    How large have been the above-trend capital gains? Well, arguably $15T-20T in the USA alone, of which probably half have been cashed in, and thus will not merely be a deflation of a paper gain.

    Roubini thinks that the accordingly the actual losses held by the USA financial system are around $3T-$4T, and I suspect there is at least as much outside it.

    Now the problem is given that the winners in this game (those who have chosen and received the monetization of the paper capital gain) are not going to return their cash gains, the losers will have to suffer an haircut of around perhaps $6T-$8T, which they don’t have.

    Who is going to suffer those losses? That is the big question. And perhaps this is the big answer:

    «Maybe, instead of your read–the Administration doesn’t get it–the reality is that they completely get it. Bond haircuts take down life insurance, health insurance, the health care system, pensions, etc. That is all you need to know. No bankrupcies, no nationalization, no bond haircuts. Doesn’t matter for how long.»

    Overall it is the outcome of class war, where the class of old asset owners have realized and cashed in enormous capital gains by selling to a new class of asset owners who have borrowed to create those giant capital gains for the sellers.

  46. Anonymous

    Vigilante stuff is important.

    For one thing it is a field the common man can compete on. He cannot get influence in Washington that matters.

    For another thing it will not elicit sympathy for the victims. If the press reports there is a groundswell of sympathy it will be BS, and what’s more, people will know it. What it will elicit is a feeling of effectiveness and power in the common man, so he can go from that success to the next.

  47. Anonymous

    The strucure simply boils down to this:

    1) Taxpayers pay $80 to bank for $100 face assets trading at $30 and worth, at best, $50

    2) To disguise and confuse the situation, taxpayers pay $77.6 to the bank and give an option, supposedly worth $2.4, to the bank.

    3) The option gives the bank 20% of any net interest income and 20% of any price appreciation on the asset.

    This structure is such an obvious scam that even Rick Santelli, Mark Haynes, and Larry Kudlow would be outraged.

    So Giethner was told to add another layer of indirection.

    A hedge fund chips in the $2.4 and gets the option.

    Some number crunching tells you that the hedge fund can quickly lose its $2.4 investment if default/recovery rates stray too far below 50% — so they are going to be reluctant to go in great numbers.

    The realistic alternative is that the hedge fund flips the deal back to the bank for $2.5 (a quick $0.10 profit) in some manner.

    The bank has gotten $77.5 in cash, no price risk on its mortgages, and an option on 20% of any income or gain.

    Note that the 20% participation is not too far from the 30% current trading value!

  48. Anonymous

    Also, why do we pretend that these proposals are originating from the Treasury.

    The structure has the fingerprints of Blackrock, PIMCO, and GS all over it.

    I’m sure that MarkIT will get some kind of exclusive contract to monitor the strucutres also.

  49. Anonymous

    Also, why do we pretend that these proposals are originating from the Treasury. The structure has the fingerprints of Blackrock, PIMCO, and GS all over it. I’m sure that MarkIT will get some kind of exclusive contract to monitor the strucutres also.


    This is another reason Geithner’s plan is illegal. The Administrative Procedure Act legally bars Geithner from taking regulatory actions without issuing proposed regulations, and allowing a period for public comment, and having a public hearing.

    Giethner is flagrantly violating the law by putting out programs without legally required input from the public, so he can cook up plans with cronies, like GS, Blackrock, and Pimco.

    Bernanke is violating the law by giving grants and calling them nonrecourse loans. It is illegal for the Fed to give grants.

    Bernanke and Geithner are criminals.

  50. Anonymous

    I’m a bit confused here. Who is paying the deadweight loss here: Treasury or Fed?

    If it’s the Treasury, then it’s Congress’ job to clamp down and allocate no more money for any of such shenanigans.

    Though I recall the statement a month or two ago that they are going to fund Treasury games like Defense programs, which I guess means the black budget.

    If it’s the Fed, it’s still theft, but there is no legal authority to stop it, short of decertifying the Fed and going with US Notes.

    Which would be hard to do but worth trying.

  51. Anonymous

    David Rosen, I was not intending to say that the banks would run this game in order to get a tax break. No one will mark the assets down to $60m immeidately. Although hedge fund XYZ might in a couple of years when the cash stops coming in.

    As you are probably aware many “toxic” portfolios are still spinning out considerable cash. The problem is that they will not in the future. So Hedge Fund XYZ gets the benefit of the cash for now, as I suspect that the loan the Treasury gives to fund XYZ will be far lower than the rates you might expect. Perhaps that is one reason the Fed just crushed the 10 year yeild and promised to keep doing it. It makes for a nice low fixed rate, no? That low rate probably means the interest payment on the loan is well below the expected cash spin off rate of the assets in question.

    There are literally dozens of ways to structure these deals. I am sure there are some tax ramifiactions somewhere, but that would be at best a secondary consideration. The real value here is that the banks get to sell bad assets at their current book value and don’t have to take writedowns while the Treasury (ie the US taxpayer) gets stuck with a loan that will surely go bad. XYZ Hedge fund will make some risk-free money and worst case scenario the bank is out the small penance for taking care of the hedge fund.

    Of course these loans won’t go bad for a few years and so Treasury the Fed and Congress get to kick the can down the road one last time.


  52. bb

    the simplest option indeed is for a bank to lend the money to an entity to bid for the assets above market price. thus the bank pockets more money than the asset is worth, the entity does not repay the loan, the bank loses only the loan amount, so the overpayment has to be more than 3%.
    and to simplify the game, it could only be restricted to banks to bid for each other’s assets with gov’t money.

  53. Leo Kolivakis

    I just spent an hour listening to ABC’s This Week. The round table discussion featured George Will, Donna Brazile, Betsy Starks and Robert Reich.

    It was interesting to see how both George Will and Robert Reich agreed that bankruptcy of AIG is a better option than the hybrid approach.

    Mr. Will raised the issue of “who in their mind would want to partner up with the federal government” after the AIG bonus fiasco.

    Donna Brazile said the financial system has gone out of control with all these “too big to fail firms”. Her new hero is Fed Chairman Ben Bernanke (sigh!).

    Ms. Stark said that letting AIG go under was not a real option because it would have meant the collapse of the global financial system.

    And therein lies the masterful “PR spin”. We need to save the banks first and then we can save the American taxpayers and consumers.

    The logic has been completely inverted to benefit the crooks on Wall Street and their mega hedge fund and private equity clients who provide them with huge fees.

    Finally, all this media attention on Geithner’s plan and the AIG bonuses is keeping everyone’s attention off the pension tsunami that will wreak havoc on public finances over the next decade and possible decades.

    Speaking of pension tsunami, I want to plug Jack Dean’s outstanding website which focuses exclusively on pension news:

    Stay tuned on the Geithner plan and I will continue to write my thoughts throughout the week.


    Leo Kolivakis
    Pension Pulse

  54. Martin, the Netherlands

    I may be naive, but isn’t is a bit risky to be willing to lend someone 97% of the purchase price, on a non-recourse basis, for purchasing assets whose value is completely opaque? Let’s assume I’m a hedge fund, and I’m able to borrow $ 3 from bank A, who, quite coincidentally, has a lot of toxic waste on its books. We arrive at a price of, say, 30%. (When asked how we arrive at this price, we refer to the ABX indices. Or whatever. 30% doesn’t seem too ridiculous, if I’m informed correctly.) When, in the fullness of time, the final payout on the rubbish thus bought turns out to be 30%, I get my investment back. Or rather, since I have borrowed the $3, the bank gets its money back. When the payout is less, the U.S. taxpayer will make up the difference. When the payout is more, I pocket the difference: anything over 30% is a profit, and a profit on an initial investment of $ 0. Now that’s a nice rate of return.

    I understand this scheme is meant to generate sufficient interest in buying toxic waste to raise the market prices to something above the present levels, which are said to be unrealistically low.

    But I fail to see how, in the present situation, the buyers have any incentive to start bidding proces up. The selling banks might have some incentive (since getting a better price would reduce the losses which they have to recognize). I think we will have to wait some time before we can say that this incentive does work, since so far the U.S. government has has not indicated that this is the last programme that will be launched to assist te banks. Either nothing will happen (if the whole program turns out to be a dud), or the scheme will be a runaway succes, resulting in banks selling lost of toxic waste at firesale prices, becoming visibly insolvent, and getting bailed out again as being too big to fail. And I’m not going to be surprised if, at the end, those private parties that bought the toxic waste turn out to be affiliates of the same banks.

    The net result: the banks have written off the toxic waste at the expense of your taxpayer.

    If I have it wrong, please tell me.

  55. Anonymous

    The problem with this is *so much greater* than just heads-I-win, tails-you-lose. You have to examine the incentive structure that this creates.

    Once the investment is deep underwater, the private investor *has no incentive* to increase recovery value. Every second of effort devoted to the investment at that point is a total and complete waste of time and money. These investors aren’t charitable organizations. They’ll let the investments rot.

    The only party that has incentive to increase recovery value once the equity is gone forever is the lender — the US government in this case.

    You’ve seen the picture of trashed foreclosed houses, right? The same principle applies to all underwater investments. Requiring little to no money down always brings this risk with it.

    We labor under this crazy right-wing assumption that “privatizing” everything must necessarily yield benefits. No, not when all the incentives to the private sector are geared toward giving society the worst of all possible worlds. You would think this wouldn’t be too subtle an idea for people, but I guess it is.

  56. Anonymous


    There is no plan just a scheme to funnel taxpayer to banks such as BAC and C.

    BAC and C decide that they want $80 for $100 face. They put out the word that they are a $2.75 bid for equity in such a structure.

    The hedge fund hits the BAC’s $2.75 bid and then goes to the auction. The hedge fund knows that BAC will not accept any offer less than $80. To be safe and (since it needs to deliver to BAC), the hedge fund might even bid $85 for the assets.

    The cost to the hedge fund is $2.55 ($0.85*3%). They deliver to BAC for $2.75 and earn a tidy $0.20 profit.

    A hedge fund hits their bid and the goes out and bids $90 for the assets.

  57. Martin, the Netherlands

    @Anon 11.00: Thank you. If that is what the hedge fund is going to do -and of course I should have realised that they would get out at this first opportunity- wouldn’t that result in the value of the assets getting elevated above the realistic level? I know it would be ridiculous, but isn’t that what your government is trying do do, to make everybody believe that $ 30 assets are really worth $ 80, or perhaps even more, so that they can be carried at a book value of $ 80? I know that it’s a case of deceiving oneself, but as long as it does the job, I’d be willing to refrain from being the little girl who points out that the emperor is rather scantily dressed… I mean, we’re in such a mess now that any trick that gets us out of it is welcomed by me.

    Or am i, again, being too naive?

  58. Anonymous


    The problem is one of perception.

    1) The government wants to give the banks as much as $1 trillion from taxpayers

    2) Banks have nothing worth anything remotely close

    3) Taxpayers are not going to take a direct transfer with nothing in return

    3) Treasury tries to concot a scheme that will get the blessing of or at least confuse the media (CNBC, WSJ, etc.) that hides this direct transfer. Hank Paulson tried this and managed to give away several hundred billion dollars with praise from the likes of CNBC, WSJ and CNN.

    4) In Geithner’s scheme, the Treasury lies to the taxpayer and says that the price has been set by the private sector and the taxpayer has the potential for upside.

    5) Bottom line, taxpayers fork over $1 trillion to the banks and get maybe $200 billion back in five to ten years.

  59. cap vandal

    I think people are making this way to complicated.

    The proposed plan would have $30 in private “capital”, $120 billion from the Treasury, and borrow the remaining $800 billion. The leverage is 5 x 1.

    The NYT’s is calling this a subsidy to the hedge funds. But the Treasury has 80% of the capital and will make 80% of the profits or take 80% of the losses.

    The 5×1 leverage makes the deal attractive.

    Simple solution — let the public buy into the Treasury piece. You might say no rational person would do it, but there must be an opportunity or the NYT’s giveaway to the rich meme will never die.

    If it is a give away to Citi, then buy C stock in the open market. If it is a give away to the hedge funds, give the public the same deal.

    If it is some complex hedge that involves collusion, then go for complete transparency and make all transactions publicly available.

    People need to slow down for a minute and think for themselves.

    There will be winners in this. No one knows the outcome. Any convoluted scheme that creates only losers except for a few insiders is too complicated to work.

  60. Anonymous

    cap vandal

    1) Treasury has no money — taxpayer has money

    2) Taxpayer can get stuck with 97% of the losses and 80% of the gains

    3) The loss on $100MM can be as much a as $70MM, the gian on $100MM can be as little as $10MM

    4) The taxpayer risks $70 million to make $7 million

    5) Vikram Pandit and Ken Lewis’ are CEOs in the George W. Bush model. They will quickly find a way to burn through this $1 trillion welfare check.

  61. S

    cap vandel I nominate Paulson of subprime investor fame to represent taxpayers…what I would give to watch him tell jamie dimon and blankfein and the lot to go F$ck themselves and while they are at it to prepare DIP

    Perhaps one of the great unknowing discoveries of our time is to find that the truly civic minded will emerge from the shawdow banking system – heaven forbid

  62. Eric L. Prentis

    President Obama’s appointment of Tim Geithner and Larry Summers, the same people who got us into this credit crisis, is a terrible disappointment. Now that Obama stands behind Geithner/Summers/Bernanke, no matter the justifiable criticism, it is clear that the plutocracy controls Obama, even as he addresses his “Katrina moment.” Wall Street bankers, strictly for their own benefit, manipulate the government with TARP kickbacks to political campaigns. Congress, especially the Republican neocons, and the Obama administration are a stinking cesspool of corruption, bought and paid for.

  63. Anonymous

    If you can get away with converting $28 billion in debt to a 20% equity share in Citi Corp. on a day when the market cap of Citi was $5.8 billion you can get away with anything period. There are no rules/laws left to be broken.
    Santa Cruz, CA

  64. n. ron hubbard

    "Perhaps Lay, Skilling and Fastow should be hailed as innovators in the field of public finance."

    perhaps skilling & fastow should run TALF from the joint…at the federal prison pay rate of 24cents/hr.

    i could think of no better qualified persons to run such a program.

    even better, we could raise kennyboy from the 'grave' (down in paraguay) with an offer of immunity.

  65. Blissex

    «If you can get away with converting $28 billion in debt to a 20% equity share in Citi Corp. on a day when the market cap of Citi was $5.8 billion you can get away with anything period. There are no rules/laws left to be broken.»

    The rule of law has never been strong in Real America, and those who buy influence wholesale can get away with just about anything.

    And some people like Newt Gingrich recognize that is an essential part of national culture:
    «If you have a society where almost every middle class person routinely fudges the law, that’s telling us something. We have laws that matter-murder, rape, and we have laws that don’t matter. [ … ] The first thing that every good American says each morning is “What’s the angle?” “How can I get around it?” “What does my lawyer think?” “There must be a loophole!” Then he proceeds to work the angle, and the bureaucracy spends its time chasing that and writing new regs to stop him. America is the most incentive-driven society on the planet.»

    WINNERS do whatever it takes!

  66. Anonymous

    Some acquaintances in the financial industry tell me that the US government is quite afraid of social unrest here. That is why we have a trade war to protect US jobs, inflation to reduce our debts, etc.

    Without the specter of social unrest here, our government would not even be doing that “for us”. They would not give a flying you-know-what about us.

    But now we are being treated as real stakeholders, in the government and even in the banking companies we are unwillingly supporting. Keep it up, it’s working! Courage!!

  67. Anonymous

    The Geithner plan is a scam designed to allow the investor to bid for the remaining coupon payments and leave the taxpayer holding all the losses. The key to the scam is the high leverage ratio COMBINED with a non-recourse loan:

    Investor buys a CDO tranche at 50 cents on the dollar that is currently paying a 5% coupon. The investor puts up 20% and the govt provides the remaining 80% via a non-recourse loan. This highly leveraged CDO tranche will stay current on the coupon payments for 3 years and then default with zero residual value.

    The end result is that the investor who pays 10 cents(20% X 50 cent bid) ends up walking away with 15 cents(.05 X 3) over three years and the government ends up losing the entire 40 cents of non-recourse financing. (Note that I haven’t included the cost of the low interest financing, nor used present value discounting in order to simplify the point I’m trying to make.)

    The beauty of the scam is that the losses on the govt’s books won’t show up for 3 years.

  68. DownSouth

    Blissex said: “WINNERS do whatever it takes!”

    And thus neoclassic theory contains the seeds of its own destruction:

    A paradox arises to the extent that it is true that the market is dependent on normative underpinning (to provide the pre-contractural foundations such as trust, cooperation, and honesty) which all contractural relations require: The more people accept the neoclasical paradigm as a guide for their behavior, the more the ability to sustain a market economy is undermined. This holds for all those who engage in transactions without ever-present inspectors, auditors, lawyers, and police: if they do not limit themselves to legitimate (i.e. normative) means of competition out of internlized values, the system will collapse, because the transaction costs of a fully or even highly “policed” system are prohibitive. This holds even more so for the regulators that every market requires. If those whose duty it is to set and to enforce the rules of the game are out to maximize their own profits, a-la-Public Choice, there is no hope for the system.

    –Amitai Etzioni, The Moral Dimension: Toward a New Economics

  69. Anonymous

    >Some acquaintances in the financial industry tell me that the US government is quite afraid of social unrest here. That is why we have a trade war to protect US jobs, inflation to reduce our debts, etc.

    Social unrest (through riots and violence) is the only way this country makes legal reforms to help the public. Social unrest led to the People's Party in the 1890's, the Union Party in the 1930's, Civil Rights legislation in the 1960's, and so on.

    The government should be afraid of the people. The IRS can't collect taxes if enough people refuse to pay them. The police can't stop illegal protests or assaults on individuals if enough people engage in them. If the politicians want the little people to obey the laws, they shouldn't engage in illegal bailouts to help rich campaign contributors.

  70. John

    I like the title “You’d have to be a criminal…” So, what’s your point? That means you’d have to be a typical “Wall Street” insider.

    It’s starting too look like America hasn’t had anybody with “moral character” running anything of importance for some time now.

    (This is a great site, btw. But, you already know that).

  71. Martin, the Netherlands

    @ Anonymous, 11.00 and 11.34: Thank you, I read your last post just now because of the time difference between the U.S. and Europe.

  72. Anonymous

    Let’s say the market is $0.30 and the real value is $0.50. The asset is on the books at $0.80.

    You’re Citibank. You set up a semi-independent fund (essentially Citi itself in disguise) to buy the stuff at $0.90. Citi books a $0.10 accounting profit.

    The buyer has 5% down and 95% non-recourse loan from the government. The buyer loses $.045 (5% of $0.90), and the government eats the rest.

    Citi books a $0.055 net profit ($.10-$0.045 loss). The taxpayer eats a $0.855-$0.50 = $0.355 loss.

  73. Cix

    I hear prices of 30c for RMBS. I would personally be a buyer of these assets at these prices (actually even at 50c) as I think those numbers discount some 20-25% IRR for the buyer.

    Is there any traded instruments that I can buy that tracks those prices?

  74. artichoke

    I would love to buy back my own mortgage for 30 cents on the dollar or even 50 cents.

    If others can buy it for that, why can’t I?

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