Private Public Partnership Details Emerging

The New York Times seems to have the inside skinny on the emerging private public partnership abortion program. And it appears to be consistent with (low) expectations: a lot of bells and whistles to finesse the fact that the government will wind up paying well above market for crappy paper.

Key points:

The three-pronged approach is perhaps the most central component of President Obama’s plan to rescue the nation’s banking system from the money-losing assets weighing down bank balance sheets, crippling their ability to make new loans and deepening the recession….

The plan to be announced next week involves three separate approaches. 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.

Yves here. If the money committed to this program is less than the book value of the assets the banks want to unload (or the banks are worried about that possibility), the banks have an incentive to try to ditch their worst dreck first.

In addition, it has been said in comments more than once that the banks own some paper that is truly worthless. This program won’t solve that problem. Back to the piece:

In the second, the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money.

Yves here. Hiring asset managers to do what? Some investors get 85% support (more as is revealed later), others get dollar for dollar? This makes no sense unless very different roles are envisaged (but how will the price for assets given to the asset managers be determined? Or are these for the off balance sheet entities that should be but are still not yet consolidated, like the trillion dollar problem hanging around at Citi?) Back to the article:

In the third piece, the Treasury plans to expand lending through the Term Asset-Backed Secure Lending Facility, a joint venture with the Federal Reserve.

Yves again. While the first TALF deal got off well, Tyler Durden points out its capacity is 2.7 times pre-credit mania annual issuance levels, which means the $1 trillion considerably overstates its near term impact. And credit demand by all accounts is far from robust. Cheap credit is not enticing in an environment of weak to falling asset prices and job uncertainty. To the Times again:

Although the details of the F.D.I.C. part were still being completed on Friday, it is expected that the government will provide the overwhelming bulk of the money — possibly more than 95 percent — through loans or direct investments of taxpayer money.

The hope is that such a generous taxpayer subsidy will attract private investors into the market and accelerate the recovery of the country’s banks.

The key protection for taxpayers, according to people briefed on the plan, is that the private investors will bid in auctions against each other for the assets. As a result, administration officials contend, the government will be buying the troubled loans of the banks at a deep discount to their original face value.

Because the government can hold those mortgages as long as it wants, officials are betting the government will be repaid and that taxpayers may even earn a profit if the market value of the loans climbs in the years to come.

To entice private investors like hedge funds and private equity firms to take part, the F.D.I.C. will provide nonrecourse loans — that is, loans that are secured only by the value of the mortgage assets being bought — worth up to 85 percent of the value of a portfolio of troubled assets.

The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that, while private investors would put up as little as 20 percent of the money, according to industry officials. Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent.

Yves here, If this isn’t Newspeak, I don’t know what is. Since when is someone who puts 3% of total funds and gets 20% of the equity a “partner”?

And notice the hint of skepticism from the Times regarding the Administration’s supposition that the bidding will result in fair prices. Huh? First, the banks, as in normal auctions, will presumably set a reserve price equal to the value of the assets on their books. If the price does not meet the reserve (and the level of the reserve is not disclosed to the bidders), there is no sale; in this case, the bank would keep the toxic instruments.

Having the banks realize a price at least equal to the value they hold it at on their books is a boundary condition. If the banks sell the assets as a lower level, it will result in a loss, which is a direct hit to equity. The whole point of this exercise is to get rid of the bad paper without further impairing the banks.

So presumably, the point of a competitive process (assuming enough parties show up to produce that result at any particular auction) is to elicit a high enough price that it might reach the bank’s reserve, which would be the value on the bank’s books now.

And notice the utter dishonesty: a competitive bidding process will protect taxpayers. Huh? A competitive bidding process will elicit a higher price which is BAD for taxpayers!

Dear God, the Administration really thinks the public is full of idiots. But there are so many components to the program, and a lot of moving parts in each, they no doubt expect everyone’s eyes to glaze over.

Later in the article, there is language that intimates that the banks will put up assets and take what they get. However, the failure to mention a reserve (a standard feature in auctions) does not mean one does not exist. Or the alternative may be, since bidding will almost certainly be anonymous, is to let the banks submit a bid, which would serve as a reserve. That is the common procedure at foreclosure auctions, when the bank puts in a bid equal to the mortgage value (so either a foreclosure buyer takes the bank out or the bank winds up owning the property).

Regardless, the equity comes from TARP, and Elizabeth Warren of the Congressional Oversight Panel is no slouch. What will happen when she asks for reports of how the actions have gone (for instance, how many failed because the reserve was not met?) The mechanics will become more apparent to the public over time and may yet come back to haunt Team Obama.

Print Friendly, PDF & Email


  1. Richard Kline

    AwfulawfulawfulawfulAWWWWFFUULLLLL! It would be difficult to conceived of a scheme further from any public interest than this maxi-bogus shennigan. If it was done for penny stakes, we’d call it a thimblerig game. But it’s being done for $1T stakes on the public’s dime. There isn’t a fragment in this entire plan that passes the stink-test—and yet this is Plan A’ from Geithner and Summers.

    I want my revolution, and I want it now!

    Regarding which, there is much cutesy name calling in certain sectors of the MSM, whose operators think themselves gatekeepers on acceptable discourse, regarding ‘populists’ unhappy with the bank stealout in progress. This is a cut-and-paste’ synonym for exactly the concept of 110 years ago, i.e. ‘silly, envious softheads who know nothing of finance.’ So I have news: we’re people; no lable, no -ism, people. Most of us are citizens, in point of fact, in a putative democracy. (I know, I know, we had a quiet coup by the wealth class oligarchy six months ago, but formally we’re still a democracy.) And those out here who oppose the Bank Stealout, including this ludicrous monstrosity of a money gift from our children to incontinent speculators, have few common denominators. Yes, some of us are Rainbowtarians, but there are plenty of downhome Guvmint suspectors who dislike all this as much or more. There are plenty of legitimate investors out there who are steamed in piss over being cheated by the oligarchy on top of flattened in the blow-down from the bubble. There may even be a couple or three actual populists out there unhappy with the drift of all this. But we are united in our dislike of being lied to our faces by the officers of the Federal Government, and robbed stoneblind by failed speculators who contribute _less than zero in the long run_ to our society. That isn’t populism, that’s civic responsibility.

    This Tera-Ripoff Plan needs to be torched before it’s signed. And anyone who proposes it or supports it is not part of any solution to the financial crisis but ipso facto a legacy of the problem.

  2. Mark

    There is no incentive to overbid, since you might lose your 3%.

    However…. if you also are long banks, you’ve got every incentive in the world to bid up to face value, and let the SIV crash an burn, leaving the toxic stuff on the public’s balance sheet.

  3. Russ

    Whatever happened to the original reverse auction idea? Is it simply that these banks are incorrigible and absolutely refuse to sell this garbage at anything below the fantasy value?

    I guess by now they feel 100% confident that a corporatist administration will bail them out completely, one way or another (the “Geithner put” as Krugman calls it), and they have zero incentive to compromise.

    It’s the same attitude everywhere – banks with their poison portfolios, cadres with their bonuses, bondholders with their expected returns – just sit tight, hold out, don’t give an inch, and the administration will find a way to bail you out. Help is on the way.

  4. Swedish Lex

    This is so unclear and not making sense on the whole. Even the positive ascpets of it, if there are any, will be overshadowed by the inherent inconsistencies and the corruption this scheme will generate.

    I fear that people soon will more regard the flawed attempts to address the financial crisis as the problem, more than the financial crisis itself.

  5. esb

    The absolute determination in both the Bush Administration and the Obama Administration to gift the the wealth of the many to the few (best represented by those who possess “cottages” along Long Island Sound) continues to amaze me.

    This is like living in some sort of SciFi alternate reality in which there exists a form of secret government or power which immediately assumes control over any newly elected group and directs policy to the same predetermined point.

    The tax-evading S o T is clearly at the core of whatever this actually represents, a man without character placed into office without opposition even after his offenses were revealed.

    There is something underway here which is not clearly seen.

  6. Steve

    The only way to `get bad financial assets out of the system’ is to let their prices drop to the level where someone thinks they are good assets. There’s no other way. The accompanying loss must fall on shareholders and bondholders, and only on government if the losses are so great that nationalization is the only remedy.

    If Bernanke, Summers et al think that borrowing by Treasury to inflate these crap assets will magically bring the securitization markets back to life and allow financials to raise fresh capital, they’re out of their minds. The Fed is now THE market for ABCP, and that’s not about to change. The government is now THE market for ABS, and that’s not about to change, either. Let’s face it: the banks fucked their customers so badly that markets failed. Treasury can trundle off all of the existing bad paper onto the taxpayer, and we’ll still be left with gigantic financial firms that no longer have an OTD purpose and have no prospect of earnings except through the magic of the zero limit. In other words, they’re now structurally wards of the state.

  7. Anonymous


    You are missing 2 key points.

    First, the program is guaranteed to result in inflated prices because big banks can sell old trash and buy new trash with non-recourse financing. The big banks have an absolute incentive to overpay because they can effectively trade old trash for new trash plus a huge amount of cash and non-recourse debt secured by the new trash.

    Second, 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 / FDIC 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.

    Hopefully, Sheila Bair will refuse to play along. Or some folks in Congress will get offended by Summers / Geithner violating separation of powers by usurping Congress’ power to appropriate funds.

  8. Anonymous

    The Shell Game

    The con men now have changed the game,
    With three shells they are no longer able,
    To con the marks with mere sleight of hand,
    So they change the game on the table,

    Three shells become four,
    And then four goes to five,
    More and more shells are added,
    And more shit talking jive,

    The marks are intently bent over the game,
    Its the pea they are trying to find,
    And the con man smiles his knowing smile,
    As their wallets are lifted from behind …

    Its after 10:00, do you know what your CIA is doing tonight?

    Deception is the strongest political force on the planet.

    i on the ball patriot

  9. ruetheday

    Why is the FDIC providing 85% of the funding?

    Will institutions not covered by FDIC insurance be allowed to participate in the PPIF?

    What do the asset managers get in return for their 3% equity and how are they compensated from a fee perspective?

  10. TallIndian

    Please, people get a grip.

    Until and and unless we buy these assets on bank balance sheets at a premium, the talented traders at BAC, C, GS, MS might well quit and take up trading jobs in Dubai or Mauritius!

    As Mark Haynes on CNBC had the testosterone to point out, only the geniuses at AIG understand the complexities of these instruments — not the riff raff that write blogs or those who post on them.

    Rush Limbaugh (PBUH) has rightly pointed out that only socialists demand that bonus and compensation pools come from company funds.

    Buying these assets at a 500% premium to market value is nothing but pure capitalism.

  11. Anonymous


    Well it’s not only CNBS that feels there will be a “brain drain”. Heard the same bullshit on Bloomberg Radio yesterday morning. Tom Keene (?) asked Arthur Levitt, former chair of the SEC, about the “brain drain” from these companies if restrictions are put on them. Levitt pooh-poohed the idea and asked where does Keene think they will go. So the “Brain drain” bullshit is the new MSM meme.

  12. fredw

    The disturbing part to me is FDIC providing non recourse funding to jump start this scheme. Is this the real reason for the recent request by FDIC for increased funding for Congress ?

  13. Anonymous

    “Because the government can hold those mortgages as long as it wants, officials are betting the government will be repaid and that taxpayers may even earn a profit if the market value of the loans climbs in the years to come”

    Scams, Lies and Fraud.

  14. TallIndian

    Surely we understand the danger of losing our best and brightest to foreign lands.

    If only CNBC had been around in the 1960s, the hundreds of railroads forced into bankruptcy would still be around and their talented managers still receiving bonuses.

    If only CNBC had been around in the early 1990s, we would have found a way to keep those talented traders from the S&lS.

    The very notion that bonuses must be paid from company generated funds is 1994!

    Let's get real — linking bonuses to company performance is barbaric. These are hardworking traders who have drinking and drug habits to support. These are hardworking men and women who have done so much to society.

    Only the cretins would dare suggest that taxpayer subsidy of such men and women is not in the national interest.

    I know not about you, but I shudder to think where we would be if Ken Lewis, Vikram Pandit, John Thain, David Li, Boaz et al had gone 'John Galt' on us back in 2004.

    Please, let us cease such hateful posts and bless our lucky stars that these brave men and women are there making bids and offers for the future of our grandchildren.

  15. Terry Maynard

    Besides my basic rejection of the USG (& taxpayer) backstopping the purchase of any toxic assets, I am particularly upset with the notion that the FDIC would be the backstop entity. It is a total perversion of its three-quarter century role as a means of protecting the small individual bank customer. Now it will be used as a sewage pump for fraudulent major bank holding companies.

    What the hell are they thinking in WDC?????

  16. TallIndian

    BTW, the Geithner Plan amounts to the functional equivalent of having the taxpayer buy the asset at some inflated value and then selling the private investor a call option for some pittance (say $1.00).

    Any gain on the asset goes to the private investor. Any loss resides with the taxpayer. And bank shareholders are freed of any burden.

  17. lambert strether

    Swedish lex continues:

    This is so unclear and not making sense on the whole

    I think it’s quite clear. The Bush administration initiated the largest transfer of weatlh in American history — with no transparency and no accountability. The open question was whether the Obama administration would continue the transfer, and with an equal lack of transparency and accountability. Now we have our answer: Yes, they are.

    It’s also clear that we don’t have a party problem, here; the problem is Versaille, as such.

  18. john bougearel

    Yes Yves,

    If Obama can jump onto the Leno show and yuck it up on Thursday night about the Bama’s bowling game, his campaign promise to get the kids a dog, march madness etc… and reduce the role of the presidency to that of being Leno’s court jester for public consumption and entertainment, then yes, the Administration thinks the American public are indeed idiots.

    After watching clips of the Tonight Show with Jay Leno, I was left with a strong distaste in my mouth that Obama does not comprehend the role and office of the presidency.

    The Bama should be knee-deep in pig shit and focused on shoveling out the rot amongst Wall Street Banksters. It is all well and good that Obama has a strong desire to be well-liked by Americans, but that was the absolute wrong way to go about it. This is no time for Obama to be joking, not until he has shit-canned every last bankster on Wall Street. But no, while he is pandering to the american people on Thursday night, Obama’s administration led by Geithner is scheming at the very same moment of how to expropriate hundreds of billions of dollars from the very same Americans Obama is smiling at on the Leno show. Is Obama’s smile on the Leno show alone worth trillions of dollars to the American people? Oh, and it should not go unmentioned that The Bama defended the job Geithner was doing amidst calls for Geithner’s ouster. And while I am on the soapbox this morning, it should be noted that another Citi exec was appointed to a post in the US Treasury alongside Geithner.

    Collusion and protection racketeering between the US Treasury and the banksters runs deep. It is high time the US Attorney General start firing up the indictments.

  19. DownSouth

    Thanks Yves for yet another great post and to commenters for their superb additions.

    It boggles the mind to see just how politically flatfooted Obama and many members of the senate and congress are. I suppose they and their banker-controllers thought they could fly their bullshit policies through under the radar. Yves summed it up perfectly when she said: “Dear God, the Administration really thinks the public is full of idiots.” Or Russ when he said: “I guess by now they feel 100% confident that a corporatist administration will bail them out completely…” Maybe under normal times being a handmaiden for the finance industry wouldn’t carry such a huge political price. But these are far from normal times.

    In attempting to try to carry water for the banksters, Obama is burning up political capital so fast it makes one’s head spin. I would question whether, if he continues down this road much further, he can salvage his presidency. Gallup shows his approval dropping to 61% from 68% in January. And another politician, Senator Chris Dodd, has seen his support dwindle so rapidly that, according to this CNN News segment, his re-election possibliities next year are in doubt:

    Dodd accused of AIG ‘flip-flop’

    It’s a wonder to behold when public opinion–that “great gorilla in the political jungle”–comes to life.

    Vox populi vox Dei!

  20. Anonymous

    It is even worse than what Yves says. Since Geithner will let the banks buy and sell at auctions, he guaranteeing that the banks will overpay in buying assets from each other because it helps them to swap old trash for new trash at inflated bids.

    Before each bank has old trash, and after they’ve got new trash plus cash plus non-recourse debt secured by the new trash. The auction is a complete charade. The banks are effectively trading trash assets with each other, and Geithner is pretending it is an auction as an excuse to give them 50%-100% undercollateralized non-recourse loans, which are obviously a handout to the extent of the undercolateralization.

  21. Anonymous

    People should start writing to Congress saying Geithner / Summer’s plan is giving banks illegal grants because the Fed / FDIC are only authorized to lend, and Geithner having them lend non-recourse and undercollateralized is in substance a grant to the extent of the undercollateralization.

    People should also write to civil rights organizations like the ACLU and politicians saying that Bernanke / Geithner are violating the the the administrative procedure act by taking regulatory actions without issuing proposed regulations, soliciting comments from the public, and holding public hearings.

    Congress and the ACLU can stop Geithner from violating the law to help the wall street banks. Let’s go people.

  22. Anonymous

    This is a thing of beauty! I am willing to bet the following actually occurs:

    Merrill Lynch sets up a private partnership to bid on toxic assets. It bids on assets conveniently on the balance sheet of its new parent, BofA. Obviously the higher the bid, the better for Merrill Lynch, as their own bonus will depend on BofA’s earnings. Merrill can continue bidding—once again only on those toxic assets which were hurt by M2M accounting—and push the price far above the level to which the assets have been marked. Obviously MER wins the bid. BofA gets to book a “gain” on the sold assets, thereby generating bonus-able earnings.

    MER uses taxpayer funds to finance the portion it needs, and the “own” capital it puts up is the TARP money MER and BAC received last year.

    The taxpayer absorbs the “first loss”, which will be defined as the difference between market price and the winning bid.

    And in the event that the loss exceeds the first loss, BAC can go back to the USG for another bailout, and no doubt auction off the exact same bad assets yet again.

    This is the new capitalism.

    I’m heading off to Home Depot right after posting this to buy my pitchfork.

  23. PghMike

    Isn’t there a huge incentive for large banks to commit financial fraud with this plan?

    The funding balance is 3% investor, 12% other government equity investment, and 85% government provided non-recourse loan, as I understand it.

    So, if Citi can somehow smuggle $1B, for example, of its own money into one of these public/private funds, call it “Self-dealing Investments 1,” then SI1 can essentially buy, with government aid, $33B of Citi’s own assets for face value, when it would otherwise eventually be worth perhaps only $0.30 on the dollar, or $10B. Citi would lose all of its investment, but at a cost of only $1B, Citi would manage to salvage all of its $33B investment, effectively allowing it to recover $32B of its $33B in toxic assets. Of course, there is a huge loss here, but the taxpayers take it: $32 (paid by Feds) – $10B (recovered) = $22B loss for taxpayers to swallow.

    I assume that somehow this self-dealing will be officially forbidden, but I can’t believe it will be that hard for these banks to get around the restrictions, given how hard Geithner has been working on deceptively hiding Federal purchases of bad assets at face value.

  24. Anonymous

    I assume that somehow this self-dealing will be officially forbidden, but I can’t believe it will be that hard for these banks to get around the restrictions, given how hard Geithner has been working on deceptively hiding Federal purchases of bad assets at face value.


    The banks absolutely have an incentive to try to do self-dealing by bidding on their own assets with taxpayer money.

    Prohibitions against self-dealing don’t go far enough. Each bank holding garbage assets has an incentive to form subs and buy other banks garbage at inflated prices. This drives up the price of their own assets using MTM, and if they sell in an auction, it raises the price they get.

    This is a brazen attempt to had free money to banks, and pretend they are arm’s length loans to finance arm’s legnth purchases.

  25. Anonymous

    No need for any self-delaing. C will ‘buy’ BAC’s ‘assets’, BAC will ‘buy’ C’s ‘assets’

    Each also retains a call on any market appreciation.

    To modify, PghMike’s example, C puts up $1 billion, the taxpayer puts up $39 billion to pay $40 billion for $50 face of assets.

    If, by some miracle, the Tsy is able to recover the full face and get $10 billion in profit, C is entitled to a portion of that.

  26. joebhed

    I am with Richard Kline and Russ.

    And the shellgame analogy is too accurate.

    It’s probably just my ignorance, but I have a suspicion that the “counterparties” who are piled up on top of this are what I would call “each other”.
    Or, in other words, “themselves”.

    There is an essential element of dishonesty here, some call secrecy, wrapped in the flag of corporate propriety.

    “Whooooooooooo are you?”

    The scheme places we the taxpayers as the fish in the barrel, and the bankers are loading up for the big one.

    Someone needs to step up and demand there be limits on what a couple of brainiacs think is the right way to FORCE credit down the old financial pipeline.

    After some hundreds of TARP Billions did nothing but build up reserves, which ALLOWS more lending, and a few TRILLIONS pushed on to corporate balance sheets in return for crapola by the FED have gone unnoticed, maybe we need to be looking in the other end of the pipeline and put money directly in the hands of the consumers.
    Demand cannot be force fed.
    Get a grip, Obama !

  27. Don

    “Risk-taking institutional investors, like hedge funds and private equity funds, have refused to pay more than about 30 cents on the dollar for many bundles of mortgages, even if most of the borrowers are still current. But banks holding those mortgages, not wanting to book huge losses on their holdings, have often refused to sell for less than 60 cents on the dollar.( NB DON )

    The result has been a paralyzing impasse. Banks, unwilling to sell their loans at fire-sale prices, have had less capital available to make new loans. Mortgage investors, unable to leverage their investments with borrowed money, have been unwilling to pay more than fire-sale prices.

    To break that impasse, the government’s crucial subsidy is meant to provide investors with the kind of low-cost financing that has been utterly unavailable in today’s credit markets.”

    This is all such a tangled web now that there’s no easy answer. For instance, by keeping hope of the government helping to buy the TAs alive, the government has kept the price up and given the owners of the TAs an incentive to hold on to them. The government has also advanced money to some of these owners, also allowing them to hold out. This has created the possibility that it could take years to clear the TAs off the books, also giving the owners an incentive to keep them instead of selling them.

    Having now created a raft of incentives for owners of TAs to take a hard stance on them, the government now needs an incentive to counter these incentives. It’s decided to give that incentive to the buyers, many of which will be Hedge Funds. They would be the likely investors to buy this crap anyway, but we will be subsidizing them.

    However, it is important to see that the government has gotten itself into a bind. I’m not defending them, since I believe that all of this could have been avoided, but I want everyone to understand that the government has nowhere else to go given their previous actions. Also, remember, they claim that they can’t seize the large banks.

    There are other alternatives, but, given their presuppositions, they’re pretty much stuck with this plan.

    Don the libertarian Democrat

  28. Anonymous

    this is a silly plan in many respects.
    these securities (which are just repackaged loans) will pay out what they pay out. that is the “hold to maturity” value. that number determines the amount of money the banks will ultimately lose, and above a certain number, it’s in many ways inevitable that the taxpayer will pay most of the bill. in any case, someone will.
    the ultimate losses are not known, obviously, but in aggregate they are probably very close to the threshold where taxpayers will ultimately take a loss.
    this plan won’t change the losses. it isn’t even supposed to.
    what this plan is aimed at instead is changing the “mark to market” value of the securities. mark to market is the “liquidation” price of the security, or the price you could get by selling it today.
    there is no reason to believe that these two numbers should or should not be the same, and throughout history these numbers are often very different
    so the question is: why do we care about mark to market and not hold to maturity?
    we care about it because our accounting rules say we must, not because it is fundamentally sound.
    i don’t know how to fix the accounting. it’s a hard problem, and not my area.
    what this plan does, though, is attempts to fix the mark to market number (for accounting reasons) and does so at potentially large expense to the banks and taxpayers.
    the reason is if the current mark to market number is incorrect, these securities are worth more than mark to market, and there will be little taxpayer loss ultimately. therefore you want the upside to go to either the banks that currently hold these securities or the government — preferably the banks i would say, so that they do not need government aid. if you sell these securities to a third party, this value belongs to them and not you.
    now if the current mark to market numbers are correct, the losses will be devastating and someone will have to pay a couple trillion dollars. the private money coming into this program will help pay the losses, some bondholders will pay, and the taxpayer will end up paying a lot as well, probably the bulk.
    my opinion is that the mark to market values are incorrect in aggregate and that the future hold to maturity losses are manageable in aggregate. if that is the case, this plan is a very expensive and stupid way of trying to fix a problem that is not a real problem.
    there are two ways of dealing with this better: one is to prop up the banks via a ’swedish’ guarantee (guarantee the bondholders) until you get more visibility on how bad the loan losses are really going to be. the other is to bring the ‘toxic’ securities directly onto the treasury’ s balance sheet (via nationalization or another mechanism) where the taxpayer gets all eventual losses or gains and where mark to market valuation is not applied at all.

  29. Anonymous

    >>>> these securities (which are just repackaged loans) will pay out what they pay out. that is the “hold to maturity” value. that number determines the amount of money the banks will ultimately lose, and above a certain number, it’s in many ways inevitable that the taxpayer will pay most of the bill. in any case, someone will.

    It isn't inevitable that the taxpayer bail out bondholders. If Geithner / Summers give more handouts to rich bondholders, they risk violence in the streets. Union members kidnapped hedge fund manager Eddie Lampert when he went to far.

    If Geithner continues to take illegal actions to bail out the rich, he and bankers risk the same. I don't support violence, and I hope the country remains peaceful. But the american people are armed and slightly crazy, and I personally wouldn't want to do things that incite them to violence.

  30. Anonymous

    It is time to start protesting again. I have been trying to come up with a pithy phrase to put on my sign and have come to the conclusion that I can probably leave it like it was when I first used it in early September, 2008; NO BAILOUTS

    I think people will continue to understand the sentiment.

    NO BAILOUTS Make it a mantra folks. Repeat it like a drumbeat until it is deafening. We must stop this madness for humanity’s sake.


  31. Anonymous

    >>>>why do you think bank bondholders are rich? a lot of people have money in banks.

    Economic data from the fed and other organizations shows the vast majority of financial assets are held by the wealthiest 1% of households. Your second sentence is intentionally misleading because it confuses people having money in FDIC insured accounts with financial assets that are risk capital (such as bank common stock, preferred stock, sub debt, and senior debt). Most people just have FDIC insured deposits in banks, and own no risk capital in them. The same is true for insurance companies, most people own annuities and insurance issued by regulated subs that is senior to all risk capital. You are not dealing with idiots. Lies and trickery will not get you far.

  32. Anonymous

    Ok…there are problems with the plan. There is with any plan…

    Now tell me why it just flat out will not work. That’s all I care about.

  33. Anonymous

    This is amzing on two levels. First over at the Democratic Underground, heads are exploding trying to wrap around the concept that Mr.Change turms out to be Mr. Wall Street. As a Democrat that is too old for this crap, it falls on deaf ears when you try to explain that nothing really changes when it come to to the cash. President Obama might as well call himself Jimmy Carter because when this is all said and done, he is the one termer I suspected he is. So much hope, so little reality. Are there futures on reality?

    Oddly I find myself admiring Bush the Elder and the RTC handling of the S&L fiasco. At least people were shitcanned, building taken and sold. I know the magnitude is going off the charts in comparison, but it seems that the Obama financial gang have learned the lessons of the past to maximize profit on this little episode.

  34. Anonymous

    “Ok…there are problems with the plan. There is with any plan… Now tell me why it just flat out will not work. That’s all I care about.”

    Geithner’s plan will not work because it is a scheme to give banks over 1 trillion dollars for worthless assets with no strings attached. Banks will sit on the money until consumers and business go bankrupt, so the banks can buy their assets for pennies on the dollar.

    A banker will not do anything unless the law requires it at pain of severe penalties and a vigorous prosecutor.

  35. Anonymous

    On the issue of reserves: The Federal government has more than enough leverage on Citi to prevent them from setting their reserves at 100% of the value.

    They’ve already established that they’re willing to sell at 60% of the book value (which is not shockingly a part being omitted from every opposition opinion).

    Citi will in effect be presented with 2 options:
    1. Sell your tranches at a price below your asking price, but above a level at which your company will be bankrupt


    2. Face nationalization and explain this to your now former shareholders.

    I am confident that they are not going to be unreasonable here. They want these assets off of their books as well.

  36. OSR

    “Dear God, the Administration really thinks the public is full of idiots.”

    Yes, and they’re right. Their plan will happen while we’re worrying about AIG’s irrelevant bonuses or the next distraction du jour.

    “What will happen when she asks for reports of how the actions have gone (for instance, how many failed because the reserve was not met?)”

    The answer is: Not a damned thing. I have nothing but respect for you and when I’m elected God, you will be the Treasury Sec’y, but if you think anyone is going to stop these asset transfers to the taxpayer, you’re being naive.

  37. Anonymous

    On the issue of reserves: The Federal government has more than enough leverage on Citi to prevent them from setting their reserves at 100% of the value.


    Your so-called plan does not force pain on bondholders and counterparties that financed the banks misbehavior. They all need haircuts and forcible conversions of their claims from debt to equity in a receivership or c 11.

    You sound as corrupt as Geithner who is doing his level best to bail out the wealthy (i.e., bondholders and hedge fund counterparties) at the cost of higher taxes and inflation down the road.

  38. theo

    Since when is someone who puts 3% of total funds and gets 20% of the equity a “partner”?

    When that someone is George W Bush and the investment is the Texas Rangers.

    Anywhere else, not so much.

  39. Don

    Paul Krugman says this:

    “Why was I so quick to condemn the Geithner plan? Because it’s not new; it’s just another version of an idea that keeps coming up and keeps being refuted. It’s basically a thinly disguised version of the same plan Henry Paulson announced way back in September. To understand the issue, let me offer some background.”

    Here’s the first I remember about this plan. It’s William Gross in the WaPo on Sept. 27th:

    “And so, instead of mild medication and rest, it became apparent that quadruple bypass surgery is necessary. The extreme measures are extended government guarantees and the formation of an RTC-like holding company housed within the Treasury. Critics call this a bailout of Wall Street; in fact, it is anything but. I estimate the average price of distressed mortgages that pass from “troubled financial institutions” to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent. Calls for appropriate oversight of this auction process are more than justified. There are disinterested firms, some not even based on Wall Street, with the expertise to evaluate these complicated pools of mortgages and other assets to assure taxpayers that their money is being wisely invested. My estimate of double-digit returns assumes lengthy ownership of the assets and is in turn dependent on the level of home foreclosures, but this program is, in fact, directed to prevent just that.

    In effect, the Treasury will have the fate of the American taxpayer in its hands. The Resolution Trust Corp., created in the late 1980s to deal with the savings and loan crisis, dealt with previously purchased real estate, which was flushed into government hands with a “best efforts” future liquidation. Today, the purchase of junk mortgages, securitized credit card receivables and even student loans will be bought at prices significantly below “par” or cost, and prospectively at levels allowing for capital gains. This is a Wall Street-friendly package only to the extent that it frees up funds for future loans and economic growth. Politicians afraid of parallels to legislation that enabled the Iraq war are raising concerns about a rush to judgment, but the need for speed is clear. In this case, there really are weapons of mass destruction — financial derivatives — that threaten to destroy our system from within. Move quickly, Washington, with appropriate safeguards.

    The Treasury proposal will not be a bailout of Wall Street but a rescue of Main Street, as lending capacity and confidence is restored to our banks and the delicate balance between production and finance is given a chance to work its magic. Democratic Party earmarks mandating forbearance on home mortgage foreclosures will be critical as well. If this program is successful, however, it is obvious that the free market and Wild West capitalism of recent decades will be forever changed. Future economic textbooks are likely to teach that while capitalism is the most dynamic and productive system ever conceived, it is most efficient over the long term when there is another delicate balance — between private incentive and government oversight.”

    Interestingly, even the price of the TAs is the same. The overall plan is to have someone buy the TAs at a discount, borrow cheaply from the government, and sell the TAs down the line for a profit.

    There were various schemes offered for the government to do this. Why didn’t anything come of them? This is harsh, but I believe it’s because there’s a widespread belief that the government is either incompetent or a sucker, and would vastly overpay for these TAs no matter the plan. Every other reason boils down to this in my view.

    I suggested that the only way for the government to do this was to lie, hire Gross and John Paulson secretly, and have them buy up the TAs under their own names for the government. Needless to say, this is not politically feasible.

    So, in my view, the government is meant to be played in many investor’s minds, and history has reinforced that view to them. That’s why the Swedish Plan was the only way to go. The government needed to show that it would be ruthless in protecting the taxpayer’s interests in winding down this crisis. Once this ruthlessness was not shown, we were bound to end up in a mess, with hybrids in which the government and investors danced a costly tango.

    In theory, some of these TAs could be profitably purchased. But no one really believes that the government would make the hard choices necessary to do this. We’re paying more precisely because the market expects us to.

    Don the libertarian Democrat

    By the way, thanks to Yves for allowing us to post our thoughts, giving it our best shot. Krugman’s blog rejects many comments.

  40. Anonymous


    The part about “hiring investment managers”

    The fees collected by the hired investment managers would offset the capped losses from their 3% equity stake in the assets purchased from the bank.

    If the fees are scaled properly, the private investors could be looking at positive cash flows no matter what price the assets transact at, and no matter whether or not the assets appreciate in value.

    Its a mechanism for raising the price paid to the banks while still claiming a “market mechanism” set the prices.

    Its fraud, not “new speak”

  41. Anonymous

    –there are certainly bank creditors who are senior to the govt and depositors in the case of bankruptcies (a lot of deriv contracts fall into this category, even CDSs do, which is a real problem).–

    No. Deposits in a regulated bank are structurally senior to swaps written by an unregulated parent or affiliate.

    –lots of people do have capital at risk — in money markets (short dated commercial paper) and bond and stock funds in their 401ks / “savings”. the poorest don’t but the poorest aren’t taxpayers either.–

    No. Most people are covered by FDIC insurance that covers up to 250k.

    –also, it’s the same people with assets who are paying taxes in this country. probably 40-50% of people in this country pay no net income tax if you don’t count FICA/medicare.–

    No. The people are not the same. The wealthy are generally older and whiter than the high earning your and unborn.

    You are not dealing with idiots. Geithner / Summers plan is completely corrupt. An attempt to steal from the middle class, the young, and the unborn to give handouts to high net worth and ultra high net worth households, who own the bulk of risk capital in banks and insurance companies.

    Insurance companies can be resolved as well. There is no problem with haircutting and forcibly recaping their risk capital as equity.

  42. Yves Smith

    Great commens, thank. Anon of 1:39 PM, correction: I did not say the banks were try to sell or set reserves at 100% of purchase value. They are not willing to sell for less than whatever the value for them is on their books now. They have taken haircuts on these assets. They NYT cites a current “mark” of 60% (versus 30% market value), but the current mark on their books will vary widely by the particular asset held.

  43. john c. halasz

    So, say CITI has a $100 million MBS on its books at $80 million, given the risks and uncertainty, its market price is $30 million, but held to maturity it will yield $50 million. So CITI makes a deal with a hedge fund, which will bid $75 million for the MBS, of which only 3% is its own money, $2.25 million, and out of another branch of CITI, the latter writes a $!0 million CDS on the MBS to the hedge fund for a modest consideration and with cash settlement. SO CITI ends up taking a $5 million write-down and a $5 million CDS loss, the hedge fund ends up making a $2.75 million profit on a $2.25 million investment, about 120%, and the U.S. government ends up with a $20 million loss. Is it really that simple?

  44. Anonymous

    >So, say CITI has a $100 million MBS on its books at $80 million, given the risks and uncertainty, its market price is $30 million, but held to maturity it will yield $50 million…. Is it really that simple?

    It is simplere than that. Citi bids on $1M of another MBS at another bank at 200 cents on the dollar, and books a MTM gain of $120M for the assets on its books. And then sells the MBS to a Geithner hedge fund for $202M.

  45. Anonymous

    It is simplere than that. Citi bids on $1M of another MBS at another bank at 200 cents on the dollar, and books a MTM gain of $120M for the assets on its books. And then sells the MBS to a Geithner hedge fund for $202M.


    Citi would have to finance the hedge fund’s 3% investment that the Fed/Treasury won’t finance. Reducing the take a bit.

  46. Anonymous

    John C Halasz,

    Apologies, but I thought your post was so important I wanted to clean up a little math and amplify your point.

    Again, apologies

    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.

    Its 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.

  47. bebe rebozo

    A lot of good information and opinions here. I still have one question….does Congress have to appropriate the money or does treasury appropriate the money? The famous 700 billion bailout bill passed last October was a patriot act for the treasury department. So legally they can probably do whatever they want. I still think, at least in the short term, it matters how they roll this thing out.

  48. Anonymous

    The will certainly do what it’s intended to do: reinflate the price of CDO’s and turn these “toxic assets” into government insured “good assets.” Hard to see how bank stocks don’t soar. Should prevent CDS-megeddon as all the assets now backed by the US tax payer.

    Seems to me, there are only 2 other strategies. Nationalize the banks (seems like a better deal for the tax payer, especially when the gov’t can then insure new lending resumes…and a chance at profit for tax payer). Or, let them fail without gov’t backing and let the world economy burn and churn. The last option is just too risky for everyone, so it’s just mental masturbation to consider. The Treasury plan does afford the option to nationalize later, so it’s probably the safest bet.

  49. Anonymous

    If Geithner continues to take illegal actions to bail out the rich, he and bankers risk the same. I don’t support violence, and I hope the country remains peaceful. But the american people are armed and slightly crazy, and I personally wouldn’t want to do things that incite them to violence.

    I DO support violence, particularly when the rich are stealing food from MY mouth in order to protect their access to concubines and spas. This crap has GOT to stop, and if Obama and his criminal cohort continue the theft from the People started by Bush in order to serve his Wall Street masters (in spite of the rage of the People this engenders) then that leaves only violence as an option.

    When a government of the people, by the people, for the people blatantly and repeatedly ignore the people then it is hard to consider any other alternative exists. What, seek redress from the government that abjectly REFUSES to abide by the will of the people in the first place? Insane.

    We must force Congress to stand up and defeat Obama/Geithner before he hands any and all chances for our future prosperity over to the banking interests that purchased his loyalty.

  50. Anonymous

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

    why do you get 100% back from the CDS? recovery value is 50% so you get 50%.

  51. Anonymous

    also, if you have a bond trading at 30, why can you buy CDS with a premium of 10? if you are insuring to par, you will pay 70 for that.

  52. Warm, Dry and Well Fed

    The structure of many mortgage pools makes the non-recourse-note aspect of this program very problematic.

    If the troubled asset on the bank’s books is a pool of mortgages without a default pass through (more on that in a moment), then the holder of the asset gets a payment stream made up of interest payments and the return of capital for any prepayment through a refinancing of the properties. The short-term cash flow gain is balanced by a long-term reduction in asset value (the defaulters stay in the pool and, if the pool owner is lucky, the owner get 60% back when the properties are auctioned). Also the future value of the pool is reduced because there will be less future interest (the refinanced properties are gone from the pool) and there are fewer properties left to cash out.

    In the old days people purchased these packages because they provided a nice, predictable stream of 6-7% interest. The risks were defaults (usually 1-2% and very predictable) and pre-payments (if interest rates went down more people would pay early and the usual 50% pool shrinkage in seven years would accelerate so there would be a smaller-that-predicted stream of future interest).

    In these pools there is a very large early payment stream to the holder with all the capital losses further out (defaults take time). First the holder each year gets interest for the whole pool minus the interest payments not paid by defaulters- call it 5%/year if there is a 25% nonpayment rate on 6.75% mortgages. Then, if the federal low interest loan refinancing kicks in, even with a haircut, the holder gets more cash out (e.g. if next year 10% of a pool’s loans are refinanced with a 20% haircut, the holder of the pool gets 8% of the pool’s original value back in cash and the pool is now 90% as large and takes an additional 2% capital hit for the 20% haircut on the 10% of loans removed from the pool). So, in this scenario, the buyer of the pool gets 13% of the total original capital cost of the pool back in the first year.

    Let me see; I buy the pool at, maybe, 70% of the original cost from a bank using 3% down, a 15% private loan and most of the rest covered by a government-provided, non-recourse loan. The first year I suck out 13% of the original price- maybe a 19% return on what I paid for the package and 400% on my invested capital, pay off maybe 50% of the 15% private loan I’ve had to borrow – and leave behind an even more impaired pool (in this case the defaulters stay in the pool and those able to refi. leave). These are the numbers for a very good pool, and most of them will not be this good (more defaulters; less interest paid; fewer able to refinance).

    This scenario assumes that the impaired asset is a private label loan package or a tranche based on one and the package retains defaulted mortgages, meaning the defaulted loans don’t “pass-through” to the original writer (who is probably out of business anyway). Also it assumes no insurance or worthless insurance. But if there is insurance from someone like AIG… the new purchaser may be further bailed out.

    In the Fannie and Freddie loan packages most defaulted loans are not retained in the package; they are “passed through”. In other words, after the “predicted” 1-2% of defaults, Fannie or Freddie takes the loan back and pays cash into the pool to make up for the default. So if the “impaired asset” is based on one of those gems the deal is even better.

    If these pools of loans are such a good deal why doesn’t the bank just keep them? The back end, silly. The cash comes out early but the capital loss piles up as the pool ages, which means the bank is facing a whopping long-term loss. But if you buy the package with a non-recourse note you take the cashflow, default after three years and walk away from the non-recourse note.

    In other words, you act like a lot of the alt-A homebuyers; don’t pay, get free rent, and wait for the eviction.

  53. mz

    It’s the mother of all moral hazards.

    If I have 100 billion worth of toxic assets on my books which are actually only worth only 30 billion, I can bid 3 billion and the Goldman Sachs boys, I mean the Treasury, will put up 97 billion of the government’s money – and I’ve just made a 67 billion profit.

    Of course, I can’t put the 3 billion myself, but that’s nothing that can’t be easily arranged one way or another, relationships being what they are among the banking big boys.

  54. killben

    “Although the details of the F.D.I.C. part were still being completed on Friday, it is expected that the government will provide the overwhelming bulk of the money — possibly more than 95 percent — through loans or direct investments of taxpayer money.”

    2 things are clear … despite all the dressings …

    1. pricing is going to be rigged in favour of banks
    2. dumb suckers (tax payers) are going to lose their shirt while the bailout bandits make out with their money

    I think the time for words is past!!

  55. Andrew Gould

    I was about to post, but mz said exactly what I was planning to say.

    This system of government subidies for “investments” will be easily gamed to make the banks virtually whole on their worthless assets, leaving the gov’t holding the bag.

    And supposedly “brilliant” Summers, Geithner, Obama, etc don’t realize this? Or are they just so arrogant that they think the rest of us are too stupid to notice?

  56. PghMike

    To Warm, Dry and Well Fed:

    You make a very interesting point — paraphrasing, it seems that with only 3% down, you can pull enough out of these toxic assets in the first few years that you don’t mind overpaying for the base assets. You overpay, you take 300% return on invested capital, and then you leave the Federal government with a 30-50% loss.

    Oops, I forgot, that loss is all of ours to share :-(

    Thanks for the point!

  57. JazzPaw

    I worry that the involvement of hedge fund operators in this process with 97% of the money being supplied by taxpayers, is a recipe for the mother of all ripoffs. I’m not sophisticated enough to articulate the process, but I’ll bet that these participants will find a way to structure their participation so that they will profit from its failure. In that case, this plan will not only cost alot of money, but we’ll end of worse than had we done nothing.
    The Obama people just don’t seem to get it yet. Having read about the history of the Great Depression, I see the same denial being repeated. Only when all of these wishful thoughts are played out, with horrible results, leaving us at the bottom of a big hole, will new people be installed and better ideas tried.

  58. Anonymous

    I’m not a financial expert, but I thought the main role of the FDIC was to protect the savings of ordinary citizens. Instead, it is going to be abused to serve the banks and hedge funds.

    Also, I thought the TALF was created to enable lending for ordinary citizens to enable them to get car loans and credit card loans. This is also now being perverted to serve the interests of the friends of the Treasurer.

    Apparently the ongoing fiasco will not stop until every resource and asset of the American citizen, including future earnings, has been transferred to the elite financial class.

    Enough is enough. Just say no to the biggest robbery in the history of the world.

  59. Anonymous

    Whether we give the banks money ("capital injections") or overpay for their worthless "assets" (the Geithner plan), the effect is to indemnify their creditors from losses. That also was the effect of giving money to AIG so they could pay 100% of the CDS claims of Deutsche Bank, Soc Gen, etc. Ben & Timmy may truly believe that the big banks are too big to fail & that their demise would bring about armageddon. I'm willing to chance it. Until then, the primary effect of propping up the insolvent big banks is to insure bondholders against any loss whatsoever. Why? GM's bondholders will be taking a major haircut. Those who directly or indirectly lent the big banks money with which to make lousy loans need to take their lumps – even PIMCO (which, by the way, is using the Fed's massive purchase of agency MBS's as an opportunity to dump their own MBS's).

  60. Kreed

    Mostly astute comments that begs the question why does the government not come to the same conclusion/why the bankers are so quiet on this and why does Wall St. jump 300+ points on the news……..oh yeah that’s right, they are all on the same team.

    Geithner i presume owns a violin? therefore just like Nero he can play whilst the American economy burns (or more spectacularly goes into meltdown)!!

  61. ecoranter

    Ladies and Gentlemen; Please!

    Have none of you ever heard that a fool and his money are soon parted?
    The American taxpayers/voters may be the biggest group of fools in Earths history. Where a big group of wealthy fools gather, a group of predators will soon appear. It is always so.

    I can’t understand what all the complaining is about. Didn’t our American fools get to choose the particular predator that will slaughter them? Didn’t they cheer and send contributions to their predators of choice? Didn’t they have every chance to inform themselves about what sort of creatures the were cheering and voting for?

    Even now most of them are very happy with what the predators are doing; hopey/changey, hopey/changey!

    This is all for the best. Americans are too corrupt and stupid to be trusted with all this money and property. They are not responsible enough to even take care of it. Justice requires that it be taken away from them.

    So-get in line, take out your wallets, and; please; let’s quiet down before Daddy have to spank!

Comments are closed.