"Private Public Partnership Details Emerging
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. when at foreclosure auctions, 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.
Don said...
"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
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