Geithner Announces Banker Bailout Plan

It’s being reported that early next week Treasury Secretary Tim Geithner will announce the details his plan to put the financial system back on its feet:

WASHINGTON — The Treasury Department is expected to unveil early next week its long-delayed plan to buy as much as $1 trillion in troubled mortgages and related assets from financial institutions, according to people close to the talks.

The plan is likely to offer generous subsidies, in the form of low-interest loans, to coax investors to form partnerships with the government to buy toxic assets from banks.

To help protect taxpayers, who would pay for the bulk of the purchases, the plan calls for auctioning assets to the highest bidders.

Basically, taxpayers will pay as much as 97% of the freight:

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.

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.

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


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.

I would think it might. Free money has a way of doing that.

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.

The Geithner plan is illustrated above. Perhaps if it’s complicated enough nobody will notice how lousy it is.

So far I have not been able to find anybody who actually likes this plan.

Paul Krugman

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.

Calculated Risk

With almost no skin in the game, these investors can pay a higher than market price for the toxic assets (since there is little downside risk). This amounts to a direct subsidy from the taxpayers to the banks.

Yves Smith

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.

This is a plan with incentives made in hell. Not only does it encourage excessive risk taking and subsidize bankers at the expense of taxpayers, it subsidizes politically-connected institutions at the expense of the rest.

I can only conclude that this is another case of “the smartest guys in the room”. They’re so convinced of their own brilliance that they can’t see the obvious flaws in their plan.

11 comments… add one
  • PD Shaw Link

    The government should just seize the toxic assets. They’re off the bank books. The government can find a way to make money off of them at its leisure. If that doesn’t work, tax them at 90%.

  • Brett Link

    So, let me get this straight. In order to get rid of these bad assets and help the banks, Geithner’s going to let companies buy these bad assets through a bidding process, driving up the price to the taxpayers . . . by allowing these companies to buy these assets with largely government-provided loans whose only collateral is the assets they’re buying?

    Good lord, no wonder they (potential buyers) like the idea. They can’t lose; even if they get the craptacular assets, they’ll still have made money off the loans, and then they can always do what the government apparently can’t and cut their losses on the bad assets.

  • PD Shaw Link

    Brett, you missed phase II — once the public figures out what happened and get’s outraged . . . [pause] . . . Yep, 90% retroactive taxation on the purchases.

  • Good blogging, but it’s the Rube Goldberg machine that sticks with me. I had forgotten that he colud do them so they were not just absurd contraptions but absurd topical contraptions.

  • Yeah, I’ve always loved his cartoons. For some reason people only remember the complexity of the machines and not the thought behind them.

  • M. Coyle Link

    I would like to be bailed out also. My bailout would only cost $50.00

    Thank you

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