- James Saft is a Reuters columnist. The opinions expressed are his own –

The pig that is British property is furiously flapping its wings, but despite signs of a recovery in prices and activity, rest assured there will be no take-off.

The country, which witnessed a property bubble that made the U.S. seem sober and sensible in comparison, has seen prices fall by about 20 percent but still faces a tough recession, rising unemployment and serious short and long term questions about the price of financing.

In the face of this, Britons seeking to sell their property last month turned again to a tactic that worked so well in the boom years: they raised prices, with property website Rightmove recording a 2.4 percent rise in asking prices in May.

“While some of the impetus behind the increase of over 5,000 pounds in average asking prices will be due to ambition or optimism, it will also be out of necessity as new sellers attempt to scrape together enough equity to move,” Miles Shipside of Rightmove said.

Just how ambitious can be seen by comparing Rightmove’s average asking price of just over 227,000 pounds with an average April selling price in the Halifax survey of 154,000 pounds.

House sellers are choosing a price that will give them enough cash not only to pay back their existing loan but stump up the 25 percent or so for their next house that banks are now requiring in order to give the best mortgage deals.

Because it is hard or prohibitively expensive to get a mortgage with a low down payment, this means that in the absence of a similarly optimistic or charitable buyer, many will be unable to sell at a price that allows them to move.

On the face of it, this is a bit surprising; after all prices more or less tripled in less than ten years, why would a fall of only 20 percent cause such a squeeze?

Firstly, because many people continued to move and kept their leverage at a constantly high level, and secondly because so many people simply borrowed their paper housing gains from the bank and, well, did something with it.

There has been some regional variation in house prices, with London falling only about 15 percent, perhaps partly explained by the fact that for foreign buyers active in the centre of the capital, the discount from the peak is closer to 40 percent in currency adjusted terms.

THE GROWTH OF THE MARGINAL SELLER

The two pieces of evidence most often cited as an indication that house prices will soon right themselves are an increase in buyer enquiries and a bottoming in mortgage approvals.
The Royal Institution of Chartered Surveyors’ monthly survey showed new buyer enquiries rose for the sixth month running and at a pace not seen since August 1999. Recent Bank of England data showed that mortgages for new house purchases rose in March and were the highest in ten months.

All well and good, but the data has to be seen in the correct context. Mortgage approvals even having climbed are still a third lower than they were a year ago and, according to consultancy Capital Economics, about half of the level that has historically been consistent with stable, much less rising, prices.

And the marginal buyer who arguably drove the bubble, the buy-to-let investor, remains remarkably quiet. The amount of money advanced by banks to buy-to-let landlords fell 78 percent in the first quarter from a year before, though a steep fall in interest rates has perhaps meant fewer have thus far been forced sellers.

Forced sellers ultimately will end the standoff between asking and selling prices, and in the old fashioned way, as a lousy economy and the unemployment it breeds bring a wave of properties on to the market in the second half of this year and in 2010.

And while mortgage interest rates may seem low, courtesy of a 50 basis point base rate from the Bank of England, the typical spread above that on offer to new and existing borrowers is about 350 basis points, according to Capital Economics. That is a function of the risk of the loans, the capital of the banks and the supply of savings, and cannot be counted on to improve markedly soon.
This brings us to two crucial differences between the U.S. and UK markets, both of which make the UK a worse bet for potential buyers.

Unlike in most U.S. states mortgage lenders have recourse to the rest of borrowers’ assets. There is no walk away and post the bank the keys option, at least if you care about your car and retirement fund.

More importantly, British borrowers almost always bear some or all of the interest rate risk. There is no government subsidized fixed rate market there, unlike in the U.S.

That means if inflation, and with them mortgage rates, rise buyers will feel the shock.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.

(Editing by David Evans)

-- James Saft is a Reuters columnist. The opinions expressed are his own --

The U.S. faces a lengthening series of request from industries and interests seeking shelter under the Troubled Asset Relief Program, most of which it should dismiss out of hand.

YRC Worldwide, a large trucking company, told the Wall Street Journal it will seek $1 billion in TARP funds to help relive it of its pension obligations.

YRC said that about half of the $2 billion it will owe in pension payments over the next four years covers the costs of retirees who worked not for it but for other companies, now vanished, that are part of a multi-employer pension plan.

That's certainly an irony but doesn't seem to be the basis for a claim on the public purse.

YRC is not systemically important and its pension woes, presumably the result of negotiation and free agreement, must be its own responsibility.

Next up: states and municipalities.

California Treasurer Bill Lockyer has asked Tim Geithner to provide assistance under the TARP, warning of a hit to public services and infrastructure if the money is not forthcoming.

Lockyer wants the TARP to provide insurance to banks who themselves provide insurance backstopping California's short-term borrowings. That insurance would cover the banks in the event of a default by California making the deals a surefire moneymaker for the banks.

Lockyer says that because of the credit crunch the banks are imposing too high fees for their letters of credit. That is true, but only up to a point.

The real issue is that California, because of the recession and its own decisions about taxing and spending, is not a particularly good bet.

While California is most certainly systemically important, and while keeping government spending ticking over in a recession is arguably a good thing, this plan is not the way to do it.

As proposed, it is a subsidy to California and to the banks, or in other words one subsidy too far. Like so many other of the government actions during the crisis, this short-circuits market discipline and encourages risk taking in search of private gain but with public insurance.

If the U.S. wants to bail out California, by all means do it, but take responsibility for the decision and do it directly.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. --

– James Saft is a Reuters columnist. The opinions expressed are his own –

If anyone has reason to pray that the current equity rally holds, it is the world’s active fund managers who need investors to return to the folly of betting on outperforming the markets rather than the uninspiring but reliable business of cutting costs.

Pension funds, particularly those where the employer bears most of the risk of making good on promised payouts, are hurting after more than a decade of poor market returns.

In Britain, for example, pension funds which promise to pay a fixed percentage of workers’ final salaries are woefully underfunded. If you use a more conservative government bond yield to value the funds, the top 200 firms in Britain needed a whopping 120 billion pounds to be considered fully funded, according to consultants Aon Corporation.

This is not the result of some unforeseeable economic storm but instead the fruit of two related delusions; that a prudently managed portfolio can expect to get a return of 8 percent a year or so over the long run, and that individual funds can maximize their returns by choosing the right active fund manager who will outperform even that optimistic benchmark.

And as is so often the case when we are kidding ourselves, these assumptions allowed employers and savers to avoid doing something unpleasant; in this case putting away the cash required to actually fund retirements. Workers felt as if they were “earning” more because their take home pay was larger than it would have been if they were saving sufficiently and businesses could often take contribution holidays or avoid chucking in extra to make good the shortfalls. Win-win, right?

Well, actually no. It was more lose-lose-win, with the two losers being the savers and employers, and the sole winner the financial services industry.

Now it is essentially impossible to know what rate of return capital in aggregate can demand over a long period, but given the way debt goosed the economy and asset markets, and given the way a long, and for investors benign, period of disinflation in the past 25 years affected returns, I’d be willing to bet that the 8 percent benchmark will prove too high.

So that leaves the question of how pension funds and other retirement savers should best invest and on one point there seems little doubt: paying the extra for active fund management is not a good bet.

Active funds create drag on returns in a number of ways; the managers themselves must be paid, as must the investment banks and brokers who advise them and executive the trades they make in order to try to beat the market.

While it is always possible that market returns will more than make up for this, there is no doubt whatever about who bears whatever costs are generated.

LOTS OF DATA, LITTLE OUTPERFORMANCE

Andrew Clare, Keith Cuthbertson and Dirt Nitzsche of London’s Cass Business School have published an analysis of decades of performance data for 734 British pooled pension funds with more than 400 billion pounds under management.

As about 40 percent of UK institutional money is in pooled funds and there is data going back more than 20 years, this is a pretty fair sample.

The result, according to the authors, is that there is “little evidence” of positive performance persistence, i.e. that managers can outperform over time. Further, there is “virtually no evidence” that active fund mangers can time the market.

For example, over a 20 year period ending in 2004, only 3 of 42 pooled funds showed statistically significant outperformance, while 2 showed statistically significant underperformance. All 42 did, however, charge statistically significant fees.

“With increasing numbers of UK fund mangers purporting to be able to provide ‘high alpha’ products to the UK’s beleaguered pensions industry, our results do not give us great confidence that the solution to the widespread deficits lies in the hands of the UK’s active institutional investment managers,” the authors wrote.

About 20 percent of the UK’s institutional money is now in passive strategies, with most of the growth happening in the past 10 years.

The response of the fund management industry to this has been to offer ever more complex fund structures, often with more freedom to short stocks or employ leverage and almost always at a higher cost to the ultimate consumer.

Who knows, perhaps some of these will work. Perhaps all that was wrong with the old fashioned funds was that they couldn’t bet against things, or use borrowed money to amplify returns.

My guess however, is that the best solution is a simple one: go passive and cut fees. It is money in the bank, as it were, from day one.

Employers and employees have a common cause here and should not let an evanescent rally blind them to the steady bleed that fees represent.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. –

-- James Saft is a Reuters columnist. The opinions expressed are his own --

The recession will soon be dead, laid to rest alongside the idea of the "Great Moderation", a set of hopeful assumptions that underpins expectations about economic growth and asset valuations.

This, when investors, bankers and executives ultimately realise it will cause them to pull in their horns, take less risks and be less willing to pay high prices for assets.

Economists, observing that since the 1980s recessions have been mild and short and expansions long and robust, developed the theory that better economic management, namely cutting rates in the aftermath of bubbles, globalisation and, get this, improvements in financial markets, had led to a sort of best-of-all-possible-worlds "Great Moderation", in which economic volatility fell and with it the risk premia required for holding financial assets.

This little theory has, needless to say, come somewhat unstuck during the current downturn which has been great but far from moderate.

This raises the uncomfortable possibility that the last 25 years of good times were just a bit of luck, or even worse, an artificially engineered consumption binge with central banks and governments playing a role similar to what Chicago tavern keepers used to do -- opening up early so last night's patrons can have a quick nip to take the edge off on the way into work.

It's a debate which is far from academic and its outcome will influence much more than the actions of central bankers and regulators.

While financial market volatility has been a feature during the past decades, the idea, or at least the feeling, of the Great Moderation has seeped into the culture, influencing the behaviour of actors across the economy.

A corporate manager is going to be more likely to leverage up and go for the big hit if he feels as if most recessions are mild and short, in the same way that a consumer will buy a boat on credit or an investment property for the same reasons. If the weather never gets that cold why waste money on insulation?

What if these people now decide that the universe is a less friendly place and that they ought to, heaven help us all, save a considerable amount against the day?

This is really about volatility, which, because it can tend to ruin you, is expensive. Most investment or economic management strategies have at their heart attempts to limit or cushion volatility. And so, if we really can expect more volatility in the economy we can expect it to find expression in a lower ceiling for economic growth, leverage and asset prices.

IT AIN'T NECESSARILY SO
Of course, the current debacle may be just one data point rather than a trend, a view financial markets seem to have adopted. That is more or less the argument of Larry Summers and the U.S. administration, who are betting that this is the kind of thing that happens only very rarely.

This is a version of the 100-year storm argument beloved of company managers trying to explain why their results are so poor; the implication is you could not have been expected to plan for a freak storm and once it is past it is back to the good times.

This thinking lies behind the strategy of making financial conditions so easy that people are tempted to borrow and invest. It just might work, and we just might have a sharp and long recovery which generates enough revenue to pay off the public debts we are now racking up.

But two other possibilities, both speculative, spring to mind.

One is that deleveraging proves to be not just an event but a state of mind. As in Japan, people may simply decide that they've had enough risk, thank you very much, leading to a weak recovery, a relapse and then a quandary about how best to pay off the bills we've recently run up.

The other is that the current mix of policy, deep cuts in interest rates, deficit spending and quantitative easing, the effects of which are little understood, ends up breeding volatility of its own, probably in inflation.

The cost of that volatility will be an unpleasant surprise to the investors now bidding up the prices of shares and managers now preparing to invest for expansion, and one that might lead them to at last act more conservatively.

Add to arguments for a new "Great Immoderation"  that emerging markets will almost certainly be more of a driver of global economic growth under most of the reasonable scenarios in the coming decade. Emerging markets historically are more volatile and if as they grow to be a bigger piece of the pie are likely to make overall growth more volatile.

None of this takes away from the essentially good news that the recession looks to be ending soon, but higher economic volatility will hang heavy over the recovery and the cycle to come.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.--

-- James Saft is a Reuters columnist. The opinions expressed are his own --

While they have avoided the opprobrium heaped on bankers during the bear market, traditional active fund managers have quietly been proving that they too are often highly paid destroyers of value.

Active managers have few bushes left to hide behind, and the release of a new report from Standard & Poor's uproots one of the few left: that somehow they provide protection during down markets, being able to go into cash and defensive stocks.

Check out the study for the gory details but the takeaway is that across styles and markets the majority of active fund managers, often the vast majority, simply can't manage money well enough to make up for their own costs and the costs of all of those trades.

Over the five year market cycle 2004-2008, the S&P 500 outperformed 71.9 percent of actively managed large cap funds and most active funds in each of the nine U.S. domestic equity style boxes were outperformed by indices during the disaster of 2008.

At least casinos offer free drinks and valet parking.

Beyond tighter regulation and controls on leverage, a good outcome from the current morass would be a fundamental re-think by holders of capital about what exactly it is they are paying for from investment managers. Diversification? Not really, with so many closet index funds out there.

And spare me the argument that active managers earn their keep by holding company management's feet to the fire. With precious few exceptions, this simply is not happening and arguably is a common good which individual investors are unwilling to pay for.

Most individual investors would likely be better off paying an annual fee for an asset allocation check-up and simply putting the advice to use via ETFs or index funds.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund --

-- James Saft is a Reuters columnist. The opinions expressed are his own --

A look at credit insurance prices for U.S. banks shows that market thinks the government's mouth is writing checks its body can't or won't cash.

Despite a blistering rally in bank shares and Herculean efforts by the U.S. to build confidence in its financial sector, the price of insuring some leading banks' debt against default has increased markedly in recent weeks.

That tells us that bond investors have serious doubts about the popular perception that the United States won't allow systemically important institutions to fail, or in saving them in some form won't make bond holders take substantial losses.

Since the KBW index of bank shares began a 65 percent rally on March 6 the cost of insuring Citigroup for five years via a credit default swap has risen to an annual payment of 627 basis points from 470, meaning it costs 6.27 cents to insure every dollar. Wells Fargo 5-year CDS stand at 292.5 basis points, as against 240 on March 3 and 120 at the end of December, while Bank of America's ended last week at 355, exactly where it was on March 6 but 50 above its March 3 level.

The people buying this insurance fear if a big bank fails over the coming five years, or needs further buttressing with public money, the bill will be too large for the U.S. to bear, either politically or otherwise. That implies that there could be burden sharing by creditors, either through some sort of divvying up of the remaining assets or through forced or government orchestrated conversions of debt into equity.

OPTIONS

The options for the U.S. aren't particularly attractive. As pointed out by Tyler Cowen in the New York Times here for the U.S. to simply fess up and say it stands behind all bank debt is to take on a gargantuan liability and to effectively neuter bond holders as a force for market and company discipline.

If the U.S. were to allow someone big to go down and make bond holders suffer too, there is a legitimate fear that creditors to the banking system would stage a disorderly wildcat strike which could bring down many healthy institutions.

It is very similar to the situation last year when the U.S. took Fannie Mae and Freddie Mac into government conservatorship and did everything short of explicitly guaranteeing the two mortgage lenders' debt. But that wasn't enough for the markets, specifically the Chinese, who lightened up on Fannie and Freddie bonds, making mortgage rates higher than they otherwise would have been and hampering monetary policy. Ultimately the U.S. was forced to use the Federal Reserve to buy up Fannie and Freddie debt directly as a means of keeping mortgage finance flowing.

BURDEN SHARING

Remember too that these are 5-year credit default insurance contracts, so the same cast of characters might not even be in charge when the bills come due. The range of outcomes is pretty wide and so it's no surprise people want insurance.

It is possible too that the CDS market is distorted or deluded; after all these might be the same people who are paying good money to insure against U.S. sovereign default, an event that might happen but would surely leave very few counterparties with the ability to make good claims.

To be sure, this doesn't create funding problems for banks at this stage. They are able to sell bonds backed by the Federal Deposit Insurance Corp's rather hopefully named Temporary Liquidity Guarantee Program. If those CDS spreads don't come down it isn't going away any time soon. It has already been extended into 2012 and I'd expect more in due course.

So, the U.S. is likely to continue to make soothing noises to bank creditors while saying nothing too specific or legally enforceable, all the while hoping that something, anything, turns up. That might work.

COSTS

However, the current fudge imposes its own costs. Banking is a long-term business built on trust. The very existence of concerns among creditors will breed them among clients and will tend to undercut a bank's ability to get new business and hold on to the old. Lack of trust is a vicious cycle.

So should the U.S. force creditors to pay their share if a major bank needs rescuing? My heart says people should bear responsibility for their decisions and pay the costs. But even the most puritanical capitalist should be extremely worried about what holding this particular group of vested interests responsible for their mistakes might mean for the rest of us.

Remember too that the rather successful Swedish bank bailout made creditors whole, but hit equity holders and management. I'd settle for that.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. --

-- James Saft is a Reuters columnist. The opinions expressed are his own --

When prophetic long time bears turn a bit cuddly, it is usually best to take notice.  A real estate maven who rejoices in the "nom-de-blog" of Professor Piggington has now, after five years of correctly shouting bubble, labelled San Diego housing prices "reasonable" based on the latest available housing data.

Remember, San Diego has been, along with Phoenix, Las Vegas and parts of Florida, among the most bubbleicious markets in the U.S., and the massive busts there still represent a huge problem for bank balance sheets, for employment and for the U.S. economy generally.

So a bottoming, if that is what we are seeing, would be very significant. Housing is usually among the first sectors to recover in the aftermath of a recession and many economists argue that it actually drives the economic cycle.

Piggington, whose mother knows him as Rich Toscano, is making more modest claims; that prices are reasonable historically, but his arguments have some merit and fair value is a necessary but not sufficient precondition for a bottom and a turn.

He argues that, based on the historical relationship between San Diego county house prices and both incomes and rents, prices are now not so bad. The ratio of home prices to per capita income in December was below eight (remember San Diego housing has always been expensive!) as opposed to a bubble peak above 14. And buying the average single family home now costs the equivalent of just about 200 months of the average rent, as against well over 350 at the peak.

I think it's fair to say that we are getting ever closer to a bottom in some of the bombed out markets, not just San Diego, but I don't think we are there yet. On the plus side, in many of these markets transactions are now well above last year's extremely low levels, driven by banks selling foreclosed properties at aggressive prices. And many of the buyers in places like Florida appear to be investors who are happy to take the quite positive cash flow from renting, a real sign of health, as opposed to 2006's flippers.

But be cautious: we are in the midst of an awful recession and the employment effects will last long into 2010. Prices also are liable to overshoot on the way down, as they have in the past, including in California.

That means that price measures are now biased to the lower end of the market and don't give a true picture of affordability. Professor Piggington may have more pain to chronicle as more prime and jumbo foreclosures hit the market.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund --

-- James Saft is a Reuters columnist. The opinions expressed are his own --

The dollar is, and will remain, the U.S.'s currency and its own and everyone else's problem.

The idea of creating a global currency, as espoused by China earlier this week, is interesting, has a certain amount of merit and is simply not going to happen any time soon.

U.S. desire for free access to the cookie jar that being the world's reserve currency represents will be too strong, especially given its need to finance huge amounts of debt reasonably cheaply. As well practicalities are fearsome, even if consensus was more or less there.

Chinese central bank head Zhou Xiaochuan on Monday called for the creation of a new "super-sovereign" global reserve currency, advocating building on an International Monetary Fund instrument called Special Drawing Rights.

Zhou echoed a call by Russia last week, when it indicated it would raise the issue at the upcoming Group of 20 meeting in London on April 2, saying the idea had support from emerging market economies including Brazil, India, South Korea and South Africa.

There is no doubt that the current system breeds instability, but it enjoys the great advantage of entrenchment and sticking with it allows the U.S., and others, to avoid making hard choices and paying true market prices for their economic decisions.

No surprise then that President Obama knocked the idea down in blunt terms. "I don't believe that there's a need for a global currency," Obama said, terming the dollar "extraordinarily strong right now."

Exactly. Too strong by some margin, especially when one considers the coming effects of both quantitative easing and a massive long-term need to fund the costs of the debt binge that exploded and the ever increasing bailout to clean up the aftermath.

In fact you could say the dollar's "extraordinary" strength can only be fully explained when you take into account the fact that foreign central banks keep piling up huge reserves of the thing and that it is the international medium of exchange for commodities and energy, well really for global trade and financial intermediation.

Treasury Secretary Timothy Geithner said on Wednesday the U.S. dollar is still the world's reserve currency and will remain so for a long time, but expressed openness to greater use of IMF SDRs.

The dollar's central role has two main implications, both rather ugly but also very seductive for those involved.

For the U.S. it's a bit of a free ride as far as debt financing goes. People buy and hold treasuries more and the U.S. gets cheaper financing that would otherwise be the case. Of course that's a bit like an alcoholic bartender getting a discount at work; a real benefit, but not a true one.

It also means that even if the U.S. has the will to take away the proverbial punchbowl or drive the dollar down, it doesn't always have control, as what it does at the short end of the interest rate curve can be confounded by foreign purchases that keep the long end and financing costs down and the dollar up.

SOVEREIGN OVER US ALL?

The U.S. reserve status also opens up the opportunity for mercantilist countries, like, say China, to keep its own currency cheap, building up huge dollar stocks and force-feeding the American milch cow with cheap credit with which to buy imported goods.

That may not work any more anyway, as all of the cow's stomachs are full and the milk's gone thin.
There is a temptation also to build up reserves as protection against bad times and bitter IMF medicine.

Many Asian leaders seem to have vowed after 1997 that they would do what was needed, which often included building up dollar reserves, to avoid having to meet an IMF director's plane at the airport and accept the accompanying prescription.

That rather indicates that the old system, with the U.S. as global reserve currency, is dying, but I doubt it will do so without a fight and with cooperation among nations willing to cede part of their sovereignty, even for a greater good.

It is amazing and encouraging that China speaks of ceding control of a portion of its foreign reserve assets to IMF management, but I have a hard time seeing it happening widely soon.

So, we will have to get through the next year or two without a super-sovereign currency and with global imbalances being worked out, or around, under the current system.

My best guess is that things actually go in the right direction, more or less. The dollar should weaken as a result of U.S. policy even without a deliberate push downhill from the Chinese. Asian exporting nations will see slowing reserve growth generally, which should translate into diminished flows into the dollar and Treasuries.

That's going to be painful all around. The Chinese and others will see their investments dwindle, even as they have to resist the impulse to sell into the fall. For the U.S. the process of implementing monetary policy and paying for fiscal policy will be made that much more difficult.

So, goodbye and perhaps good riddance to dollar hegemony, but don't expect a stable system of global cooperation to rise easily and quickly in its place.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund --

-- James Saft is a Reuters columnist. The opinions expressed are his own

Treasury Secretary Geithner is all but admitting that U.S. banks are suffering not from market failure but self-inflicted collateral damage.

The U.S. Treasury on Monday detailed an up to $1 trillion plan to buy up assets from banks in partnership with private investors, using financing bankrolled by the government, financing that is only secured by the value of the doubtful assets the fund buys.

One portion will be dedicated to buying complex securities from banks employing capital contributed by private investors and the government topped up with funds borrowed from the Federal Reserve. A second portion will buy older securities that are, or were, rated AAA, using, you guessed it, more non-recourse funding.

But most interesting of all is a plan to buy whole loans, dubbed "legacy loans", from banks but this time the private-public subsidized vehicle will get its leverage courtesy of Federal Deposit Insurance Corporation-guaranteed debt.

Notice that the ground has shifted subtly and the government is now talking not just about "toxic" assets but "legacy" ones. A legacy asset is, more or less, everything real estate related now on bank balance sheets.

These loans are not marked to market they are held to maturity, so no blaming the market here. They are nothing more than doubtful loans in the process of going bad as the economy implodes and the real estate they are collateralized with drops in value.

There is an almighty bust in the U.S. real estate market and it is blowing holes in bank balance sheets having nothing to do with securitizations.

It rather undercuts the argument that was advanced about earlier subsidy plans, that there was a "market failure" leading to hard-to-value complex securities being priced by the market at too little, below their fair "held-to-maturity" value.

The only uncertainty around a whole loan is whether the debtor will pay back the loan and, if not, what the collateral is worth. So there is no more deception about liquidity, market failure or anything else, only a naked subsidy to the banking industry, using the private sector as a pricing mechanism and cutting them in on the deal in exchange.

DEFINITION OF PRIVILEGE
So, will it work, and if it does how will this step influence the way banking functions down the road? Depends on what you mean by work, but it will doubtless take a tranche of lousy assets off of banks.

But as for creating confidence, I can't see it. Firstly, investors will twig to the idea that the balance sheet issues are deep, and secondly, now that we are talking whole loans I think it's clear that the $1 trillion is only a down payment.

That means the administration will need Congress to play along and fund another wodge of subsidy. That may be a tough sell, especially considering that the administration has bent over backward to keep Congress out of the funding loop, using the Federal Reserve and FDIC as funding mechanisms and thereby effectively arrogating the funding powers Congress is supposed to hold.

The plan also hugely encourages moral hazard, as it leaves too big and too failed companies, boards and executives in place while providing them with a chance to climb out of the holes they have dug themselves. Not much of a lesson in accountability.

Writing in the Wall Street Journal, Secretary Geithner said the U.S. must strike a balance between promoting public trust and spending taxpayer cash to get the banking system functioning.

"This requires those in the private sector to remember that government assistance is a privilege, not a right. When financial institutions come to us for direct financial assistance, our government has a responsibility to ensure these funds are deployed to expand the flow of credit to the economy, not to enrich executives or shareholders," he wrote.

It is just astounding that he even sees the need to remind us that free government money is not a right, and reveals much about the balance of power between him and those seeking handouts. And you simply can't give a subsidy without enriching executives or shareholders, you can only hope not to do it too obviously.

Finally, don't even begin to believe that concerns about government interference will leave the U.S. with few well qualified asset managers willing to commit their capital to the plan. New York and Connecticut are stuffed to the gills with asset managers who would crawl naked over hot coals to get access to cheap, non-recourse, long-term funding from the government.

That there are suggestions to the contrary is simply an attempt to try and influence the debate about government control over compensation at firms which accept taxpayer largess. A smokescreen within a smokescreen.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund --