Geithner’s naked subsidy redefines toxic
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 —