The Great Debate

Geithner’s naked subsidy redefines toxic

By J Saft
March 25, 2009

jimsaftcolumn31– 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.

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 –

55 comments so far | RSS Comments RSS

It’s actually much worse because:
What keeps a bank from buying it’s own toxic assets for full 100% value through a proxy company with 10 or 20 to one leverage thanks to the treasury and federal reserve’s latest destructive buffoonery??

Even if the true value in the market of the toxic assets is 30 cents on the dollar OR ZERO it is of virtually no consequence.
If the toxic assets turn out to be worth zero even, the only loss to the original owner and seller (and buyer)is the tiny sliver that the Fed and treasury didn’t finance.
Remember they got full book value for the toxic asset though. The only loser is the U.S. taxpayer…and bondholder as the Fed inflates ever more.

Posted by Chris | Report as abusive

Don’t get distracted.
The real problem is Peak Oil.

It is the fundamental driver of all of this and it is not
a problem that is going to be solved with a Trillion
or two.

Posted by Louis | Report as abusive

Collateral is meaningless without without demand and ability to pay by other potential buyers. This is the situation we are presently in. Tremendous amounts of wealth generated by inflation has disappeared. Many believe greed and unethical practices are at the core of this crisis. True. It is at the core of all our crisis’: climate change, health care, education and more.

I remember when growing up adults used to tell me “What’s good for big business is good for America”. What shall we tell our children now?

Posted by Anubis | Report as abusive

I would say the posting of Mr. atomicweasel and franz kafka are right on. As I have been urging on every bolog I can find it is critical to write your congresmand, the white house, and your senator’s to express your outrage. The current crisis has clearly shown that our governmental bodies will not act in the best interests of its own citizens until they feel threaten with removal from office. Therefore, the outrgae must continue to be expressed and loudly. Otherwise the lobbied interests will get the programs they want, but these will be sold to us as something to “help the economy”. In fact as far as I can tell the great majority of these programs amount to a great wealth transfer from the tax payer to corporations. Eventually we will end up with the final solution, but if the bankers get their way our nations wealth will be used up in the process and transferred to them.


Posted by db | Report as abusive

If executive compensation limits would prevent these big institutions from participating, perhaps they don’t deserve taxpayer funds. I’m sure there are lots of community banks and lenders who would love to have access to those funds even with compensation limits.

What if the institution is too big to fail? Perhaps the market will find buyers for whatever is left over, and life would move on. Not everyone was irresponsible, so there will definitely be people with the capacity to pick up the pieces, and perhaps they deserve to be given a chance.

Posted by DCX2 | Report as abusive

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/