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 –


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Seems like a pointless debate but at least Mr.Saft is doing his bit, though judging by the comments the discussion is all too one-sided and losing steam lately. Look the government needs to be seen as doing something, and at least pretend to look like it knows what they’re doing. Else they risk the common folk hitting the streets. So that’s the main objective right now. What you see now is nothing more that a ‘fire-fighting’ and trying to figure out the next move. Right, it’s hopeless but since when did politicians come up with anything other – not their primary objective for taking office. Geithner is a banker (allways a banker – though paid by the state now) so his hands are tight plus the other Wall Street bankers are crying meltdown, collapse etc. Like with AIG the counterparty risk and subsequent settlement failure risk is too great. No single person or entity is willing, able or has any incentive to tackle it – so Uncle Sam comes to the rescue, as allways. The lessons to be learned are all here laid out. You’d have to be extremely gullible to think that a solution of any kind can be proposed by the very people that could not see the bubble in the making although were charged with an oversight responsibility. How could they if the best brains are overpaid by the Wall Street. Where are all those MBA’s and PhD’s and economists with their awards for theories that seem to work in a boom time?. Employ them now! (Nobel prices and press will help as that’s all they care about anyway).

Posted by Franz Kafka | Report as abusive

I criticize Shaft a lot but this is a good statement:

“The plan also hugely encourages moral hazard”

Posted by jimmy | Report as abusive

I am a Brit who is still reeling at our own governments incompetence – of course things are gathering pace here with a schism between the government and the head of the Bank of England – Mr. King. Who allegedly was called in to see the queen yesterday…. very strange – could we be facing a quiet coup d’etat in Britain?

Anyway re the Geithner plan. I have to admit I watched the explanation of the plan on Bloomberg with a slack jaw. I understand a few things about finance – having worked in it for a number of years in a previous life – but I did not understand this plan. Or rather I did not understand how it would work. I mean wont this plan just be respreading the risk? Re packaging it up and selling it on? I may not have understood it – but if that is the case I would imagine that should be the last thing we should be doing.

It is interesting that the Brits and the US are doing the same thing once again – following each others policy and telling the rest of the world that is what they should be doing too but the rest .

However I do not think Americans should be overly optimistic about Europe. Britain is in dire straits – so is Ireland and Spain and Greece. The ex Eastern bloc is in a terrible condition – every other day a country gets an IMF loan. There is widespread unrest in Europe now – rioting in Latvia, Romania etc. Rioting and demos in Greece and France. In fact the French have started taking their factory owners hostage – we may slate the French but they know how to fight for their rights.
Of course we Brits have done it our own quiet way and smashed a bankers house!
So I am not too optimistic for you guys but then again I am not too optimistic for us or the Euro Zone either!

Posted by crackersan | Report as abusive

I have a simple suggestion for people who are outraged by our US gov giving away our hard-earned tax dollars to their cronies who lost it by being greedy pigs:

Sell short the US. Buy gold, buy foreign currencies, invest in China. At least you’ll make some money out of the Obajerks.

Posted by Jerusalemight | Report as abusive

If Saft is right, then what we have is fiction returning as fact on a monumental scale — the fiction I refer to is Tom Wolfe’s “A Man in Full” which details the unravelling of commercial real estate speculation in Georgia in the 90s. If bankers have messed up the most elementary form of plain vanilla lending — loans collateralised against real estate of a type that have been around since the Phoenicians, then you have to ask whether there is any brand value, intellectual capital or commercial reputation left to save at these banks and it wouldn’t be kinder to put them out of their misery. Geithner’s “highball” offer — which some reporters have priced at US$6 worth of no-risk loans for every 1$ of at-risk investment — should have sparked a feeding frenzy. At those prices somebody assumed that only 15% of all securitised paper has any value at all… and the rest is trash. Plainly that’s untrue as a house is still a house.

Posted by celebrand | Report as abusive

Stop creating money to give to institutions and banks that made bad financial decisions. Let them fail and compensate at some percentage the investors. As a penalty the CEO’s and top managers should have a job like picking up our garbage and or having their credit score lowered to .001! A cushy prison cell is to good for these greedy idots.

As I see it, the party of Robin Hood, i.e. Democratic party, taking from the rich and giving to the poor, has now decided to contradict its basic philosphy by financing bets of the rich and famous. The purchase of toxic assets using 6c of the private investor against 94c of the taxpayer to make a bet that the assets will someday be worth more is tantamount to going to a casino and if you win, take the money but if you lose ask the casino for a return of 94% of your losses. Great deal for those with money. Bad deal for the rest of us.

Posted by John Caiazzo | Report as abusive

I feel the better way for the US government would have been to add notional federal long-term loans in the balance sheets of banks for a percentage of the total toxic assets thus avoiding printing notes and adding to the federal deficit and inflationary trends.

The banks in this way do not get absolved of their wrong-doing but get a moratorium period to get things back on track. A new law could be enacted to link bonus payments to return of federal long-term loans wherein bonus payments above a certain amount would only be possible if banks start paying back federal longterm loans.

Posted by Amit | Report as abusive

OK, now I truly beleive we are f#@ked, no matter what the governemtn does. Here’s why:
The banks return to profitability after their so called ‘toxic’ assets are shifted to the national debt by lending? TO WHOM WILL THEY LEND WHEN EVERYONE IS GOING BROKE?
The CBO estimates the government will owe over $17 trillion within 10 years. Clearly if that level of debt is reached the dollar will be worthless and if the dollar becomes worthless anarchy and major wars will follow.
The GAO has reported some time ago that the REAL national debt was over $50 trillion. If the amount of debt reaches that the government chooses to be transparent about is $17 trillion, will this off balance sheet debt be $100 trillion?! How could that ever be paid unless the economy doubles in 10 years to $20+ trillion in GNP (and it won’t)?
Taxes are already on the march, so if you have a job and money, say goodbye to the days of discretionary income due to record taxes and inevitable devaluing of your cash (and therefore your real buying power). How does that make a recipe for the consumer to buy or borrow? I see more stealing on the horizon instead.
2-3 Quadrillion in CDS, CDO’s and other derivatives?! WTF! Unless all these morons end up actually owing themseleves, that will be a nuclear explosion in the FIRE sector. The financial landscape will be demolished for 1000 years, and could possible lead to a real nuclear exchange! Since commercial real-estate and securitized garbage of credit cards, auto loans, signature loans, and student loans (another gov. guaranteed loan vehicle!) are the next bomb to go off and all these derivatives seem to be set to the short, this will trigger yet another round of losses to the people who got into this casino/ponzi scheme. The government seems to be in the gambling addiction rehab business!
I’m probably running out of space, but if you want some brutally honest commentary, go to and looks for P.C. Roberts and M. Hudson among others. Ahh, what a nice time to be an American.

Posted by J | Report as abusive

How is this private-public plan different from the bad bank plan proposed by then Treasury Secretary Henry Paulson? Both involve pricing of these assets, both these assets are hard to price, both require lump sum of taxpayers money, both are still supporting Big institutions that are already brain dead on a life support machine that SHOULD be dead a long time ago.

Posted by ohdear! | Report as abusive

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