Cincinnatus BLOG *** Political Commentary - Social Commentary

Treasury Secretary Geithner’s toxic asset plan appears to be a conundrum wrapped in an enigma. On the surface this pari passu public-private partnership seems simple enough. The government puts up $75 to $100 billion of TARP funds matched by an equal investment from five major investors and then the brew is levered six times and voila $700 billion to $1 trillion worth of toxic assets disappear from bank balance sheets. Financing for these purchases is to come from the Federal Deposit Insurance Corp (FDIC) and the Federal Reserve. The FDIC, which regulates the banks, has an even more important role: It will act as the hammer to pressure banks into participating.

The devil is in the details — specifically, pricing. Up until now the banks have been required to follow the “mark-to-market”, 157, rule, implemented in 2007 to price these toxic security assets. Banks complain that the mark-to-market rules have led to assets being priced well below their real value, making it impossible for banks to purge toxic assets from their books at anything but fire sale prices. Banking institutions must record, permanently in earnings, the current market’s view of losses, which often has no relationship to losses that are expected to occur if the asset is held to maturity.

The upcoming changes by the Financial Accounting Standards Board (FASB) to the mark-to-market rule will to some degree ameliorate this problem. Although estimating fair value in illiquid markets will always be more of an art than a science. Therein lies the pricing riddle. The buyer is not constrained by what could be considered arbitrary accounting rules; they simply make an assessment of the assets future cash flow and then offer the lowest price they can get away with to insure the greatest returns. Since five government handpicked bidders hardly make a free market, it is likely the banks will not receive anything approaching fair value. The same problem will apply when trying to value a banks loan book. The obvious question is why would banks participate? When the FDIC (Luca Brasi) holds a gun to your head, it’s a deal you can’t refuse. I must have missed something, I thought the plan was supposed to help the banks improve their capital structure not diminish the value of their assets.

The most disturbing part of the plan is that the Treasury wants to work with only a select few companies. To become a fund manager the treasury requires that a firm already have a minimum of $10 billion in toxic-assets under management. The rule also states that the $10 billion can only be made up of commercial and residential mortgage-backed securities that are secured directly by the actual mortgage loans, leases or other assets and not other securities. The only firms that appear to qualify to be fundbanj managers and who are not trying to sell the toxic-assets are Pimco, Black Rock, Goldman Sachs, Legg Mason and possibly the giant hedge fund Bridgewater. I guess we know who’s on Tim Geithner’s Christmas list!

If, in theory, the whole idea was to create a liquid market for these toxic-assets; logic would dictate that Treasury would encourage as many players as possible. Selecting four or five companies as “fund managers” to purchase toxic securities only guaranties a non-competitive market and exorbitant profits for the favored few at the expense of the banking industry and their ability to make loans.

Tim, did you forget you were supposed to be saving the banks so that they can make loans to spur the economy? Contradiction, Confusion and Cronyism will be the epitaph for Treasury Secretary Geithner.

P.S. It appears that the Treasury has decided to open this process to more bidders. I would like to think that this commentary and others like it helped make that happen.