It seems like the pace of bailouts, major announcements, stimulus packages, etc are accelerating exponentially. What would have been a magnitude 10 event a year ago and front page news for a whole week thereafter is now relegated to the back pages. When this crisis started back in 2007, a few billion dollars in losses was a big number. Months later we were talking 10's of billions. Months after that 100's of billions. Now, the "T" word is being thrown around. Does anyone even have the faintest idea how much a trillion dollars is? I was still trying to wrap my mind around the idea of a billion dollars. My head is spinning.
A couple months ago, I essentially gave up in trying to follow all of this. My cynical side tells me that was probably the point. By throwing around increasingly larger numbers, outrage would turn to numbness; numbness to quietude; quietude to acceptance. Punch-drunk in other words.
But this weekend, I decided to delve into the details of this recent plan by the Treasury led by Tim Geithner. Perhaps it wasn't so bad after all. Heck, maybe it would work. "Don't knock it 'till you've tried it," right? I didn't want my ideological disbelief in government intervention to get in the way of what might otherwise be a good idea. So I read everything I could find on the subject. The result?
Disgust. Not only is this "plan" so far away from the core issues of the crisis (altogether another topic that I won't get into today), but the language used by the treasury secretary in describing it is purposely designed to mislead the average person into thinking this is something that it is not. Typically, these plans have been laced with uncertainty and vagueness with regards to the intended consequences. The Paulson gang had done so in order to ensure "plausible deniability" in the event that something other than it's mission was the result. So while incompetence was suspected, malevolence could not be proven. This is blatantly malevolent, and the treasury secretary is purposely trying to use the "punch-drunk" state of the masses as a shelter for the barrage of indignation that would otherwise spew forth.
Everywhere you look and everything you hear about this plan, including from Geithner's own pen in the WSJ is that this is a "public/private partnership." It is structured like this in order to ensure that a realistic market price is found for the "toxic" assets on bank balance sheets. Without private participation, the government would not have the faintest clue what the assets should be purchased for (which is true), so this participation will ensure that government gets the best "bang for their buck." And the American taxpayers are assured that the only way they lose is if the private partners also lose, and vice versa. If the private partners end up making money, so will the government.
These are all blatant lies.
The language is used in a way that makes people think that the deal is 50/50. It is not. Not even close. Treasury is matching private investment 1:1, but the FDIC is providing 6:1 leverage on top of that. Where does FDIC get the money? From the Treasury, of course. Here is a sample from the Treasury's own website:
Sample Investment Under the Legacy Loans Program
Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.
Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.
Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.
Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6.
Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis – using asset managers approved and subject to oversight by the FDIC.
You can't make this stuff up. Let's do some complex mathematics:
Translation: The taxpayer is on the hook for 93% of the entire bet. The private investors get to reap the rewards of the leverage on the way up and the taxpayer eats the losses if the leverage blows up in everyone's face. It is free leverage for the investors. Pretty sweet deal, eh?
So sweet that one would probably overpay for the toxic waste being bid on in order to benefit from the potential upside, wouldn't they? And if one is willing to overpay, what exactly is that price? Is it a market price? No. It is fantasy.
This might seem perplexing. If the taxpayer is taking most of the burden themselves, and we aren't achieving a true market based price for these illiquid assets, what's the point? Why not just skip the formality and nationalize the assets? This is where it gets interesting.
There are more inherent benefits for the private investors to purchasing these toxic assets at far above their real value than meets the eye. Think about a common situation, where a hedge fund is already heavily invested in financial corporate bonds. Let's call this hedge fund "OCMIP" for no real reason at all. They might own a hundred billion in Citigroup bonds. Those bonds themselves are trading at a steep discount to their NAV (let's say 60 cents on the dollar) and if marked to market would likely require the liquidation of the entire fund. But now you and many other hedge funds have been given the opportunity to make an "investment" in Citigroup's troubled assets. You can put up 6 Billion Dollars, and the government will follow up with 78 Billion of their own dough. All in all, Citigroup gets 84 Billion dollars that they didn't have before (it was there, but not "liquid"). The value of OCMIP's bonds are now much higher because of the perceived balance sheet improvement of Citi. In fact, Citigroup may even have enough money to pay off the entire value of that tranche of debt, thus making OCMIP whole on much or all of their Citi bonds - making them $40 Billion better off than they were before. They can then write the value of the $6 Billion investment down to zero (what it is probably worth) on their balance sheet and hope to "get lucky" if it ever becomes worth something. They are $34 Billion richer and have had to take zero risk to do so.
This is not a program designed to make the banks healthy again. It is a bailout of hedge funds, pension funds, insurance companies and anyone else who got in way over their heads in leveraged bets on bank debt. Geithner is essentially passing out taxpayer money to the greasiest slime on Wall St. They saw the banks getting free money. And now they think it is their turn.
This is a heist. And it is perhaps the biggest heist in human history. No matter how outraged you are about this travesty, I can assure you that it is not outraged enough. Tim Geithner should resign immediately. This is blatant fraud.
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