Geithner's Plan's Got Problems
So, Geithner has announced the next phase of the bailout plan -- the FDIC will partner with hedge funds, private equity funds, pension plans and other large institutional investors to buy loan securities off of the banks. Hopefully, they'll do this at prices that will allow the government and its partners to make money over time while not forcing the banks to take excessive writedowns now.
The plan could work but its problematic at best and it focuses on helping the wrong people - institutional investors rather than ordinary citizens.
It's inevitable that if anyone makes money at this, they're going to be politically well connected and we're going to have to discuss some uncomfortable relationships among members of the Obama administration. For example, Larry Summers was a partner at hedge fund giant DE Shaw Group and so we have to ask ourselves whether or not it's appropriate for Shaw funds to participate in this.
The beauty of the Geithner plan is that if the private interests win, the Treasury wins too. But the public only wins in the abstract. At best, if you're covered by a pension fund that participates you get some benefit. But if this is really a great deal for private investors, shouldn't there be some sort of mutual fund set up so that smaller investors can participate directly? Heck, if this is really going to work, maybe the government should agree to use positive returns to pay out a dividend to every citizen?
It's stunning to me that in the wake of AIG I'm now being asked to help well connected hedge funds get a good deal on mortgage backed securities. I'm also concerned that if these mortgage backeds really do represent some reasonable future return that the hedge funds would have bought them already or will eventually buy them without public financing and guarantees against losses.
We are, yet again, subsidizing private sector profits with little regard for the public interest. It's going to be interesting following the money on this one. My guess is that some funds will make a lot of money while the public will do okay. A few well connected hedge fund managers and financiers will get a lot more out of this than the rest of us will and they will never even deign to thank us for the yachts we'll be buying for them.
The plan could work but its problematic at best and it focuses on helping the wrong people - institutional investors rather than ordinary citizens.
It's inevitable that if anyone makes money at this, they're going to be politically well connected and we're going to have to discuss some uncomfortable relationships among members of the Obama administration. For example, Larry Summers was a partner at hedge fund giant DE Shaw Group and so we have to ask ourselves whether or not it's appropriate for Shaw funds to participate in this.
The beauty of the Geithner plan is that if the private interests win, the Treasury wins too. But the public only wins in the abstract. At best, if you're covered by a pension fund that participates you get some benefit. But if this is really a great deal for private investors, shouldn't there be some sort of mutual fund set up so that smaller investors can participate directly? Heck, if this is really going to work, maybe the government should agree to use positive returns to pay out a dividend to every citizen?
It's stunning to me that in the wake of AIG I'm now being asked to help well connected hedge funds get a good deal on mortgage backed securities. I'm also concerned that if these mortgage backeds really do represent some reasonable future return that the hedge funds would have bought them already or will eventually buy them without public financing and guarantees against losses.
We are, yet again, subsidizing private sector profits with little regard for the public interest. It's going to be interesting following the money on this one. My guess is that some funds will make a lot of money while the public will do okay. A few well connected hedge fund managers and financiers will get a lot more out of this than the rest of us will and they will never even deign to thank us for the yachts we'll be buying for them.
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Between you and Krugman and the fact that it's Monday, I feel like going back to bed for say, 5 years?
But seriously, thanks, I think you've got about the best handle on this stuff as any I've seen.
March 23, 2009 8:38 AM | Reply | Permalink
Oh, and I like the new duds, matches my mood.
=D
March 23, 2009 8:40 AM | Reply | Permalink
Back to bed? I don't want to get up.
March 23, 2009 11:56 AM | Reply | Permalink
I go back to bed almost every morning these days. I find that reading in bed immediately after I get up in the morning has my mind the most active.
I read Krugman and others that way and am reading Kevin Phillips that way.
I do get up later and put the book down until I use it as bedtime reading, but I usually fall asleep after one paragraph so all the progress is on the AM side!
March 23, 2009 9:55 PM | Reply | Permalink
eds.
Shut UP!
=D
March 23, 2009 11:07 PM | Reply | Permalink
mmmph!!?
March 24, 2009 3:10 PM | Reply | Permalink
"The beauty of the Geithner plan is that if the private interests win, the Treasury wins too. But the public only wins in the abstract."
How can you decouple the public from the treasury? The treasury is taxpayer funded, so if they win, we win too. The treasury is putting up a bulk of the equity, so the treasury will make more money than the private investor, if the value of the assets go up.
I think your idea of a dividend payment to the taxpayer is interesting but given the deficits and energy/healthcare/education priorities, maybe that's not the most prudent use of the money.
March 23, 2009 11:03 AM | Reply | Permalink
Yeah the Treasury represents the public but what I'm getting at is the story that you're inevitably going to read 3-5 years from now. It'll go like this:
"Hedge Fund Manager X made $30 million last year on distressed mortgage debt that he purchased with government assistance. X was able to get in on the deal because he was Harvard roommates with Larry Summers and..."
Some folks are really going to make a bundle here and we're also insuring our private partners against at least some losses.
Beyond that, if these assets are really going to generate a profit if bought at or near their current prices then why in the heck do we have to subsidize the purchases?
March 23, 2009 11:25 AM | Reply | Permalink
Well of course some people are going to make a bundle on this, no doubt the same damned criminals that got us into it in the first place.
March 23, 2009 12:19 PM | Reply | Permalink
Yep!
March 23, 2009 6:11 PM | Reply | Permalink
I was kind of hoping we could lynch them instead. We could sell tickets. I think we'd raise money.
March 23, 2009 7:35 PM | Reply | Permalink
I hear you, but I don't necessarily think Geithner and Summers are insiders who care about Wall St more than they care about the public. There are a lot of reasons that I feel this way. Obama knows that if he doesn't fix the banking system then the economy will continue to be bad and the Dems will lose in 2010 and he'll be out in 2012. It's part of his legacy to fix the economy. I just can't see a scenario where Obama would prefer to do right by Wall Street before he'd do right by us.
Ultimately, if Joe the Hedgefundedooshbag makes $30mm in the next few years from this plan, that means it worked. It means that you and I are better off as American taxpayers and people who benefit from US economic stability/growth.
March 23, 2009 1:08 PM | Reply | Permalink
I think you're engaged in quite a bit of wishful thinking here. If the hedge fund guy makes $30 million that means it worked for him, not that it worked for the public at all. The government is going to get stuck with the most undesirable stuff on the menu and the private sector investors are going to take the items that are most likely to make money over time. If this plan works the public gets screwed. Also, there's no reason to believe that "fixing" the banking system in the manner that Geithner proposes is going to do anything other than pile debt onto the backs of taxpayers. We might as well just take out a massive loan and hand it straight to the wealthy managers who lost all that money to begin with and precipated the crisis. So you see, it's quite easy to see a scenario in which Obama does right by Wall Street and gives the shaft to the common people because that is precisely what is coming down from his Sec. of the Treasury.
March 23, 2009 6:11 PM | Reply | Permalink
First, the structure of the fund is that the gains/losses on the equity are shared equally between the private investor and the Treasury. If the private investor profits it means the investors' joint venture equity partner (taxpayer via the Treasury) profits.
Second, the buy-side private investors are not the main guys who caused this problem. They are culpable for creating excess CDS and MBS demand, but the finger-pointing should primarily be directed at the sell-side banks, the regulators, the front-line sub-prime loan sharks, irresponsible borrowers, and of course W.
March 23, 2009 6:56 PM | Reply | Permalink
But remember, the private investor doesn't have to put up all the capital because the government will subsidize their purchase with a non-recourse loan. That loan means that the private investor's total capital isn't at risk, only the portion they put up. If the securities drop in value the public eats the loss plus the loss of the loan that the investors will walk away from.
March 23, 2009 7:32 PM | Reply | Permalink
This is a smart and valid point however, I believe there are protections in place to limit or avoid this scenario:
1. For the more esoteric CMBS and RMBS securities, the leverage that the FDIC would provide is 1 - 1 (they'll consider 2 - 1 in individual cases)
2. For the more straightforward mortgage loans, the leverage can go as high as 6 - 1, but this is entirely subject to the FDIC's approval. The program requires that the loan pools are submitted to the FDIC for review. The FDIC can decide if they want to provide max 6 - 1 leverage, no leverage, or somewhere in between. They have great experience because they examined these types of loans during the Indy Mac conservatorship process. Sheila Bair has proven herself to be savvy and concerned about protecting the taxpayer.
3. PIMCO, Blackrock, and hopefully Buffet will be the private investment partners amongst others. They're not in the habit of making bad bets. Not everyone in the Wall St world is the same and these folks in particular largely avoided a lot of these garbage securities and systemic problems. They have excellent track records and are good risk managers. Bill Gross, the head of PIMCO believes it's possible for double digit returns for the private investors and the taxpayer.
March 23, 2009 8:02 PM | Reply | Permalink
This convulted setup is the sort of crap that got us in this mess to begin with. The only real quesiton is how bad are the common people going to get screwed by the Paulson/Geithner plan? And how does the President square his Republican proposal for bailing out Wall Street with the rest of his agenda? It's a basic contradiction and a bad setup for Obama and for the country.
March 23, 2009 11:30 PM | Reply | Permalink
The corruption's already begun.
Citibank's selling its REO (foreclosed properties) at fire sale prices just to get it off the balance sheet and using the $235.4 billion guarantee Bernanke and Paulson gave it to transfer the losses to the taxpayers.
March 23, 2009 1:14 PM | Reply | Permalink
Corruption seems to be the only thing I can reliably count on in this entire mess. Is there a way I can invest in an corruption index fund?
March 23, 2009 7:38 PM | Reply | Permalink
That's more a demonstration of incompetence than one of corruption.
March 23, 2009 8:09 PM | Reply | Permalink
That's exactly what it's supposed to look like.
NOT!
March 23, 2009 8:13 PM | Reply | Permalink
Corruption and incompetence go hand in hand.
March 23, 2009 11:32 PM | Reply | Permalink
How do loan guarantees turn into sales subsidies?
Is that what the loan guarantee was meant for in the first place?
March 23, 2009 10:09 PM | Reply | Permalink
The late November guarantee of $304 billion of Citigroup toxic assets seems (does anyone know for sure) to include losses on its REO portfolio.
Note: Citigroup is responsible for $29 billion of these losses, but with its recent financial performance, we can assume that obligation was met months ago -- that is, it's all gravy from here on out.
March 24, 2009 12:21 AM | Reply | Permalink
Non-responsive. Typical.
March 24, 2009 1:57 AM | Reply | Permalink
Everybody keeps talking about this as though it's money taken out of our pockets. It isn't; it's money that will be borrowed, generating a debt, and will be payed back to that debt (probably not covering all of it). This is why it would be best if we were using this kind of money to make bad mortgages good, as this will actually cure people's problems as well as the mortgage industry's problems. Several things are probably going unsaid, that the mortgage industry is really screwed up, between lending when they shouldn't (talking people into more mortgage than they could afford), lending a kind of loan that shouldn't have been allowed to exist (interest only, "walk away/rent" loans, that encourage defaults and inflate home prices artificially) and that the toxic investment industry is probably well over its head, and if it were to declare truthfully its status, they'd be bankrupt.
March 23, 2009 11:17 AM | Reply | Permalink
It was just reported that the market is up and it is being attributed to the Geithner plan. (Right now Dow is up almost $284.)
March 23, 2009 1:57 PM | Reply | Permalink
October 13, 2008: Dow gains 936.42, or 11 percent, to close at 9,387.61. Investors cheer "global cash infusion designed to unthaw the credit market and avoid a global meltdown."
So much for listening to the market. Just noise.
March 23, 2009 2:24 PM | Reply | Permalink
Destor, I don't understand the beauty of this plan at all.
This plan is basically to provide loans of 95% for these firms to buy these toxic assets. To the tune of $1 trillion.
Krugman says that if they are able to drive up the prices of these assets, these partnerships pay back the loan and pocket any profit. Taxpayers get the loan money back. No bonus or exec pay strings attached.
If they cannot sell anything at a profit, the firms walk away and taxpayers write it off as a loss.
The original Paulson plan was for the government to buy these assets in total and then attempt to sell them at a profit, so any upside would go to taxpayers in full.
What am I missing?
March 23, 2009 2:58 PM | Reply | Permalink
You're not missing anything. The plan is just worse than I thought when I blogged on it this morning.
March 23, 2009 3:04 PM | Reply | Permalink
WSJ now says it's $100 billion (not $1 trillion) if it makes any difference
March 23, 2009 3:19 PM | Reply | Permalink
I thought it was $500 billion now and up top $1 trillion.
You know, until we get to $5 trillion I don't even start counting anymore.
March 23, 2009 3:40 PM | Reply | Permalink
A trillion here, a trillion there.
March 23, 2009 8:16 PM | Reply | Permalink
How do you get the loan money back? That goes to the "bank". It's gone. It's a gift, not a Trojan Horse.
Look at the big picture. Any single slice can be spun any which way.
March 23, 2009 10:17 PM | Reply | Permalink
Any plan that is founded upon rewarding people who have thoroughly screwed up is a problem. This is a lesson in the power of money. May as well just sign over our paychecks. That's what this amounts to.
March 23, 2009 4:49 PM | Reply | Permalink
Its not going to help the economy, it will likely sink it even faster, transtitioning into stagflation as the dollar starts dropping again. Your mortgage may cost less, if you have one, but everything else will start going up in price again.
The Geithner plan will just sink hundreds of billions, or trillions due to the leverage, of US dollars and debt to keep a bloated banking system alive a while longer, while it aims to protect bank bond and stock investors.
Our economy cannot support and doesn't need all the banks or all the loans, CDO's, super CDO's, swaps, and banking con artists we had during the recent bubbles.
March 23, 2009 6:53 PM | Reply | Permalink
It is more financialization trying to save failed financialization.
It is a gift from Geithner to the investor class, which will allow the investor class to buy assets from itself. Read down the page ... http://tpmcafe.talkingpointsmemo.com/talk/blogs/eds/2009/03/re-tpm-headline-geithners-last.php
In a way there is some justice to this. The investor class got ripped pretty bad so this is their chance to get some back. But it's being sold by lies and it ignores the human beings who, greedily or not, got caught up in high finance manipulations. Dodd is lying about it, and it looks to me like Obama now is too (but I'm not sure yet).
So that puts me in the same mood and affect as Krugman, if for different reasons.
March 23, 2009 10:15 PM | Reply | Permalink
One can't help but feel that the complexity of the plan is precisely it's point: it's opaque enough so that it's essential similarities to completely discredited TARP ideas are disguised. But the unavoidable truth is that the public is shouldering the lion's share of the risk: they're taking the toxic assets off the balance sheets of insolvent institutions whose shareholders and bondholders should have been wiped out. The 'public-private' partnership is a joke; before we get to the part where we're partners, taxpayers are being forced to provide a back-stop representing 85% of the downside risk. And who will 'manage' these assets? Not the Treasury, but Wall Street. And who will get a fee for doing that? Not the Treasury, but the hedge funds and private equity firms that are lining up to cash in on this nearly-free ride levered up to the sky by the largesse of the administration. We're not partners in this plan; we're chumps.
In lieu of facing down the big banks, the administration has crafted a plan of enormous political cowardice--hiding behind a mask of buzzwords like 'partnership', 'legacy assets' and 'home affordability'. Those are the tactics we rightly decried from the last bunch. For all the good Obama may do in other domains, at this rate, he will more than undo it in the economic realm.
Sorry, but I voted and worked for him, too!
March 23, 2009 10:44 PM | Reply | Permalink
Would you be less unhappy if the backstop were 50% instead of 85%? Then investors would have to put up 25% of purchase price.
The thing is, this presumes that banks will be selling assets. Just providing a market for an asset doesn't necessarily drive up the price. That's simplistic thinking, not even good Econ 101.
The supply could still exceed the demand for any rational setup. That is, unless you basically overpay for an asset, you don't drive the price up.
I get the impression that Geithner has two key faults here: He's 1) either thinking naively or failing to explain/develop the advanced nuances of his thinking well, and 2) still thinking as if he were working for the Fed (Federal Reserve) instead of for the Feds (Treasury). I don't know if anyone else has said #2, but when I thought of it, it rang true. What do you think?
Okay, fault #3 like #1: He's not telling us why this is the only or best plan, that is, how has he ruled out other ideas and which ideas has he considered how well?
March 24, 2009 1:50 AM | Reply | Permalink