Treasury put out a white paper on the new bailout plan, the Public-Private Investment Program. Wall Street just loves it: the market shot up 500 points. CNN quotes Jack Ablin, described as the chief investment officer at Harris Private Bank:
He said the stock market is also reacting well because the plan is skewed in favor of the private investor, who only has to be responsible for around 7% of the total in any transaction.
That’s a great reason for investors to cheer. Taxpayers might wonder why we are sharing the rewards when government is putting up almost all the money. It should be obvious that the first step is to evaluate the individual mortgages which make up the pools of mortgages. It isn’t rocket science, it’s a bureaucratic problem. If we do this, we can use software to evaluate the pools. Then we know what they are worth.
Under the PPIP, banks state which pools they want to sell.
In order to protect taxpayer dollars from credit losses, the FDIC will employ contractors to analyze the pools and will determine the level of debt to be issued by the PPIF that it is willing to guarantee. This will not exceed a 6-to-1 debt-to-equity ratio.
The FDIC will auction off the pool. Private investors will bid for the right to contribute 50% of the equity for a Public-Private Investment Fund, a new entity for each pool. The winning bid is offered to the bank, take it or leave it.
Suppose the debt-equity ratio is 6 to 1, and the bid is $84. The PPIF issues $72 in debt, which the FDIC guarantees, and the equity, the remaining $12, is paid half by the private investors and half by the government. The $84 goes to the bank, if it wants to accept it. Then the assets will be managed by the private investor, under the “strict oversight” of the FDIC.
What does Wall Street bring to the party that justifies enormous returns? Treasury offers an explanation. It says that the problem began with the bursting of the housing bubble, which generated losses for investors who had used a lot of leverage to buy this stuff. As prices fell, investors dropped out of the market, which reduced liquidity. Credit markets dried up, so investors didn’t have as much money to buy. Treasury believes that this is the cause of the very low prices: lack of liquidity has a negative impact on prices.
Here’s the explanation for the value of private investors:
This program should facilitate price discovery and should help, over time, to reduce the excessive liquidity discounts embedded in current legacy asset prices. This in turn should free up capital and allow U.S. financial institutions to engage in new credit formation. Furthermore, enhanced clarity about the value of legacy assets should increase investor confidence and enhance the ability of financial institutions to raise new capital from private investors.
It can’t be the price discovery itself, because that is based on the information collected and paid for by the FDIC. Treasury could do these calculations of value. No, it is that making more credit available removes what Treasury says is excessive discounts in prices because of lack of liquidity. The Wall Street Journal explains it this way:
Mr. Geithner is making a central bet: that subsidies will encourage private investors to bid up the price of these assets and narrow the gap between what the banks think the assets are worth and what investors are willing to pay.
They are saying that private investors will get a lot of non-recourse leverage from the FDIC guarantee. They bid higher than they otherwise would because, thanks to the leverage, their returns will be greater. Again, the availability of credit drives up prices. Krugman offers a numerical example of how this works.
No wonder Wall Street is rejoicing. About all I can see for Treasury is fig leaf of coverage for the prices it pays for toxic waste.
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If the FDIC doesn’t have enough staff to properly do ’stress testing’ (and BTW, what is occurring with that Geithner ‘action’?) how can it do ’strict oversight’?
It’s a complete ripoff and Obama is standing behind it(as is McCain);anyone still feel represented in the government?
“Anyone still feel represented in the government?” No!
This has been another episode of simple answers…
OT: Prime Minister Benyamin Netanyahu got the votes of the Israeli Labour Party enabling him to form a government with nearly 70 seats in the Knesset.
Does that lock out that Russian thug (can’t remember his name) on the Israeli loony right?
Yes, but will the Labour Party split is the next question.
Back to topic; in today’s hearing Kanjorski said “Large reason for reaction last week from American people is because they’re not well-informed.”
Yeah, we’re all dunderheads. I’ll go against Kanjorski all day ,any day about who is ‘informed’. He’s a herniated rectum.
We have already heard how funds could buy swaps betting against their deal and make a profit even if the government lost its whole investment.
I saw a link at Naked Capitalism that offers another scheme:
http://interfluidity.powerblog…..7649.shtml
Pension funds are big into hedge funds but also into bonds. They could encourage a hedge fund to take a losing bet on a bank and even pay more than face value on some of this trash. Why? The hedge fund would lose a little. The bank would gain a lot and the government would lose a lot. As a result, the pension fund would lose a little on its hedge fund investment but make out like a bandit protecting its bonds.
In the example in the post, the pension fund could lose $10 billion with the hedge fund investment but have effectively protected a $100 billion in bank bonds. The point here is that Geithner’s plan is being put forward as if it were simple and one dimensional. The truth is however it occurs in a system that is built to game everything, and let’s face it even Geithner is trying to game us with his plan. This has nothing to do with price discovery. Such discovery is bogus if the mechanism that produces it is rigged. Geithner wants to funnel government money to banks to ease their insolvency. He thinks this will cause them to lend more. It won’t but being wrong is something Geithner is good at.
So how exactly is this supposed to help real people? Housing prices going up is bad for those of us who make less than $10 million a year.
Political opportunism and fascism are the two dominant characteristics of recent Israeli politics.
What is Wall Street bringing to the party? A fleet of dump trucks to pick up all the cash, of course.
What in the world ever gave you the idea that this was about helping real people?
No, it’s basically Labour, Friedman’s National Unity and Likud with a smaller number of religious parties..
As I understand it, “stress testing” has morphed from “In case things go badly, will you fail?” to “How much money will you be needing the USG to give you now so you won’t fail a little later on when things go badly, as we fully expect them to do? Also, is your chair comfortable, and can I get you something to drink?”.
the same thing the telcos and the MIC do: massive campaign contributions, revolving door fortunes for insiders and a commitment to a foreign policy stuck in the cold war.
It’s never been about helping people in the real economy. It’s about distorting the relationship between risk and the yield to maturity for capital investment.
One part of the equation is leverage. The other part is capitalization rate on the total asset value. The point at which leverage & cap rate far exceed more modest rates available in the economy of producing goods and services — i.e. creating real wealth — capital abandons the real economy for short term arbitrage profits in the financial economy. This spells the end of capital formation, investing in businesses that generate cashflow with healthy balance sheets. Why bother when faster, more lucrative profits can be gamed from manipulating securities & derivatives?
When these elements are added to Paulson’s zombie bank plan of privatizing profits and socializing losses, it is the worst of all three worlds for Main Street.
Amy Goodman’s interview with Thomas Geoghegan today described the effects of runaway interest rates on the real economy. His article in Harpers is here.
Absolutely, bang-on!
A brief explanation of the debt-equity ratio as it relates to the example, which is the example provided in the White Paper. If the ratio is 6 to 1, the the total capitalization is 6 debt plus 1 equity for a total of 7. Dividing the purchase price of $84 by 7, we get $12, which is the equity portion, and the debt portion is 6 times $12 = $72. The total is the purchase price of $84.
That is a really good explanation.
Yes why invest in the “Goods & Services” (aka: Job) economy to get a 10% return, when the money can make 20% or more in the financial economy.
“capital abandons the real economy for series of short term arbitrage profits in the financial economy.”
Fixed.
Where’s the FDIC going to get $1 Trillion or so?
RE: “Does that lock out that Russian thug (can’t remember his name) on the Israeli loony right?”
ANSWER: NO. Avigdor Lieberman will be the Foreign Minister and his far right Yisrael Beitenu Party will be part of the governing coalition.
Sorry about the Harper’s link in #14, it’s available by subscription only.
However, the transcript of Amy’s interview is up.
Why does the phrase “Taxation WITH MISrepresentation” continue to echo in my ear?
WTH is this dichotomy between “investors” and “taxpayers” which is talked about as though the two were disjoint sets? Do I get a chance to “invest” by buying a house on the cheap? Where do I go to invest? Can I lay down money to bet that a hundred families on “the wrong side of town” will lose their homes this year? Why does everything — and I mean everything — about this smell wrong?
If the rates of return were only off by 100%. but they’re not.
When a $100 million portfolio of mortgages paying 6% is pledged on a 1 to 20 derivative CDS, profits are generated against a $2 billion risk position. These ROI’s are obscene even before factoring in socialized losses to keep a perversely broken system afloat.
The neo-Paulson plan is pouring high leveraged gasoline on embers while pretending that the forest hasn’t already burned down. Adding insult to arson, the government is protecting the criminals who crashed the derivative & debt markets to extinction, absent massive Treasury & Fed intervention.
Speaking of fig leaves,did anyone hear any questions about future offshoring of taxes by bailed out corporations?
Perhaps I missed it in this and previous hearings,but shouldn’t the bailees,i.e.,bailed out companies, not be allowed to avoid paying future taxes to the US by using offshore accounts?
What about AIG,Goldman Sachs?
Billions upon billions are robbed from the US taxpayers each year.
Here’s an excerpt from last summer,before the heist,in NYT:________________
A One-Time Tax Break Saved 843 U.S. Corporations $265 Billion
LYNNLEY BROWNING
Published: June 24, 2008
More than 840 of the largest American corporations reaped a $265 billion windfall thanks to a one-time tax break aimed at bringing home profits stashed overseas, according to recent government data.
Windfalls: The windfall resulted from a temporary tax deduction for big corporations, which were keeping billions of dollars in profits in overseas subsidiaries and out of the hands of the Internal Revenue Service.
American companies can typically defer paying taxes on foreign profits as long as they keep that money outside the United States. When companies bring the money back, they usually pay the top corporate tax rate of 35 percent.
In recent years, the biggest and wealthiest companies in the United States have increasingly set up foreign subsidiaries and used them either as foreign operations or offshore repositories.
The subsidiaries, many in offshore tax havens like the Netherlands, Ireland and the Cayman Islands, collectively held about $804 billion in foreign profits on which their American corporate parents had yet to pay any United States taxes, according to the I.R.S.
A one-time tax holiday enacted by Congress in 2004 offered companies the chance to bring that money back at a reduced tax rate of 5.25 percent.
In all, 843 corporations took advantage of the offer, according to recent I.R.S. statistics of income data, bringing back $362 billion in foreign profits, paid to the parent corporations as dividends. Of that amount, $312 billion qualified for the tax break, giving those companies total tax deductions of $265 billion claimed from 2004 through 2006.
Put another way, the tax break gave each company claiming it an average $370 million in tax deductions.
But the tax break would not produce income for the I.R.S. in later years in part because of associated foreign tax credit provisions set to kick in later, and in part because of the need to replenish capital in foreign subsidiaries.
.
Private-sector estimates from Wall Street investment banks, including Bank of America and JPMorgan Chase, were closer to the mark…
[MOD note: please do not quote long segments of articles for copyright reasons and to keep the servers running smoothly, thank you]
Thanks for the heads up!
With all due respect I don’t think there is any mystery about Ben’s announcement that they were firing up the printing press. The words were meant to get a bid under any paper he could. Bonds of all types, stocks, baseball cards, anything. Get something to inflate because when something is inflating that’s confidence in his mind, and it is good.
That’s what Fed words have been aimed at since October 1987. Words words words and more words to get financial assets to inflate has been the functional role of the Fed since Greenspan at 9AM on black Monday 87.
Words alone are not enough however. Under Greenspan the Open Market Operations desk routinely did repos in significant size on the days of Greenspan’s words. It is under appreciated how these cash infusions to the primary dealers were a like a snort of coke to the markets. They cash immediately put to work at the trading desks of PD’s, especially the Investment Banks.
For poor Ben it has gotten a bit more complicated. As the alphabet soup of special programs and funds has grown open market operations have shrunk to total insignificance in implementing Fed policy. If you can call the relentless growth of the Feds System Open Market Account at a 4% rate year after year after year a policy, except when it jumped to 7% sometimes. Which all collapsed in Jan 08 as the banks didn’t want the Feds cash and the SOMA collapsed, followed by the market.
So Ben needs a way to mainline cash into the financial players hands so they can go play and inflate asset prices. To wit buying every kind of paper, including I think baseball trading cards of obscure failures nobody ever heard of, so he can get something to inflate. It’s all pretty straight forward really.
Stiglitz, Krugman & Roubini are pointing to something that none of them can say outright, even after midnight on Charlie Rose:
The assumption underlying Fed & Treasury’s “too big to fail” policy (trillions dumped into the financial system since mid-2007 when the great unraveling became apparent) is that the full faith and credit of the United States of America is too big to fail.
We are operating now at $3 billion per day deficit. It’s a question of when, not if, treasury auctions will fail. The worst sign of this phenomenon is last week’s announcement that the Fed would be buying billions of long term treasuries to force down mortgage interest rates.
You and what printing press, Mr. Bernanke?
I’m sure we’ll see this inconvenient truth in tonight’s Frontline program
Ten Trillion and Counting.
P.S. Oh oh, looks like someone’s finally standing up to Goldman Sachs’ hostile take over of our federal government. Go, Bernie!
RE: “that Russian thug (can’t remember his name) on the Israeli loony right”
SEE: “Umm al-Fahm violence is a sign of things to come in Lieberman’s Israel”
AT – http://www.philipweiss.org/mon…..srael.html
RE failed auctions
In addition to my screed about the printing press.
The Feds printing for the express purpose of purchasing Treasury paper is essentially a proclamation that there will be no failed auctions. So when this trillion is gone you can count on another trillion on the way. Unless we have a miracle of course.
Taking the big ledger book picture, the Fed is now the lender of last resort and the Treasury is the borrower of last resort.
Thanks for your post, masaccio — All of this has been eating at me for the past four years since I first read Nouriel Roubini. I’m glad to see some light shining on the vermin, finally.
They can pretend all they want that the bank asset purchase plan is private. Huge portions of citizens, expert and non expert alike, know different.
The damage to the political system is going to be stupendous. Like the USSR where for years and years everyone just pretended the system was functioning. Geithner thus becomes like a high ranking member of the Polit Bureau.
God knows I could be wrong but the way I see it the Administration is making one of the biggest political blunders in American history. Every other good thing they do is almost irrelevant.
You’ll know treasury auctions are failing when 1) interest rates move up significantly regardless of Fed funds peg, and 2) stock prices go through the roof on manufacturers of wheel barrows, torches and pitch forks.
And from the Department of Irony: Putting our economy at risk for a 21st century Weimar inflation debacle is no way to boost real estate values. It’s like winning the war on drugs by having the cartels reject dollars for euros, and thereby cutting down the flow of drugs into U.S.
Tim Geithner would use “leaves of three” anywhere Rubin or Summers told him to. That gratuitous comment aside, Mr. Geithner’s plan is a kind of theater of the absurd. Liquidity seems an unlikely reason for the “decline in value” of trillions of dollars in MBS’s.
Their values have declined because the underlying mortgages are bad. They were intentionally marketed to those with bad, or insufficient credit; to those not asked to establish their creditworthiness to start with; and to those millions whose credit is now bad because they’ve lost their jobs, their credit card rates have jumped to thirty percent and they can’t pay their bills, they can’t find another job, they can’t get health care, and they can’t file bankruptcy because the rules put repaying their CC debt ahead of almost every other kind, including child support.
Mr. Geithner is using billion dollar make-up to make his pig attractive. Tomorrow he’ll take it to Kitty Hawk and tell us he saw it fly. The drop in the “value” of MBS’s is appropriate. Hundreds of banks are technically insolvent because of it, just as the assets of hundreds of pension funds are lower because they hold stock in the offending institutions or the MBS’s themselves. Addressing those problems, as ugly as they are, would be less expensive, put the public, not private parties in the driver’s seat, and actually fix what needs fixing. It would quickly restore modified confidence; more confidence building still would be to put in place a credible regulatory framework that made it harder to blow up this bubble again.
Geithner, and hence, Obama’s plan, is built around keeping their heads in the sand. They forget the part of their anatomy that leaves most prominent. The Republicans, like the banks, may take the money and run. They will still paint a huge, “Kick Me” sign on the presidential rump and take their own advice.
RE: “Does that lock out that Russian thug (can’t remember his name) on the Israeli loony right?”
ANSWER: NO. FROM TODAY’S “GUARDIAN” (U.K.): “The decision gives Netanyahu the comfort of a government with a broader base. He will lead a coalition drawn from across the political spectrum, embracing in an unlikely partnership both Avigdor Lieberman, an outspoken far-right politician, and now Barak, head of the traditionally left-of-centre and social welfare-oriented Labour party.”
ARTICLE – http://www.guardian.co.uk/worl…..-netanyahu
Look for Obama to announce his proposal to congress for repealing the law of gravity. Once passed, his signing statement will add illiquidity as a synonym for the word insolvency. Then watch the stock market really take off.