Monday, March 23, 2009

Geithner's part plan

Henry Blodget has noted that I do not think that the Geithner plan is a bad idea.

That is I do not think it is a bad idea to lend money to hedge funds at low rates to buy dodgy bank assets.

I do not love the idea.  I just think it is better than any of the alternatives.  I do require a good level of private capital before I am happy with it.

Henry Blodget publishes an objection to my plan which I quote:

Hempton's point is well taken.  As he comments to one of his readers, "If I set up a new bank and borrow with brokered deposits I can lever 12 times non-recourse. If I win I keep the profit. If I lose the FDIC pays the losses. ... Geithner lends the money to the special purpose fund. Not against the pool of purchased assets - but with private capital pitched in. Sounds like banking to me."  So Hempton objects to what he sees as Krugman's inconsistency.

But Hempton's analogy isn't quite right.  Krugman wants big banks nationalized, giving taxpayers the equity upside.  The Geithner plan is at best an inefficient way of bolstering bank capital because some of the taxpayer funds go not to bank capital, but to bank shareholders and hedge funds.

However, Henry Blodget’s objector – and most other people are forgetting the second part of my plan – detailed in the long post and elsewhwere on this blog.

I want the regulators to come into the banks and say – now you have a ready – if somewhat subsidized market for your assets then it is no longer tenable for you to say that the market price for them is unrealistic.

This asset that you have marked at 95% of par.  We want you to sell some of it (or a part interest in it or similar.)  If you get 75% of par – then we want you to mark your book to 75.  

If – given a real market for bank assets – you are shown to be capital inadequate then you should have time (say 6 weeks) to raise private capital.  Failing that your bank becomes government property.

The objection detailed in the Blodget post is still right – which is that this plan is better for shareholders than outright nationalisation of banks without a process to determine who is capital adequate. 

Nationalisation without process – which appears to be the alternative – is a dagger to the heart of capitalism.  

Tell me a process that will have banks and regulators with adequate external parties indisputably saying to bank management “this asset should be marked at 75 and you have it marked 95” then I will listen.  Until then the objectors to the Geithner Plan are left saying “nationalise now”, but without an answer to the nasty question of which banks to nationalise.  And do not say the stress tests are adequate - because they are a joke.

It is of course open for the Federal Government to follow a process that will scare liquidity away from the banking sector and result in everything being nationalised.  So far that is the only real alternative I see to a more complete version of the Geithner plan.  It is of course also open for the Government to guarantee everything and get no upside – but that is a really bad non-plan.


John

15 comments:

Oregon Guy said...

The main reason for opposition to the (unofficial) Geithner plan is the complete lack of public trust in banks, hedge funds, Geithner, and the U.S. Government in general.

Pre-release leaks on the plan speak of up to 97% taxpayer capital against 3% private for buying bank assets. If true, will the Geithner plan prevent hedge funds and banks from cutting side deals where the banks pay the hedge funds fees in excess of the 3% private capital at risk for bidding at above market prices? There are many such scenarios being discussed in the blog-o-sphere, all involving some degree of collusion on the part of the banks and private investors to cheat the public side of the trade.

When it comes to trading profits, is it unreasonable to conclude that bad behavior must be defined in advance, monitored for, and rigorously punished to keep the trade clean? Will Geithner's plan do this, or will there be a "free-market" free-for-all that enriches the banks and hedge funds at the expense of the taxpayer? The U.S. Government regulatory bodies have not earned much confidence for protecting public stakeholders.

When banking execs and hedge fund managers are characterized as psychopathic rentiers that care only for wealth, no matter how ill-gotten, no toxic asset purchase plan is going to be met with acclaim. And what have bankers, hedge fund managers, and Government officials done to dispel this belief? Sadly, the answer is nothing much.

What Geithner really needs is a better PR department.

P.S. - congratulations on the lifesaving.

babar ganesh said...

So for you, the value of this is not in clearing toxic assets off of bank balance sheets -- the value is that it is a way of creating a price discovery mechanism?

it seems like this is a very expensive way of doing that.

MB said...

http://informationclearinghouse.info/article22146.htm

There's some interesting stuff coming to light about how exactly things got to this point.

If the political process that lies behind the regulatory/central bank process does not have legitimacy, it's very unlikely any bank fix proposal will.

This feels much more like a political rather than economic crisis at this stage.

AIG bonus pool=9/11 media coverage for a week seems to be a proxy for a very large backlash against a very tangible sense of dishonesty among both government and financial market participants.

It could be said that Jim Cramer is representing the whole Investment bank/Central bank/regulator relationship in this clip - http://www.thedailyshow.com/index.jhtml.

Clearly QE/TALF is about not owning up to the losses and trying to find a way around opening up what's gone wrong here.

John Hempton said...

As long as enough private equity is required it is a very cheap way to provide market clarity.

The banks are already de-facto guaranteed by government. That is what "no more Lehmans" means. It means the government will wear it.

It is hard to build a model with

(a) 15-20% private capital which buys half a trillion to a trillion dollars in assets from the banks and

(b) where the regulator or a lottery process has chosen the assets and

(c) where the banks are guaranteed anyway in which

this costs the taxpayer any more money than the guarantee alone would.

J

Andy said...

The Geithner plan does not provide a pricing mechanism. Any price determined by it will be way higher than the actual value of the toxic assets, since the plan removes downside risk and provides the capital to lever the investment at little cost to the private parties. What a deal!

What this plan actually does is expand the bailout from just banks to hedge funds and other private parties that want to get some of the taxpayers money.

I think you're looking at this from the perspective of a potential hedge fund operator looking to score big at US taxpayers expense, instead of from the perspective of the US taxpayer.

Krugman and Simon Johnson are right this is a scam, the primary purpose of which is to cover the asses of Geithner and his cohorts. They don't have the balls to go in and restructure the banks without first playing footsie with their buddies at Goldman Sachs. I suspect this is really the GS plan, not the Geithner plan. And it could be Obama's Katrina.

John Hempton said...

Andy

If the Government charges Treasuries plus 2% for the funding AND requires only six times leverage do you still believe what you just wrote?

How about Treasuries plus 4% and 4 times leverage...

Seriously - its about the numbers rather than an absolute statement.

The inability to deal with numbers frustrates the hell out of me.

J

Talitha Halostar said...

Tiny Tim Geithner and Helicopter Ben Bernanke are going to ruin this country. They both need to GO!

http://fargoneworld.blogspot.com

babar ganesh said...

> Any price determined by it will be way higher than the actual value of the toxic assets, since the plan removes downside risk and provides the capital to lever the investment at little cost to the private parties.

If you wanted, you could adjust the valuation numbers on the raw CDO down a bit to take into account the fact that the govt stripped off a put. I don't know if they are going to do that, and they probably won't, but you could.

MB said...

The US banks are not de facto guaranteed. It's Congress, not the White House or Fed that signs the checks and right now they are saying that they aren't going to sign too many more. Bernanke and Geithner can't spend money without Congress ok.

There's a basic problem here that the legislature needs to fix this problem with cash - but they can't move forward and do this as long as everyone feels - not without some considerable justification - that the money is not going into the hands of looters.

There is no point thinking of a technocratic solution to a problem this big until there is a political one.

Bernanke and Geithner are writing checks they can't cash - that's why China is selling Fannie Mae debt into Treasuries and the Dollar is falling.

Anonymous said...

this is all very amusing. think about it.

on the one hand, you have banks claiming their assets are accurately accounted for.

on the other, you have treasury trying to create a market for bank assets.

but hang on.

banks don't need to sell if their assets are marked at the right level.

and prospective buyers won't want to buy it if they are marked too high.

the government, the de facto owner of the banks, can't force the banks to account for their loans and securities properly (or it means nationalization).

impasse, baby.

what do you do?

enter leverage.

no, you have to give away leverage.

that's the only way to persuade private buyers to buy overpriced assets.

I doubt many will...even if it's cheap.

remember that funds still have to mark their assets for their investors (even if the government as lender won't hit them with margin calls).

(hey, isn't it bizarre that post-madoff the govt won't demand marking by hedge funds it lends to...)

but to get the plan to work, the government will weaken terms and weaken terms, like it did with the TALF.

krugman is right again.

PS: to see you refer to our banking system today as capitalist damages the intellectual credibility of an otherwise great blog.

John Hempton said...

I hate to say it but Sheila Bair is the key player here.

MB said

"The US banks are not de facto guaranteed. It's Congress, not the White House or Fed that signs the checks and right now they are saying that they aren't going to sign too many more. Bernanke and Geithner can't spend money without Congress ok.

There's a basic problem here that the legislature needs to fix this problem with cash - but they can't move forward and do this as long as everyone feels - not without some considerable justification - that the money is not going into the hands of looters."

==

The problem with this is that Sheila Bair has powers to deal with systematic crises - provided

(a) the Secretary of the Treasury
(b) the head of the Reserve and
(c) the President

sign up.

She can issue a trillion dollars in guarantees without congressional approval.

If you think this is going to congress you haven't read the FDIC's legislation.

J

septizoniom2 said...

john: re two of your responses:

1. based on the leaked reports, what is your view of the "fairness" of the plan?

2. re fdic: i agree re current law, but considering the populist rage environment, have you evaluated wheher such move by bair would spark congress to supersed the curent law by new law?

Anonymous said...

John,

Thanks for the great blog. You wrote:

"If the Government charges Treasuries plus 2% for the funding AND requires only six times leverage do you still believe what you just wrote?

How about Treasuries plus 4% and 4 times leverage...

Seriously - its about the numbers rather than an absolute statement.

The inability to deal with numbers frustrates the hell out of me."

The terms of the original AIG bailout were fairly onerous. These terms were successively relaxed in each of the following iterations as the gov't continued to inject more capital. The terms of the TALF have been relaxed.

On what basis should we believe that the Geithner terms will not be relaxed at a future date? How can it be about numbers, when it can be absolutely said that to date the Fed and the Treasury are not protecting the taxpayers' interest?

Anonymous said...

After much thought, I think this is a good plan.

Private Funds are in a first loss position, so they will not overbid (as the govt would probably do if it were to create the market for these legacy assets).

Banks probably won't like the Bid but they will have to take it, unless they have enough capital withstand the charge that they will be taking when they write the assets down. Otherwise they write them down and fail.

I think this is the first step to end this Mexican Standoff.

I'd love to know if Tim thinks this outcome of this is going to be to create a market and get this stuff trading, or if it's going to be to force a bunch of banks into receivership.

tc125231 said...

You know, Mr. Hempton, I deal with numbers for a living. However, your objection to nationalization without this expensive subsidy plan is that it is "a dagger to the ehart of capitalism."

Really quantitative. I am, like, totally convinced by ypur transparent logic.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.