Gaming the Geithner plan?

by on March 23, 2009 at 9:43 pm in Economics | Permalink

Yes it can be done and here is how:

Let's say that I am a bank ("financial institution") with
$100 billion in "toxic assets".  I have them on my balance sheet at 80
cents on the dollar.  The market has them marked at 30 cents.  We do
not know what the held-to-maturity performance will be, since that
requires knowing the future, although for the moment let's assume that
they are cash-flowing at the present time.

What I (the bank) do know, however, is that if I sell them
at 30 cents I take a monstrous loss – perhaps enough to force me under
Tier Capital limits and thus render me subject to an FDIC enforcement
action.  I therefore will not sell for 30 cents so long as I have any
belief whatsoever that the cash flow – or any government subsidy – will
exceed that value.

If I, as a "financial institution" can participate as a
bidder in these auctions I can foist off my loss onto the taxpayer. 
Here is how I can rig the game so as to avoid an otherwise-inevitable

  • I become a "bidder" and "bid" on my own assets at 75 cents.
  • I am providing 5 or 10% of the money.  The rest is covered by Treasury, The Fed and the FDIC via guaranteed bond issuance.
  • The loan, ex my contribution, is non-recourse.  That is, I can lose 5 or 10% of the total portfolio purchased, but nothing more.

Now the "assets" (a passel of CDOs?) turn out to be worthless.  I
lose 5% of $75 billion, or $3.75 billion that I put up, plus the other
nickel on the original mark, but that's all. 

The taxpayer gets hosed for the remaining $71.25 billion dollars.

This can and will be done if the "sellers" of these
assets are allowed to bid either directly or indirectly as it provides
a means for banks to intentionally dump bad assets at a certain loss
that is much smaller than their expected realized loss over time, shifting the rest of the loss to the taxpayer.

This program has the potential to shift literally $500 billion or
more in losses onto the taxpayer, not through the operation of "bad
luck" but rather through what amounts to a bid rigging operation.

Fortunately that example is a pure hypothetical.  Is there a way to actually do this?

I thank DavidS, a loyal MR commentator, for the pointer.

1 anonymouse March 23, 2009 at 10:05 pm

in other words, if the plan succeeds, it will unlease another wave of hatred against the banks. it’s hard to imagine how nationalization could lead to more politicization of bank management and lending decisions than what we’re going to get.

2 ben March 23, 2009 at 10:15 pm

History provides all the evidence we need that folks will take advantage of the situation. By the time our regulators figure it out, the horse will be long gone out of the barn.

The example provided is very direct, so my belife is that the ultimate method of gaming will be much more oblique, but just as effective.

3 David Sucher March 23, 2009 at 10:29 pm

Doesn’t it all depend on the ability to ‘ “bid” on my own assets at 75 cents?”

So if we ensure that — at the very least — toxic banks etc can’t bid on their own portfolios, doesn’t that meliorate the issue? At least some?

Of course what interests me is how this all going to work since the very heart of the problem is that we don’t know the value of these assets. (“We do not know what the held-to-maturity performance will be.)

Maybe the new PPIFs will be bidding on blind pools? What due diligence will they be allowed? If none then it really is gambling.

4 Sean March 23, 2009 at 10:54 pm

Bill Siedman, former FDIC chairman and head of RTC, on CNBC’s Fast Money show indicated that there is about $1 trillion of toxic assets, of which banks would like to sell about $500 billion worth.

It seems to me that FDIC, in the worst case scenario, would lose no more than $300 billion under the Geithner plan. I for one would settle for this loss to taxpayers if it can unclog the credit market.

5 capitalistimperialistpig March 23, 2009 at 11:25 pm

Isn’t arbitrage what these guys think they know how to do? With half a trillion at stake, does anybody really believe cheating won’t utterly dominate the situation?

6 Eliezer Yudkowsky March 23, 2009 at 11:31 pm

Does anyone know of any case in which zombie banks have been induced “to start making loans again” with consequent good effects for economic growth by any sort of subsidy or assistance? Ever in the history of humankind?

7 Bob Montgomery March 24, 2009 at 12:09 am

As far as I can tell, the endless succession of plans offered up over the last six months has had one goal: come up with something complicated enough to provide political cover for foisting the huge losses of the banks off on taxpayers.

Even assuming no cheating/gaming, best-case scenario – isn’t that the whole point of the plan?

As an antidote to this cynicism, here’s some blind optimism:

While not giving full protection, the administration did show some pre-emption of possible gaming. All in all, I still don’t like the plan cos it doesn’t solve the economic issue of over-leverage and bad loans floating in the economy which makes people of making and taking new loans. However, this might give the banks some breathing space. Let’s hope they don’t abuse it.

8 Clark March 24, 2009 at 2:51 am

Cargo cult – that is all this is.

9 Logicaloutlaw March 24, 2009 at 4:06 am

You ripped this from Karl Denniger’s Ticker today – word for word:

He doesn’t mind his Tickers being reproduced/printed elsewhere, but at least give the courtesy of stating the source instead of making it look like you wrote this, Tyler.

10 David Wright March 24, 2009 at 6:19 am

As Krugman pointed out, there is actually in implicit taxpayer subsidy even without self-dealing.

What’s odd is that Krugman seems to think of his pointing this out as some sort of “gotcha” moment, whereas in fact this implicit subsidy is the core of the program. This is how treasury is going to get the market to pay the banks a higher price than its view of the payout probabilities of these assets would imply. It’s really a rather creative way to simultaneously create a market price and pay the banks more than that price.

On NPR, Krugman was giving an interview in which he claimed (1) selling the toxic assets wouldn’t help the banks, because the market’s view of their worth isn’t high enough to make the banks solvent and (2) this program subsidizes the buyers at taxpayer expense. Connect the dots, please Paul — you might not like it, but if the subsidy is high enough, (2) fixes (1)!

11 dk March 24, 2009 at 8:01 am

As has been mentioned, if firms that put up assets for sale are not allowed to buy assets in the plan this scenario is not an issue. I do not know what the rules are on this.

12 winstongator March 24, 2009 at 9:17 am

Could you provide a single example of a ‘cash-flowing’ MBS that is priced $0.30 per dollar face? I’m assuming you mean ‘cash-flowing’ as flowing as contracted because you could be paying pennies of interest when dollars are expected and still be maintaining some ‘cash-flow’.

Many normally cash-flowing mortgages would actually be priced above $1.00 per $1-face because they are at higher rates than newly originated mortgages. My mortgage is at 6%, but I plan on moving within a year, so refi doesn’t make sense, so wouldn’t $100 @ 6% trade much higher than $100 @ 4.5%? Not that there are many of these, but some pricing analysis would be helpful.

The idea that these securities are so intractable is lazy. What is actually happening to the underlying assets is important, and also discoverable. Why isn’t more attention going into that?

13 K T Cat March 24, 2009 at 10:02 am

It’s going to take a massive, spectacular failure to get us over the notion that the government is some entity separate from all of us, capable of omniscient and omnipotent actions. This might be just the thing. The government will be on the hook for mountains and mountains of bad debt.

14 Joe in Morgantown March 24, 2009 at 10:33 am


You missed loans. If Citi loans me $1B, I will gladly put up several hundred of my own dollars to make a bid that citi will like.

15 Mario March 24, 2009 at 11:43 am

Keep in mind that the price that banks are looking to receive for these assets is heavily dependent on the state of their balance sheets. So if you are looking to see if there are ways that the government can get screwed in the transaction, make sure you add in the amount they have been prepaying over the last few months to bring the prices of the assets down.

16 foo March 24, 2009 at 12:36 pm

All the banks have these toxic assets on their books. They don’t have to buy their own assets to game the system as described. All they have to do is make sure everyone participates, and all the toxic assets get bought. It doesn’t matter who the front man is that buys them, since the taxpayer is really paying.

And for those who are expressing disbelief that the banks would act in a less than honest and upfront way, how do you think we got in this situation in the first place?

17 Joshua March 24, 2009 at 1:52 pm

Isn’t the institution that will be taking the bath the FDIC? Is the FDIC funded by a fee on banks (and has been since it’s inception)? Hasn’t the FDIC fund been growing for years (with small dips when a large number of banks fail)? Didn’t the FDIC get permission to go in $500 billion of debt that it will repay with the fee FROM THE BANKS. So won’t this in fact cost us nothing?

I’m getting a little tired of everyone hating every plan so much that they don’t pay attention to simple facts.

18 Mario March 24, 2009 at 2:46 pm

Didn’t the FDIC get permission to go in $500 billion of debt that it will repay with the fee FROM THE BANKS. So won’t this in fact cost us nothing?

Are you actually suggesting, on an economics blog, that levying a tax on a nation’s banking system is free to everyone who isn’t one of those banks?

19 jeff March 24, 2009 at 3:37 pm

The cleverest thing about the Geithner plan is that it will leave the FDIC, the only regulator that hasn’t been eagerly shoveling money to Wall Street, holding the bag. The FDIC is supposed to evaluate the assets being purchased and decide how much can be borrowed to buy them. Of course, given the incentives private players will have to game the system, no agency could possibly hope to do a good job of this. The inevitable losses that follow will be on the books of the FDIC.

20 foo March 24, 2009 at 3:53 pm

Well, as it turns out, no, the banks haven’t been paying fees to the FDIC for a while.

Do you really think the FDIC will repay the $500b from fees on the banks?

21 Instareader March 24, 2009 at 4:37 pm

The owners of “financial institution” bonds have as big an incentive to run this scam as the the financial institutions themselves.

For example, PIMCO, owns lots of BAC and C bonds. They use the PIPP to buy the banks’ toxic assets.

PIMCO bids very high and eats the 3% loss (or 15% or whatever the PIPP loss rules state) on the toxic assets. The high payments for the trash assets pushes their BAC and C bonds up to face value. Mission accomplished, and cheap too.

22 Peter Principle March 24, 2009 at 6:18 pm

For the scam to work, it appears there would need to be collusion — under the assumption that even the FDIC isn’t dumb enough to allow a bank to be on both sides of the same trade.

So the question is: Do the piranas think they can trust each other?

23 Howard March 25, 2009 at 7:44 pm

I think this could very well happen. I blogged about it a bit more:

24 Cory Chomic March 26, 2009 at 10:52 am

The Geithner plan essentially finances, with taxpayer money, private-public bids for these portfolios. The key question is will any portfolios actually be sold in the gaping hole between 20 and 80 cents.If a market actually emerges we will know if the Geithner plan is working. I doubt any money will change hands without both sides seeing a profitable trade.If trades are indeed made, the banks get cash for a highly uncertain asset, take writeoffs, raise capital or restructure as required. Banks which refuse to sell have new Geithner plan market values established for these assets, which regulators will use to force subsequent restructuring.

25 DavidS March 26, 2009 at 5:39 pm

The gaming has begun!!



“I told you so…..

The huge subsidy to banks hidden inside of Tim Geithner’s public-private partnership program may already be leading banks to load up on securities they plan to sell at inflated prices.

According to the New York Post, Citi and Bank of America have been aggressively buying up Alt-A and ARM mortgage backed securities, sometimes paying more than the going rate of around 30 cents on the dollar.


Recently, securities rated AAA have changed hands for roughly 30 cents on the dollar, and most of the buyers have been hedge funds acting opportunistically on a bet that prices will rise over time. However, sources said Citi and BofA have trumped those bids.

There’s nothing complicated about this at all.

Buy for 30 cents, sell to the PPIP for 50 cents, pocket a quick (and huge) profit immediately and nobody’s the wiser.

Oops – now someone is the wiser.

Oh darn.

The reason ALT-A (liar loans) and Option ARM securities are trading at 20-30 cents on the dollar is that nearly all of those “loans” were either made to someone who lied about their income, couldn’t afford the reset/recast payment and is underwater on their house (and thus can’t refinance), or both.

When those loans default (and most of them eventually will, even if they’re paying now) recovery is extraordinarily poor; 30 cents is likely just about right.”

26 Oskar Shapley March 30, 2009 at 7:01 pm

“Is there a way to actually do this?”

I buy your shit, you’ll buy mine. All I need is acomplices on our interlocking boards.

Comments on this entry are closed.

Previous post:

Next post: