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.