Some simple numbers on the Geithner plan

Via Felix Salmon, here is a very useful post.  It's one reason why the stock market is up, although not every taxpayer should feel better.


Couldn't FDIC recover the losses by charging the banking industry a higher deposit insurance rate? Larger banks(too big to fail)should be charged an even higher rate.

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I'm sorry, I retain my initial misgivings over the moral hazard of having
a tax cheat in charge of the IRS. This guy will survive only if he doesn't screw up
again. You can bet Obama told him he's done providing cover.

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While reading I thought of something. "Our" collective risk tolerance just went to hell in a hand basket. However, taken as a whole, there's a narrower range on the value of sub-prime housing than the market is willing to offer for pieces with a high range of value. What if the gov't sold a 50 year bond and offered to renegotiate homeowners to 50 year mortgages.

The homeowner's are walking away, but there is some price that they wouldn't walk away. The government doesn't want to risk money, they need to be an intermediary. The only way the banks won't lose is to push the problem further down the road towards the economic recovery, and the only way to do this while at the same time shoring up the present value of the loans (that I can think of) is to reduce house payments by extending the loan period.

Half (roughly) of renegotiations after defaults end up back in default. But, half don't. Many people didn't dump their stocks because they have a long time horizon. Why do we arbitrarily apply a 30 year time horizon on homes? I don't know if 30 years is too long, or too short, but I do know it's wrong. And, I'm inclined to believe that right now, for people who can't make their payments, it is too short.

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i could be totally missing something here but shouldn't these toxic assets sell for far more than they are worth . if i'm a bank and i'm sitting on assets with a value of $100 wouldn't it be a great idea to put in a bid for $840 000. the FDIC kicks in around $720 000. the treasury provides $60,000 and the bank fronts up $60,000. so the bank has swapped its $60,000 + $100 asset for $840,000 and the FDIC and treasury are left holding the bag.

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I must admit, I couldn't follow the math. $8400 goes in; $5000 comes out. Not enough to cover the loan. Yet somehow, the equity investors get a profit. Man, homeowners in California must be loving it.

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DavidS' suggestion of banks bidding on their own assets is interesting, but the simple reality is this isn't necessary. A bank holding bad assets does nearly as well if it actually sells those assets to someone else through this plan. The entire point of the operation is to shift losses to the FDIC. No subterfuge is needed, the goal is right there for all to see.

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@Curt, item #2: In fact this is one of my concerns. Isn't there a principal-agent problem arising from the vastly different incentive structures faced by the gov't and the hedge fund? And then what you'd get is more overpayment than not, with some gains for hedge funds and losses for gov't.

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Could it be considered simply a bet as to whether rate of asset price increase is higher than the interest rate ? In the current low-interest scenario , considering asset price changes have been more on psychology and "animal spirits" rather than fundamentals , is that so pessimistic a bet ?
In the earlier example of a $84 bid on an average $50 portfolio , would not the market of potential investors adjust the bids such that they can afford to have more skin in the game ?

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Andrew wrote:"Why do we arbitrarily apply a 30 year time horizon on homes? I don't know if 30 years is too long, or too short, but I do know it's wrong."

30 years was an incredibly long time when that became the standard that the Federal government's agency settled on. And the forward to the past innovation of the genius investment banks was to offer five year mortgages, just like was the standard prior to FDR's financial wizards.

As for the post at self-evident, I'm sure he won't be bidding on the mortgages because he doesn't see to have a clue. The odds of any package of mortgages being worth zero is essentially zero as I understand the program. The fdic will only approve packages of whole loans, not the tiered traunces where traunces quickly go to zero. Further, the bidding is on individual packages and the key will be figuring out the likely value and there using formulas were the zip codes, styles, original asset value, let the bidders estimate the recovery. That will get them to the best current value and then they will really make their profit in working out the loans in the package.

The high leverage gives the buyers good multipliers - if they buy a package at 80%, putting in only $7 of each $100, with face values of $125. If the manage to boost the return to $102, they get $8 back. If they get $114, they get $14 back.

On the other hand, they aren't going to willingly bid so high that they end up getting only $95 on the $125 face value because their $7 turns into $2.

One might bid blindly only 25% for all the packages, but those who do the due diligence will pick up all those valued higher. Anything won at 25% will be worth less if bidding blindly. This isn't a get rich quick deal where you bid really low and flip it for high profits. The successful bidders and investors will be figuring out not only how to value the mortgages in the packages, but also how to work them out to get maximum boost to their value.

Kruegman's objection is this will help the healthy banks, and ony make the most crippled banks even worse off. I see that as a benefit. If Citigroup and BofA end up more crippled and the larger regional banks stronger and able to take the new business from the bigger banks, then the too big to fail Citigroup and BofA become small enough to fail.

And let me emphasize the key point: for FDIC to lose on this deal, the private equity loses 100% of their $7 per $100. If FDIC loses $1 of the $100, the private equity loses $7 and TARP loses $7, but with a 100% loss staring them in the face, the private equity isn't going to over bid.

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Norman Pfyster is correct.

This analysis assumes profits and losses are determined for each item and paid out individually.

If instead, the entire portfolio is summed and payouts are made against the entire portfolio and not for individual items then it is impossible for the loan manager to make money while the FDIC is taking a hit.

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Today, 30 years is not long at all. I bought my first house at 25 and will probably retire at 70, if ever. The useful life is essentially forever.

Everything comes down to people making their payments and it seems to me that all the periphery stuff is fine, but won't solve the problem. Fixing mark-to-market just buys us a year or so. Eventually, we need to stop the puckering the consumer is feeling in the vicinity of his wallet pocket caused by the drop in his housing stock.

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nemo --

i believe this program is a subsidy, meaning that it is a transfer of wealth from the FDIC to private equity and the banks. that is 100% clear. i can cook up cases where this is not the case, but they are similarly extreme.

the numbers you provided were an extreme example. your numbers exaggerate the probable effect by a long margin.

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you miss the point, and repeat it on both blogs (who knows how many other links you've gone through commenting this.)

for simplicity's sake he is using those examples to illustrate an expected value of $50. if he wanted to, he could say "suppose half the assets were worth $25 and half worth $75" or alternatively, "suppose a quarter were worth $20, a quarter worth $30, a quarter worth $70 and the rest worth $80."

the point is to show the flow and distribution of wealth between private investors, the treasury, the FDIC, and back to the original owners of the assets. (or did i miss it also?)

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nemo / hern

no, i only commented on this blog and that one. i followed the link from here to there.

i do not think i am missing the point. your point is that it is a subsidy. i agree it is a subsidy in the most likely cases.

the only exception: if the private investor overbids, he will show a loss. if then the bank is nationalized, the treasury / fdic will have to eat less of a loss because private equity is taking a first loss position.

i don't think this is a great plan. i would rather not bring private equity into this as they are clearly extracting value while it is not clear what utility they bring. on the toxic asset side they are potentially bringing some clarity with respect to marks; these marks will be high, because of the subsidy, but they may be better than the current situation. in any case, if private equity cannot raise its bid to a level acceptable to the bank even with the subsidy, we will know for sure that the bank's marks are unreasonable.

one reason these positions are mismarked on TBTF banks' balance sheets now is that, given the fact that these banks are implicitly guaranteed by the US, their positions have a "put" built in as long as they sit on the TBTF bank's balance sheet. that means that the positions will be worth less on private equity's balance sheet where they have no guarantee. so selling them to private equity with the put attached by the govt is not really adding anything --- the put is already there. this is a really bad situation, but it shows the kind of thing you get into with TBTF.

as for this being a subsidy to banks, i think that once we decided that we were not going to let any large banks fail we decided that we were going to subsidize them. i don't like the form of this subsidy very much. i would prefer a debt guarantee followed by nationalization of some banks -- but i am not at all clear how to set the line between 'guarantee' and 'nationalize' and i am not at all clear how to handle the ensuing credit events in the otc derivatives markets upon nationalization. i understand that the treasury and fdic are walking a very fine line here.

but if it works, and by 'works' i mean brings clarity to the situation, then i will accept it.

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After reading all those comments, i do wonder -- if everybody understands the market this well, what are they doing wasting their time reading this blog? Go make some money, dudes! This is supposedly the best traders market ever. (I, for one, do not claim to understand the market & I read Marginal Revolution for edification, which it regularly provides, thank you very much.)

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Point 1: if the result is caused by the non-recourse nature of the loans, that is pretty easy to fix. Point 2: the example posits a leverage ratio, and then makes up expected values, rather than, as the Treasury example seems to indicate (hope?), establishing leverage after an examination of the expected value of the pool. If the world is really as hit or miss as the example at issue, the leverage should be 1:1. Assuming, of course, that the whole point is not to transfer money to banks.

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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.

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You buy my toxic assets at 120% of former melt down full face value and I'll buy your toxic assets at 120%.

The housing market will continue to collapse because the The Mortgage Forgiveness Debt Relief Act of 2007 removed the last incentive for borrowers to remain in “their† homes. This get away with bank robbery law doesn't expire till 12/2009.

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Hi, may I know who funds the FDIC? where do they get all the money to recapitalize the banks from?

sorry, I'm not from the USA.

The FDIC is funded by the banks in first part and by the taxpayers if there is a serious crisis and they don't have enough cash. Its basically a legally required insurance scheme that has the power to close a bank and sell it at rock bottom prices without needing approval from anyone at the bank (think pennies on the dollar) if they ever leverage more than what they are allowed to (iirc its 10 to 1) or if they fail to meet a host of requirements.

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