The program will address both legacy loans and legacy securities. Under the legacy loan program, banks will identify assets they wish to sell, the FDIC will conduct an analysis to determine the amount of funding it is willing to guarantee. Leverage will not exceed a 6-to-1 debt -to-equity ratio. The legacy securities program will grant non-recourse loans to investors to fund purchases of legacy securitization assets. Eligible assets will include non-agency residential MBS that were originally rated AAA and outstanding CMBS and ABS that are rated AAA.
Whether this plan finally works to get the market back on its feet is dependent on the answer to one very serious question that is furiously debated among economists and investors: Is our current crisis a liquidity crisis or a solvency crisis? If you believe that this is purely a liquidity crisis (i.e. the intrinsic value of these assets is higher than the current mark to market) then this plan will definitely work. Investors will have access to leverage from the government, they will purchase assets at "cheap" prices, the banks will be relieved of their lousy investments and will be free to raise private capital again. Those that purchase the "depressed" assets will make all sorts of money and the taxpayer will share in the gains. The banks will recapitalize, pay back the TARP and condo flippers and homebuilders can return to their lucrative careers.
If you are in the "insolvency" camp, and you believe that the mark-to-market values reflect reality, or in some cases are optimistic, then this plan fails to solve the problem. It merely becomes a large transference of risk from the shareholders and bondholders of banking institutions to the taxpayers. Sure some private investor money will be on the table, but it will be a small slice compared to all of the taxpayer funding.
I hate this idea, much as I did when it was first introduced several iterations ago when Paulson was still the Treasury Secretary. What I think the government should be doing instead is preparing itself for large scale liquidations of institutions once they fail, and mass auctions of toxic assets (and buildings, and houses etc.) when they take over failed institutions. The RTC never had to pay for the assets it auctioned. It acquired them when all of the Savings and loan institutions failed. Investors showed up because the opportunities to pick up assets for pennies on the dollar were enticing. The government is now trading with itself. It is invested in the banks already, it has an incentive to make sure that the banks get the highest prices possible, but it also doesn't want to pay too much, so it is in a conflicted position as an investor on both sides. It seems that either way, we lose.
Granted, this is a much bigger crisis than the S & L crisis. But I still don't think that the taxpayer should be in the business of assuming risk. Frankly if buying assets at these levels was the investment opportunity of a lifetime, it would've already happened and investors would be piling in. There's a reason why private investors won't touch this stuff with a 10-foot pole without government assistance: because even at these prices, tremendous risks remain.
Equity futures are surging on the news. Once again, everyone is excited about this plan finally being the plan that gets us out of the mess we're in. I'm skeptical to say the least, but I certainly hope that I am wrong.
1 comment:
You may hope you are wrong, but you're not.
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