How Long Can You Tread Water?
Posted by Larry Doyle on March 26, 2009 11:10 AM |
The other day, I provided a cursory overview of the details embedded in the recently proposed Public-Private Investment Partnership, Will Banks Truly Sell these Toxic Assets?
The main point I tried to highlight in that piece was the need for true price discovery for these toxic assets. A loyal reader provided tremendous insight in highlighting that the PPIP needs to assure that sellers are truly at arm’s length from buyers to insure that the price discovery process is real and fair.
There are potential concerns with this price discovery process highlighted in my piece Send in the Clown. Are the bank portfolios, located within the largest banks needing to sell toxic assets, attempting to prop the market higher?
I received some real time market color from KD at 12th Street Capital as to initial responses from customers, both buyers and sellers, who may participate in this PPIP. What have I learned?
If buyers and sellers previously had a wide gap in the perceived value of these toxic securities, then it appears as if that gap may have widened. While cheap government financing and loss mitigation allow buyers to pay higher levels, their bids are only higher by a few points. Meanwhile sellers, instead of working toward a middle ground in the price discovery process, have actually raised their prices.
How might this get rectified? Uncle Sam, in the persons of Tim Geithner and Sheila Bair, will strong arm parties on both sides to engage and transact.
What may expedite this process? Little publicity has been given to the fact that the two largest corporate credit unions in the country, U.S. Central Credit Union and West Corp Credit Union, failed last week. What do these credit unions own in their portfolios? Lots of toxic assets. Who will handle the liquidations? The FDIC.
Buyers know that forced liquidations by failed institutions will establish price levels. If I am a buyer, why should I be in a hurry to purchase assets, knowing that there are plenty of assets for sale.
Why is the administration making the case for new and unprecedented powers at potentially Treasury, Fed, and FDIC to overtake non-financial institutions?
Matthew Richardson and Nouriel Roubini write on the predicament facing certain banks (thank you, Andy):
Finally, we have to anticipate the likelihood that some banks will resist selling their loans and securities. Why? Currently, the government has been giving them the option to keep holding them with the hope that market conditions will improve.
Going forward, the government must insist on the banks’ involvement in the new program. The reason that financial institutions must be pressured is that they are the cause of the financial crisis. They took advantage of loopholes to avoid regulatory requirements, taking a huge bet on securities they were never meant to hold in the first place.
What happens if removing toxic assets from a bank’s balance sheet at near-market prices shows it is effectively insolvent? Then we will have to face the elephant in the room. We may then have to start asking, “Why keep insolvent banks afloat?” And having asked that, we will have to search for ways to manage the ensuing systemic risk.
Either way, once the plan is fully implemented, we will be entering a new phase of the financial crisis.
The powers that be in Washington know that the liquidation process of these toxic assets will inevitably cause the failure of even more entities, both financial and non-financial. To that end, they are making the case now for new powers to step in, take over certain institutions that may pose real systemic risk, and methodically liquidate them. If that is the case, as a potential investor I am behooved to wait and be patient.
Moody’s Cuts Wells, BofA Ratings. What prompted these cuts? Exposure to commercial real estate. Exposure to option-ARM mortgages. Exposure to California and southwestern U.S. market that has extraordinary high levels of delinquencies and defaults.
The waves are high and getting higher. The cross currents are vicious. The undertow is strong.