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Will Banks Truly Sell These Toxic Assets?

Posted by Larry Doyle on March 23, 2009 5:25 PM |

A quick summary of the plans proposed by Tim Geithner. Everything looks great on the surface and markets rally in anticipation, but VERY FEW transactions have occurred.

Let’s go over a few points:

1. Government provides cheap loans for investors to buy toxic assets . . . DONE.

2. Government provides backstop for investors to be somewhat protected against losses . . . DONE.

3. Investors express desire to purchase assets . . . DONE.

4. Banks express desire to sell assets to unclog balance sheets . . . DONE.

5. What price will spark transactions?  Banks believe assets are worth anywhere from 60-80 cents on the dollar. Investors put valuations at 20-40 cents on the dollar. Will trades occur at 50-55 cents on the dollar? If so, can banks absorb that hit to their capital base?  NOT DONE.

6. Will government utilize a clawback provision if investors purchase assets cheaply and make a windfall over the next year to two? TIME WILL TELL.

Check back with Sense on Cents on an ongoing basis to stay apprised of developments.

I  believe that behind the scenes, the government will be working the phones with both the banks and investors to promote transactions. Then expect a LOUD public relations campaign to highlight how the program is working. Look for investors to initially purchase assets from Citigroup given that the government is now effectively running Citi. Some transactions are likely already being set up by government officials. In essence, a few prearranged trades will occur to prime the pump!!


  • Mountainaires

    Will they sell?

    Now that the Treasury Plan to “cleanse” the market of “toxic assets” has been put forward, I have noted that The FDIC is the entity that will both guarantee the debt issued and vet the bidder list.

    I also note the following quote from The FDIC:

    The FDIC will provide oversight for the formation, funding, and operation of new public-private investment funds (“PPIFs”) that will purchase loans and other assets from depository institutions. The Legacy Loans Program will attract private capital through an FDIC debt guarantee and Treasury equity co-investment. Private market equity investors (“Private Investors’) are expected to include but are not limited to financial institutions, individuals, insurance companies, mutual funds, publicly managed investment funds, pension funds, foreign investors with a headquarters in the United States, private equity funds, and hedge funds. The participation of mutual funds, pension plans, insurance companies, and other long term investors is particularly encouraged.

    There is a potential problem here.

    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 loss:

    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.

    Be aware that I, along with many others, have figured this out. Also be aware that as taxpayers and your ultimate boss, we do not intend to sit still and allow the public treasury to be looted in such a fashion.

    The FDIC’s job is to prevent that sort of looting operation by prohibiting the sellers of these assets from having any financial interest in the bidding side of the equation, directly or indirectly, and I along with many others intend to hold you to that obligation.

    I like the outline of this program if and only if it cannot be gamed in this or similar fashion. Provided that does not occur, this program has the potential to provide great benefit to both the banking system and our economy.

    If, however, the financial institutions that created this mess in the first place are allowed by the FDIC and Treasury to use it as a looting operation to intentionally shift their bad assets onto the Taxpayer you can expect that we the people will hold our government to account.

    Transmitted by email to

    • Larry Doyle

      Don’t think for a second that that sort of conspiracy can not occur. In fact it has occurred on Wall Street before. I found out after the fact where sellers and buyers entered into transactions at prearranged elevated levels to influence market prices and then unwound those trades in private.

      Never underestimate the lengths that desperate people with unscrupulous principles will go to try to make a buck.

      Great link!!

  • getfitnow

    LD, will all “toxic assets” show up on the balance sheets or will some banks still try to hide just how bad things really are?

    • Larry Doyle

      Well, you can rest assured that all these banks are having very regular meetings with regulators of all stripes.

      While it would be the stated intent to cleanse the system of all these assets, the reality is that some of the assets will likely remain buried. When a bank executive is facing the takeover of his institution he may go to great lengths to buy time in HOPES of the market improving or getting lucky.

      Even if this program is a quick success there are trillions in assets that need to be addressed. That will likely take a few years to totally capture. The question that many banks may face is do they try to sell early on or will they hold out thinking the market will improve.

      My feeling is if the bank can sell at a reasonable level, and move on with their biz that is the best move.

      This will be very interesting.

      • TeakWoodKite

        If unregulated hedge funds are “investors”, will there be any disclosure requirement to participate in this food fight?

        I am trying to figureout if this setup
        is a closed loop and will turn in on itself like an economic blackhole. When ever the word private is used in the context of PUBLIC funds, I take on the
        appearance of a pissed of porcupine

  • Andy

    LD: Could you explain in simple terms why is it that if there is a loss
    most of it is absorbed by the taxpayer ( 85% of it? I think it’s 50-50% for the first 14% percent of loss and then 85-15 for anything above that?) BUT if there is a gain then that is split only at 50%-50% . That’s crazy. Couldn’t then have imposed at least a 60-40 advantage since we are taking all of the risk?

    I am confused and don’t understand why this is the “best” of all the Gov. options (per Geithner…)

    • Larry Doyle


      Our banking industry has upwards of $750 billion in embedded losses. Thus, these banks are faced with not only a liquidity issue (ability to sell) but a capital issue (price of assets sold).

      The more advantageous terms that investors receive the greater the amount of liquidity (more people will want to buy)and capital (higher prices) will be injected into the system.

      This program is not totally a “heads” investors win, “tails” taxpayers lose but it is in that direction.

      Remember, the asset securitization business represents approximately 40% of total capital provided for lending. These markets will not restart right away but this program is an attempt to get them going.

      The taxpayers are bearing the brunt of the risk. The color Mountainaires shared above is critically important. The govt MUST make sure that these transaction are arm’s length transactions, meaning buyers must be separate and distinct from sellers so all interested parties are protected.

      Best of a very bad situation. My take is it will have moderate success. While some banks will benefit there will be others that will actually be forced into takeover in this process.

      • TeakWoodKite

        Remember, the asset securitization business represents approximately 40% of total capital provided for lending.

        I did not realize this, thanks LD.

  • thinkaboutthis

    My limited understanding, other than listening today — says this is absurd. Why are we — as tax payers — having to take the loss. The moment we fund this beyond the 1:1 we are at a loss. The split of 50:50 on profits is ridiculous — since the investment is not 50:50. I view this as an adult robbing candy from a child.

    As one CNBC guest said — Why are they not opening this up to everyone to invest and selectively choosing a small amount of people to participate. This is cost shifting to the American tax payer, as far as I am concerned.

  • TeakWoodKite

    Will trades occur at 50-55 cents on the dollar? If so, can banks absorb that hit to their capital base? NOT DONE.

    If other factors are considered it may be that the banks will return yet again to the Fed’s trough to make up the difference. The government will let prices fall with inflated dollars to a point where the assets are viewed by investors as a steal. And they would be correct in this view.

    As far as the windfall “clawback” (?), I take it that these investors will take a dimm view of any effort to retake the profits. I see the “mother of all right offs” will continue with out abatement.

    It is interesting to note that the administration is using gallows humor bonds to balance the budget.

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