Sunday, March 22, 2009

The Amazing TALF Bait And Switch

The greatest bait and switch of this generation in all its visual splendor. As a result of the TALF's non-recourse/non-margin nature, a hedge fund X can buy Bank X's MBS Portfolio which is marked on the bank's books at 80 cents on the dollar (but has a market price of 20 cents) for the marked price with a 3% equity check and TALF filling the balance. A day later, Bank X repurchases the portfolio from hedge fund X at the 20 cent market price, and pays HF X a $5 million fee for the "trouble." The way this would be effectuated is that at t+1, the Hedge Fund decides to run a loss model via TREPP of what have you, and, lo and behold, realizes the loan will default in 1 day (assumptions and outcomes can be easily fudged) and threatens to default on the entire TALF portion. The key word here is non-recourse: the HF would not be liable for anything over its first-loss equity component. In the case of a declared portfolio default, the TALF portion would have to be marked at pure market value, and taxpayers would get stuck with as close to a donut as possible. So here is Bank X running back to the rescue, offering to buy back the original portfolio at market price (even a 1 cent premium would make it politically palatable), in this case 20 cents. For the sinister minded, it become immediately evident, why hedge funds, once loaded up on these investments, would have an incentive to push down the value of the entire portfolio complex, especially if they, wink wink, bought protection via CMBX or other derivatives. The recent spike in CMBX spreads (massive buying pressure) may be one indication of just how hedge funds might be positioning themselves.

Once purchased the bank waits for the portfolio to appreciate to 50 cents on the dollar by 2014 (although the appreciation is not necessary and is a best case example of how the bank would fare if the market does pick up). Hedge fund X takes a 75% loss on its nominal equity stake but more than makes up in transaction fees. The TALF portion takes a 75% loss with no recourse and no margin to fall back on.

As a result Bank X takes no writedown now, and in 5 years may book an equity profit of as much as $25 million (net of transaction fees paid to the Hedge Fund X), while Hedge Fund X books a profit of $3.2 million for one day's work...

Lastly the U.S. taxpayer loses $54.3 million on a $77.6 million TALF Investment, or 70% (net of 5 years of interest income).

Note: the maximum TALF size is $1 trillion. Will U.S. taxpayers suffer $700 billion in losses from the TALF? Ask your congressman.


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39 comments:

OhmeOhmy said...

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So what's the alternative, widespread bank failures? Not going to happen.
Finally some profits for the banks and hedgies. Long live the TALF!

Oh and by the way, you can ask your congressman all you want. They have been preprogrammed with the appropriate response "the majority of the congressman's constituents overwhelmingly agree with the congressman's position that the TALF program WILL turn this economy around and bring stability to the banks.".


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Anonymous said...

Start mailing $10 or $20 contributions to congressmen and senators that support haircutting bank bondholders. Congress does what it is paid to do.

Anonymous said...

It is unconstitutional and illegal for the Fed to make TALF loans expecting to lose money, those are grants disguised as loans. A fraud if you will. If Geithner and Bernanke proceed with this plan, Congress should impeach them for violating their oaths to uphold the constitution.

ts said...

Goodness no, they'll lose the whole $1 trillion

Anonymous said...

Do you DIGG this article?

Then give it a digg rating.

Anonymous said...

Contribute to Congressman Brad Sherman; he wants to haircut bondholders and limit bonuses.

http://market-ticker.denninger.net/archives/887-Brad-Sherman-HE-GETS-IT!.html

qadi said...

I regret not buying 1M shares of C when it is was $1...

J.D. Swampfox said...

Take a look at

http://www.nakedcapitalism.com/2009/03/investor-on-private-public-partnership.html

It's a comment that gives a great example of how this program wastes taxpayer money through its inefficiency and desire to protect bank bondholders.

Max Leverage said...

The public's tolerance for the "it's complicated, trust us" line from the financial sector is wearing thin. I would not bet investment capital on this plan working out.

Anonymous said...

good writeup. whereas it is always possible and usually illegal to launder money i bet this hasn't been anticipated and it's probably legal.

i think the ppif is awful, not just in its potential for abuse, but for its potential to remove what underling value is there from the banks / treasury into the hands of hedge funds. if the value is there fundamentally (ie if the CDOs are undervalued MTM compared to HTM) then you want the banks or treasury to get this money. if the value is not there then this program is OK although a bit daft as the losses will get tagged on the T eventually. if the value is not there, hedge funds lose a little which is good for the T.

what's interesting as well is that i have seen nothing on the web but strong negatives for this plan. everything else i've seen has got mixed reviews. but this opens to uniformly bad reviews. perhaps someone is listening in Washington; hopefully.

Anonymous said...

one question though. can't the fed foreclose on the CDOs as collateral? in that case it's a 27 point loss (80 - 50 - 3). it's almost like buying the CDOs from the banks at their mark, but getting 3 pts of help from the HF.

Anonymous said...

This example is so extreme I'm not convinced that this would be allowed. Is there any link you can point us to that proves this would be legal under the Geithner plan?

Anonymous said...

What evidence do you have that: 1) there is a repo provision in TALF or PPIF? 2) there are large transaction fees? 3) the assets to be auctioned are marked at 400% of market value.

Expecting no answer - just footnoting the ludicrous nature of your analysis.

Anonymous said...

nice try but doesn't work that way. The non recourse is on a held to maturity basis. If the HF was to sell the loan, the govt will need to be paid back in full

Anonymous said...

good writeup. whereas it is always possible and usually illegal to launder money i bet this hasn't been anticipated and it's probably legal.

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Geithner's plan is illegal because it involves the Fed and FDIC giving grants disguised as loans. The Fed and FDIC do not have legal authority to make grants, so these disguised grants are illegal. Geithner is resorting to these illegal actions because he is afraid Congress won't authorize more TARP -- ahem, grant -- money to gift on insolvent banks.

maximus said...

4Best4Worst has selected one of your posts from the last week as one of the best on the internet.

Maximus would like to thank you for all you do to help spread the truth.

you can find the post under this weeks 4 best with the heading

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(The sinews of war, unlimited money
----Cicero)

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Anonymous said...

Anon 11:27

No need to sell anything. Hedge Fund and Bank execue a total return swap. Hedge Fund turns over income/gains/losses from structure to bank for the $5MM (paid out quarterly over five years).

Anonymous said...

Bait and switch or payment on votes. The whole thing smells of rank conspiracy and blackmail. A reliable source says BHO was given first 100 days to sell congress the globalized package. Hence the heinous payouts. Corps are already on board and recognize their time is limited. They must make all the money they can now, bank it off shore, and wait to see what the top has to say as to which currency or type will be used after April 2nd. Aig, merril, morgan stanley, all of them, the whole lot of them RBS, BOJ, the Fed, they're all in it and we the people are going to be fish bait! Shark bait...anywho, thanks for this post! It totally makes sense if this were all there was.

Anonymous said...

No need to sell anything. Hedge Fund and Bank execue a total return swap. Hedge Fund turns over income/gains/losses from structure to bank for the $5MM (paid out quarterly over five years).

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Banks can use any number of side deals to effectively have hedge funds act as their agents in making bids. Geithner's plan doesn't hand out free money unless it leaves loopholes for banks to buy through straw buyers.

Anonymous said...

The economics aren't there for anyone to pay $80 for what is worth $30 even with 97% government financing.

The only one who benefits is the bank getting $80. And they would eagerly do a side deal fork over $5 of that to an 'intermediary' to get the deal done.

Again, this proposal has all the earmarks of the type of deal investment banks would foist on thrifts back in the day -- so it most certainly originated on Wall Street.

Anonymous said...

Tyler nice work u do on this here blog, but really its all about perception and what the majority of the people perceive to be good or that it will work. U know before all this happened the was not enough to cover all bank deposits anyways so now people are woried about something that was always like this. If it all goes to hell well we are all screwed, if we can keep the good perception going then we must spend all we can to do that instead of facing the worst situation ever for all of us.

Anonymous said...

Bernie Sanders, Jim Bunning, and other opposition to the bailouts should pass a law making it a criminal offense for Fed, FDIC, or Treasury employees to give grants without specific statutory authorization, and further, says that the grants are analyzed based on economic substance regardless of the label the parties place on them.

This would shut down disguised bailouts, and require Geithner to get money through the political process. It is messy and difficult, but it is the only legitimate way to address a financial crisis in a democracy.

Anonymous said...

The solution to the S+l crisis also was a giveway.
The government seems to like making %97 non recourse loans.Just look at the FHA program with borrowers defaulting on the the first or second payment.

Sam said...

At Anon @11.25.

Nitpicking is all you can do?

I'm sure ZH merely meant this as an example of the kind of shenanigans which are possible with the TALF. This is not an actual transaction (of course!) and the real details may vary, but this scenario is definitely within the realms of probability.

How else are banks going to de-leverage and pass stress tests without shafting the taxpayer? Not expecting an answer..

mojakus said...

Here's another loophole that no doubt will be used by the more unscrupulous members of the financial world: Find a poor quality 5yr deal that still squeezes in a AAA rating on the senior tranche (say a subprime or business credit card issuer with a credit convex portfolio, or any dealer floorplan transaction). These bonds will easily price at 1ML+350-450. Assuming a 10% haircut and a funding cost of 1ML+100 (and no early am event on the underlying bond), by year 3 the fund in the first-loss position has been effectively principal-protected (its been earning 35-45% per annum for 3yrs), and is long an option on a 2yr bond. If the price 3yrs forward on the then-2yr bond is above 90, the fund sells and takes all the profit. If the bond is below 90, the fund just walks away.

Anonymous said...

Thank you Sam - for pointing out that the analysis is hypothetical and the imbedded assumptions have no validity whatsoever.

Or, as you say "ZH merely meant this as an example of the kind of shenanigans which are possible with the TALF. This is not an actual transaction (of course!) and the real details may vary"

The real details may vary is an understatement, imo. Anyone who believes the banks will repurchase the assets from hedge funds is delusional.

Anonymous said...

>The real details may vary is an understatement, imo. Anyone who believes the banks will repurchase the assets from hedge funds is delusional.

You don't understand scheme. Ex ante, a bank and a hedge fund agree to a kickback scheme whereby the bank pays a kickback to the hedge fund to overpay for bank assets using Fed, FDIC, and Treasury money. Everything is wired, so that the bank is forced to protect the hedge fund against losses. The kickback can take the form of an actual cash fee, or a bargain priced swap, sale, loan, swaption, guarantee, indemnity, or whatever.

Geithner's plan is non-economic for any rational buyer who buys at prices the banks want, unless the buyer is getting a kickback from the bank. Or actually is one of the banks.

rootless-e said...

1) Kickback schemes like this are fraud. "Non-recourse" does not mean "license to commit fraud"
2) Where's the 3% from - Brad has 17%?

Why would you expect this scheme to be legal?

Anonymous said...

1) Kickback schemes like this are fraud. "Non-recourse" does not mean "license to commit fraud"
2) Where's the 3% from - Brad has 17%?

Why would you expect this scheme to be legal?

--------

Because Larry Summers and Tim Geithner are running the scheme. Look at how they responded to the Mexican crisis in the Clinton years. Congress wouldn't give the big banks the 20 billion Larry and Tim wanted, so they misused the exchange stabilization fund to give the banks 20 billion. If Congress won't give the big banks 3 to 5 trillion in bailout money, Tim and Larry will misuse any instrument of state to give the banks the money -- for the "public good".

Rob K. said...

The math is wrong. Hedge fund equity would be wiped out completely when sold for 0.20 back to the bank. Therefore, profit would be 5.0 - 2.4 = 2.6.

Andrew P said...

Why not have the Treasury buy this crap directly. Why involve Hedge Funds? That way if there is a profit to be made, Treasury gets it.

JohnMc said...

Andrew P, that's the hook for the political component. Treasury is already making waves they want more control over hedge funds. If Congress does not give it to them now they wait for some of the hedges to fall apart and get it later.

Matter of timing.

Anonymous said...

This example is utterly unconvincing.

The asset managers who actually make buy and sell decisions are approved by the Treasury.

The term sheet forbids self-dealing (no kidding):

"Private Investors may not participate in any PPIF that purchases assets from sellers that are affiliates of such investors or that represent 10% or more of the aggregate private capital in the PPIF."

The asset managers also have to make certain warranties to the government about their practices.

Finally, the bank would have to execute this sale/repurchase/fleece without the FDIC noticing. I have no idea how they would swing that.

And why make it so complicated? If an asset holder can somehow fool the Treasury into letting it become an asset manager and somehow skirt the self-dealing rules, why not just overpay for its own assets?

Tom Maguire

Anonymous said...

***** Don't Get Mad Get Even *****

There is one way for the taxpayer to legally get even. This is what I did. I withdrew all my money from the bank and only keep enough for one months bills. If everyone does as I have, this would be the biggest and best message to send. Crush the bankers now. This is the equaivalent of getting even with NY water authority prices by having everyone in the city flush their toilet at the exact same moment. We have the power - It is just a matter of organizing.

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Anonymous said...

To me PPIP/TALF and the associated fraud certain to be committed looks like ripe territory for plaintiffs attorneys seeking to bring False Claims Act cases against banks and hedge funds.

mahesh said...

nice work mate......




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