Tuesday, February 10, 2009

Geithner = Paulson v2

As Zero Hedge expected, the market's recent misplaced optimism was tested as soon as Geithner's speech was made public earlier today, and deteriorated precipitously during his presentation.

In an eerie recreation of the market's action that would accompany Paulson's on air discourses, the equity market plunged in its biggest one day drop since December 1. Despite our, and everyone else's pleadings for transparency and a shock-treatment to stir the comatose economy, Geithner is merely perpetuating Paulson's mistakes and is taking America on a course that will result in slow, pervasive and miserable destruction of value. The derisking was punctuated by a run on Treasuries as investors sought some safe haven refuge.

In the upcoming days I will present some thoughts on the various alphabet-soup recommendations that are part of the latest bailout, with an emphasis on the much hyped TALF which, for all practical purposes, is a government-backstopped credit call option available to private investors, that exposes taxpayers to even further losses presuming asset market prices are artificially high (it will basically be a 5x leveraged bet on RMBS and CMBS assets). In the credit realm, versions of the TALF have already been extensively priced in, implying that current credit prices may be poised for a significant pull back as investors digest its full implications, especially if managers are uncomfortable with taking a 5x levered bet on RMBS and CMBS asset values which are by far the most opaque and complex to quantify.

Unfortunately, the magical silver bullet called in sick today, and while Geithner did an admirable job defending himself before the senate, he did nothing to soothe investor nerves, and instead managed to convince even more people that the widely expected breath of fresh air that would come with the Obama administration in the Treasury department, will end up being a mirage.

Goldman Sachs is more diplomatic and eloquent in their skinny on the Geithner Doctrine, so we will present that for more skeptical readers.

Here is GS ECS US Research's much more official thoughts on Geithner so far today :

BOTTOM LINE: The Geithner announcement and accompanying fact sheet are largely in line with expectations. The key features include: (1) a 'stress test' for banks; (2) another round of recapitalization via preferred shares; (3) 'public-private partnership' to purchase troubled assets; and (4) expansion of TALF to up to $1 trillion to encourage new lending. However, little detail is provided – especially on the public-private partnership – and much of the program clearly remains to be worked out over the coming weeks and months.


1. As expected, the Treasury's financial rescue plan will work within the constraints of existing TARP funding (of which about $350bn remains), attempting to catalyze private sector funds to purchase bad assets and restart the securitization process. However, the speech and accompanying fact sheet leave open many questions about the timing of these interventions and the terms of asset purchases and recapitalization. Much of the program clearly remains to be worked out over the coming weeks and months.

2. Bank stress test. A key feature of the program will be a "stress test" for all banks with assets >$100bn. This will be used to determine which banks need to be recapitalized, or shut down. However, details on the exact nature of the stress test are scant. The Treasury will make additional TARP funds available to purchase convertible preferred shares that will be converted to common "if needed to preserve lending in a worse-than-expected economic environment."

3. Public/private bad bank. Rather than a fully government-funded bad bank, the Treasury will attempt to catalyze private sector investment via a "public-private partnership." This will start at “up to” $500 bn in size, and potentially expand to $1 trn. It is clear from Geithner's remarks that this is a concept at this point, rather than a fully designed entity -- Geithner mentioned getting public comment on the potential structure. Supposedly, private sector investors will determine the prices (perhaps with the benefit of cheap financing or partial loss protection from the government).

4. TALF expansion. As leaked repeatedly prior to the speech, the Fed's Term Asset-Backed Securities Lending Facility will be scaled up by a factor of five to $1 trillion and expand to backing CMBS and possibly RMBS. The goal here is to restart securitizations and thereby expand the flow of new lending (this is not an approach to deal with bad assets). While potentially an innovative approach to restarting securitization, it remains to be seen how effective this program will be. The Treasury's commitment to this would be $100bn rather than the $20bn currently earmarked and would be drawn from the $350bn remaining in TARP.

5. Transparency and accountability provisions. Not many surprises here, though it bears emphasis that the provisions apply to new extensions of aid rather than to those already supplied. Institutions that accept new help will be required to pay only $0.01 per quarter in dividends, refrain from purchasing shares and from pursuing new acquisitions. Geithner also outlines a number of additional reporting requirements intended to keep the pressure on institutions to make new loans. Sphere: Related Content
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Anonymous said...

This market got way ahead of itself and was going to correct anyway. We can blame Geithner, but anybody who that he was going to pull a rabbit out of his hat has been borrowing Phelp's bong.

I think Obama will give Geithner some rope, either to make progress or hang himself. It has been less than three weeks.

Looking into that balance sheets of the big banks is a necessary step, otherwise any plan is driving blind. If many of the bigs are seriously insolvent, I see more radical solutions being proposed, such as the Swedish plan.

However, Wall Street isn't ready (yet) to go radical and it isn't feasible politically until we see just how bad off these banks really are.

Unknown said...


While I'm much more sanguine on Geithner than you are, I definitely agree that the TALF is going to dump a shitload of risk on taxpayers. The ABS market isn't for the faint-of-heart, so the Treasury and the Fed need to be careful what they wish for. The Treasury/Fed wants ABS backed by SBA-guaranteed 7(a) loans (now with the guarantee pumped up to 90%)? Are you effing kidding me? Section 7(a) loans are only available to businesses that can't get financing elsewhere. And when the Fed takes losses on those ABS (and it will take losses, even with the haircuts), the SBA -- by which I mean taxpayers -- are the ones who will have to cover the Fed's losses. Yeah, I feel better already.

Every time a governmental entity wades into the ABS market, they get royally screwed. The Fed is more sophisticated than the municipalities and school boards I've seen get swindled in the past, but it's not that sophisticated. And the Fed is just relying on the rating agencies -- perhaps the biggest suckers in the history of financial markets.

I actually think the TALF will have a big impact on credit markets, but at great risk to taxpayers. It may or may not be worth the risk in the long-run. We'll have to see.

I'll structure whatever ABS my clients want me to; I just hope the Fed and Treasury know what they're getting themselves into. As they say, "here there be Dragons."

Anonymous said...

first of all, cheers to tyler for the blog.

in 4 days since discoverin, it's become essential readin...just what a meister glassbeadian without a bloomberg was wishin for -- inside info w/ eagle eyes & a nose for nastiness.

i second broken's measurement of TurboTimmy's rope. it seems like the barge is turnin slowly but seemingly perceptibly.

the only question is whether that massive iceberg hit (yeah we all know the one) caused enough damage to sink the ship before shore is reached.

and whether the wizard of O (pay no attention to the man behind the curtain) makes a good skipper even when benny blowhard & leisure larry is shovelin buckets of agua onto the deck for shoots & googles.

megots the lifevest on for sure & feel grateful that me mum bought me them swimming lessons as a yute.

no matter what, got give them props for the auspicious timing of the dow drop right on the money for the T auctions.