Saturday, March 21, 2009

Will Somebody Remove Geithner From The Poker Table Please?

As Zero Hedge wrote previously, the TALF in its current formulation is merely a lot of hot air as it provides an incentive to buy assets that nobody really cares about (AAA-backed, newly issued "securitized" equivalents). It would seem that the Treasury also glances at this website occasionally, as next week's newsflow is likely to be dominated by discussions over the revamped and expanded TALF 2.0 that Geithner will soon be unveiling. And just what an expansion it is! Instead of providing back stopped, leveraged, non recourse incentives to hedge funds and asset managers to participate in a relatively safe piece of the securitization market, the Treasury Secretary is pulling out all stops: according to press reports, TALF 2.0 will include "older, illiquid and lower-rated securities." These could subsequently be re-packaged by the primary purchasers and then resold to a wider investor audience (those who remember the long, long time ago days of 2007 will recall that this kind of "repackaging" in the securitization market is what got us into this mess, and led to the bankruptcy of such previous tourist traps as Iceland). Not surprisingly, Stephen Myrow, a former Treasury official under Bush who helped create the TALF was caught saying "opening the TALF to legacy assets is the most effective and efficient way to purge troubled assets from the financial system." And in order to guard against losses, the Fed would take "so-called haircuts, or discounts on the loans, for the collateral it accepts." And to top it all off the FDIC (yes, the same people supposed to protect deposits at all costs), will start an aggregator-entity (bad bank) to purchase non-securitized whole loans, which would get a government guarantee and be re-sold to investors.

As ZH regulars can divine, what all this verbiage means, is that hedge funds will be allowed to establish investment positions, levered up to 10x with the government's aid, on which the funds will have only a stop loss of a certain percentage, and all incremental losses will be borne by you, dear (American) reader. And while this risk was "somewhat" acceptable for TALF 1.0, now that Geithner is opening it up to the whole morass of uber toxic and even more uber illiquid garbage floating on banks' balance sheets, the Treasury has just gone all in with taxpayer money in its bet that the market will recover. Geithner's Put has just been transformed to Geithner's All In. Is this vaguely reminiscent of what the rating agencies were doing: excel models which would crash if one tried to assume a reduction in housing values?

So in a nutshell:

1. The government is opening up the tax money spigot for market intermediary vehicles (hedge funds and other PPIFs or public-private investment funds) to buy up virtually all toxic assets with no accounting for default risk or loss assumptions, on the bet asset prices (i.e.the market) will go nowhere but up from this point onward. This is a huge gamble as macro economic conditions indicate we are nowhere near a bottom.
2. PPIFs use taxpayer provided leverage to agree with the Treasury that this is, indeed, the market bottom.
3. If this, gasp, is not the real bottom, hedge fund losses are limited as the TALF is non-recourse and non-remargining in nature and PPIF first-loss downside is at worst roughly in the 10% ballpark (of course they get to keep the spoils if the ploy succeeds), all the while no collateral has to be posted.
4. Banks and other companies offload all their toxic assets to these leveraged vehicles.
5. In the meantime the FASB is adjusting accounting rules to make sure that whatever assets remain can take advantage of Hummer-size FAS 115 loopholes and mark them at par.
6. Also in the meantime, the FDIC is buying up non-securitized toxic products (whole loans), and providing government backstopped capital to banks via the TLGP, all the while Sheila Bair is complaining that the Deposit Insurance Fund (DIF) is at or near zero.
7. Investors, whose deposits currently have no statutorily-required insurance as per the above point, are supposed to believe that banks are healthy, the accounting opacity is the new transparency, that the soon to be $15 trillion in total new bailout-related government debt and guarantees is sustainable as China bails and the Fed is left to purchases it own treasuries, that the FDIC will restore its DIF from fees banks pay for TLGP issues (even though banks will soon be able to issue debt cheaper in the Eurodollar market, until such time as LIBOR spikes again), and are expected to buy up equities and fixed income securities
8. As more and more buy into this all is good "new-age bull market" rally, the PPIFs will suddenly decide to sell off their resecuritized toxic garbage at a profit to themselves, people will ask just what these toxic legacy assets are really worth (again) and the whole system will crash once more, this time with the implicit guarantee of tens of trillions of US debt.

This is, of course, just one perspective. What is certain is that between Bernanke's TSY actions earlier this week, and Geithner's launch into TALF 2.0 (which is essentially stopping short of outright purchasing of bonds and equities), the administration has gone all in on selling its vision for the future to the U.S. taxpayer-cum-investor. If the pitch is unsuccessful, look out below. Sphere: Related Content
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Anonymous said...

nothing in this plan changes the size of the eventual loss.
if the banks have made really, really bad investments and you are implicitly backing up the banks, then getting private equity in there to buy these investments is good for the banks and good for the taxpayer. if the investments are really, really bad, the private equity will net lose money, thereby taking part of the loss before it hits the bondholder or taxpayer.
if the banks have made investments that are not really really bad but that are only somewhat bad, and you are implicitly guaranteeing the banks, you need these investments to stay on the bank’s or the government’s balance sheets so that you eventually capture their value.
if you believe, like me, that the investments the banks made are merely bad but not extremely bad (probably $2T loss rather than, say, $3.5T) then you think this is a very, very bad plan as it allows private equity to extract value from entities with government guarantees.

Tyler Durden said...

great point: bull case: taxpayers neutral and hedge funds win, bear case: taxpayers lose big, HFs lose small, and the fraud that is "the safest investment in the universe, the TSY" is exposed for all to see.

Anonymous said...

It is like groundhog day.

Hope has become a strategy.

Repackage, resell, hope you are not the one that gets stuck holding the losses.

Oh an borrow some more money and leverage up. Wow that is change i can beleive in.

This should make this whole deal a bit more interestin. Tomorrow, apparently, obama is going to announce a plan to increase oversight of ALL executive pay @ banks, wall street firms and possibly other companies as part of the overhaul of financial regulation.

Anonymous said...

Will debt consolidation have a negative impact on your credit score? The answer is yes, but only in the short run. But if you do it anyway, you will thank yourself later. Your first priority is financial stability right now.

Anonymous said...

"you need these investments to stay on the bank’s or the government’s balance sheets so that you eventually capture their value"

I'm more of a Peter Schiff follower. You're just looking at one aspect of the equation. For that plan to be successful you need retail buyers, many more episodes of "Flip this House", and for nothing else to go wrong with the economy. LoL.

That video was the best 1:16 (hour, sixteen) that I spend in the last month.

Anonymous said...

First Tyler, great blog. The one thing I cant work out in my mind yet is why would hedge funds overpay massively for these assets when they are looking at 10% losses if they do. To me the cheap financing enables them to get more aggresive with their bids, but not to the point of insanity. An "asset" you think is worth $0.50 might be worth $0.55 given the cheap financing and limited risk, but certainly its not worth $0.80.

Only if you assume, like Treasury apparently does, that its a liquidity issue would this plan work.

At least that is what is seems like in my amatuer analysis.

Tyler Durden said...

think of it in terms of risk/return: if this plan doesnt work, govt will be forced to buy securities outright. in the near term HFs are hoping to lock in greater fool profits by frontrunning both other buyers and taxpayers themselves. of course, the long term outcome will be very very different.

Anonymous said...

Hm, not sure if I understand this correctly, but what does stop two banks of doing the following: bank A goes to auction of bank B, bids all the toxic assets up to the maximum (i.e., face value). Bank B does the same at the auction of bank A. After this 'operation', the two banks have exchanged their toxic assets (let's say the face value of both groups of assets are the same), with the small but important difference that both banks now have now additionally received 90% of the face value of their sold toxic assets as cash.

Anonymous said...

Of course, the long term outcome will be very very different.

Oh me, oh my!

Anonymous said...

With expanded TALF 2.0, can't private investors then bid up the price of troubled asset, so long as US Treasure is willing to buy them back using TALF 2.0? If the private investors are told the criteria and pricing for "old, illiquid and lower-rated securities", can't they repackage what they bought and sell them right away to the government w a profit? If the Treasure wants to inflate the price of "troubled asset" and get them off banks balance sheet, all they need to do is to accept it with little haircut with loose criteria?!

Anonymous said...

The short term outcome might be very different too. Who knows what kind of "sure thing" Citi-esque arbs the HF's are going to try to milk, only to find out it's a bull.

All this stuff ran on the income being stripped off securities generated by increasingly indebted households and businesses. It isn't there anymore.

We've already seen in Goldman/AIG how the predators begin eating each other when there's no more prey.

Anonymous said...

well, there's a little problem. why you guys think there was little or no interest from HF community in TALF program last week? very simple: HFs don't want to be in a situation where a group of morons in DC will rewrite the law in 6 months and limit comp in HFs that participated in a govie program or choose to tax those HFs in the only acceptable way (i.e. @ 90%)

Anonymous said...

another way of putting this

it's almost like the UST is asking private equity to bail them out.

recapitalize me, i will give you warrants

Talitha Halostar said...

Helicopter Ben Bernanke is swamping us with Massive Quantitative Easing....The Undertow is likely to destroy us all!