I often wish I were Mark Thoma. If I were Mark Thoma, I could be smart and paying attention without being bitter.

So I am not wedded to a particular plan, I think they all have good and bad points, and that (with the proper tweaks) each could work. Sure, some seem better than others, but none — to me — is so off the mark that I am filled with despair because we are following a particular course of action.

Unfortunately, I have a darker temperament, a spirit less generous and optimistic than Mark's. I am filled with despair, not because what we are doing cannot "work", but because it is too unjust. This is not my country.

The news of today is the Geithner plan. I think this plan might work very well in terms of repairing bank balance sheets.

Of course the whole notion of repairing bank balance sheet is a lie and misdirection. The balance sheets we should want to see repaired are household balance sheets. Banks have failed us profoundly. We want them reorganized, not repaired. A world in which the banks are all fixed but households are still broken is worse than what we have right now. Too-big-to-fail banks restored to health are too-big-to-fail banks restored to power. The idea that fixing legacy banks is prerequisite to fixing the broad economy is a lie perpetrated by legacy bankers.

I think that critics of the Geithner plan are missing some of its tactical brilliance. My guess is that behind the scenes, Geithner has arranged a kind of J.P. Morgan moment. You know the story. During the Panic of 1907, J.P. Morgan locked a bunch of bankers in a room and insisted they lend to stave a panic. We've already seen one twisted parody of this event, when Henry Paulson locked a bunch of bankers in a room and insisted they borrow money from the Treasury. This second one is more clever. I don't think the scandal of the Geithner plan is going to turn out to be the subsidy to well-connected investors embedded in the non-recourse loan put option. On the contrary, I think that Treasury has already lined up participants for the "Legacy Loans Public-Private Investment Fund" and persuaded them to offer prices so high that despite the put, investors will expect to take a major loss. My little conspiracy theory is that the Blackrocks and PIMCOs of the world, the asset managers who do well by "shaking hands with the government", will agree to take a hit on relatively small investments in order first to help make banks smell solvent, and then to compel and provide "good optics" for a maximal transfer from government to key financial institutions.

Consider a hypothetical asset manager, PIMROCK. PIMROCK reviews a pool of loans held by the bank J.P. Citi of America, and its analysts determine they are worth 30¢ of par value. The bank holds them at 80¢ on its book. PIMROCK agrees to put down $10B to purchase loans from the pool at 82¢ thrilling stock markets everywhere. It was all just a bad dream!

Under Geithner's plan, PIMROCK's $10B permits a $10B equity investment from the Treasury. Then the FDIC levers the whole thing up, providing $6 of debt for every one dollar of equity. So, $140B of bad loans are lifted from J.P. Citi of America, nearly $90B of which is sheer overpayment to the bank.

Of course, as cash flows evolve, PIMROCK's $10B is wiped out entirely, as is the Treasury's investment. The FDIC gets repaid in a bunch of securities worth about $50B, taking a $70B loss. But, as Calculated Risk, likes to say "Hoocoodanode?" These were real market prices, Geithner or his successor will argue. Our private partners lost everything. There was no subsidy here.

Meanwhile, taxpayers will be out around $80B.

Why would PIMROCK go along with this? Because they feel it is their patriotic duty to work with the government for the good of the financial system, even if that involves accepting some sacrifices. And because they hold $100B in J.P. Citi of America bonds, and they've received assurances that if we can get the nation out of the financial pickle it's in, there will be no haircuts on those bonds. "Shaking hands with the government" means that nothing ever has to be put in writing.

Welcome to America, 2009. Change we can believe in.

The scenario I've presented is a variation on this by Karl Denninger (ht Tyler Cowen).

I liked this post today by Matt Yglesias:

My biggest concern about the PPIP approach to the banking system is that even if it works, what it does essentially is return us to the pre-crisis status quo — banks that are so large that they're too politically powerful to regulate effective and too systemically important to be allowed to fail. That's a recipe for dishonest transactions that produce short-term profits at the cost of blowups. One appealing element of nationalization is that it can easily be made to end in a world in which there is no institution named "Bank of America" or "Citi" and no such gigantic institution.

On the bright side, I'm thankful that we have people like Paul Krugman, Simon Johnson, and Willem Buiter, who fight the good fight while being too eminent to ignore.

On the dark side, try here, here, and here.

Update History:
  • 24-Mar-2009, 3:55 a.m. EDT: Fixed erroneous reference to legacy securities, rather than legacy loans, program.
Steve Randy Waldman — Tuesday March 24, 2009 at 2:54am permalink
I'll just point out a possibly darker scenario in which the banks, directly or indirectly and using Fed/Treasury money, bid at higher than book value and you know the rest.

Also, the FDIC, Fed and Treasury can keep worthless "assets" essentially hidden until long after the current administration is gone. Ah, yes, behold the transparency.

They are relying on a terrible combination of apathy, blind trust and stupidity among the public along with corruption among those with power to prevent or impede their massive looting.

The few that point out the many indications that the financial system we are saddled with was conceived by and for banksters are derided as "conspiracy theorists". No serious person could believe we have such deeply rooted corruption, evidence be damned.

I have predicted that this will go on until there is nothing left to loot. I wish someone would prove me wrong.
3.24.2009 5:12am
Independent Accountant (mail) (www):
I saw Krugman on television yesterday discussing the "Plan". I agreed with everything Krugman, the leftist said. What's this country coming to, when I agree with: Krugman, Putin and Wen? The Plan is MLEC 4.0. Another attempt to obfuscate looting the taxpayers to support the incompetent and corrupt banking establishment. A number of my tax clients have taken to calling Obama the "Negro Jimmy Carter" and expect 13% inflation rates and 17% mortgages.
3.24.2009 5:25am
killben (mail):
Forgetting for a moment that this is just another way of sticking it up the tax-payers,

I have only 2 question ...

is the quantum of toxic assets so low that FDIC and Treasury can fund it easily?

if the funds required is very high, will it not lead to more money printing and collapse of the dollar?
3.24.2009 5:40am
RueTheDay (mail):
Great post SRW.

The mainstream media really needs to pick this one up and run with it. The average American won't understand the concept of an embedded put option, but I think they're smart enough to know what it means to finance 85% of a purchase with a non-recourse loan if you spell it out for them. Unfortunately, the media reaction thus far has been "woohoo! the stock market is up 500 points. this one must be a winner. looks like the recession is over now." A truly sad day.
3.24.2009 7:01am

is the quantum of toxic assets so low that FDIC and Treasury can fund it easily?

I suppose there is nothing that prevents the problem banks themselves from funding most of this exercise. From a bank balance sheet perspective, a legacy loan transforms into an FDIC-guaranteed new loan (with face value 6/7 times the auction price of legacy) and 1/7 times the auction price in cash (paid by the private investors and the Treasury). Maybe one could call this "qualitative balance sheet strengthening" (cf. "qualitative easing") with an equity haircut (current book value of legacy minus auction price).

Disclaimer: I am just a layperson as regards high finance.
3.24.2009 7:32am
joebhed (mail):
I know you didn't want to get any darker, Steve.

But, unless I'm missing something, the answer to "why" PIMROCK is rolling for the loss on this deal, is very simple.

Musical chairs.
Cue the music.
Next !
3.24.2009 8:22am
callmecynical (mail):
the coup de grace

SIFMA's Ryan Says Toxic-Asset Plan Is ‘Highly Innovative' Idea

By Betty Liu and Joshua Fineman
March 24 (Bloomberg) -- Tim Ryan, president and chief
executive officer of the Securities Industry and Financial
Markets Association, said the group is “very pleased” with the
government's plan to buy banks' troubled assets.
“This plan is highly innovative, also complex,” Ryan said
today in an interview on Bloomberg Television. “Different
agencies are going to have to move briskly to show
that this plan will work.”
3.24.2009 8:43am
Funcity (mail):
Feudalism writ large.
3.24.2009 9:02am
dd (mail):
No doubt BlackRock and Pimco will "hedge" their losses with an AIG based derivative and so investors will lose nothing as the taxpayer will be on the hook for the "insured loss."
3.24.2009 10:01am
UrbanDigs (mail) (www):
PIMROCK just saved their a$$ and their bonds in insolvent banks. You nailed it.
3.24.2009 10:16am
Smedley Butler (mail) (www):
When I look at finance, I am reminded of another game that I used to take part in. For those who don't know me, read my speech:


Or more importantly, read my book:


So Steve, when do you round up a bunch of the bloggers, start organizing, and start protesting?
3.24.2009 10:57am
Don McArthur (mail) (www):
Language matters, as Mr. Orwell noted. We should all protest at the appearance of 'toxic assets' and the like, and insist they be called what they are - gambling losses, from bad bets made by rich and affluent people.

Misnaming them 'toxic assets' is merely part of the ploy of shifting the losses to the taxpayer, by making it appear to be some sort of environmental issue.
3.24.2009 11:30am
Anonymous (mail):
I wonder if Pimco had a heads up, which might explain why they were so excited about Citi bonds back in early Feb.
3.24.2009 1:53pm
Anonymous (mail):
That was in Feb 2008, not 2009. So ignore my previous comment.
3.24.2009 2:01pm
Yancey Ward (mail):
Yes, the plan is a clever way to vastly overpay for the worst assets without the government having to acknowledge an immediate purchase of these assets. This is a political threading of a needle, and by all accounts, it will work since the major media and the public at large are too stupid to see what is actually happening.

Three Card Monte at its finest, and for the largest stakes ever.
3.24.2009 3:12pm
Kid Dynamite (mail) (www):
Steve - i like this post - i even quoted from it today, but isn't there a flaw in the PIMROCK logic?? both PIMCO and Blackrock are asset management firms right? They own bonds in the big banks for their funds... they can't create a new fund to bail out the marks and valuations of their other funds - that's pretty illegal in the mutual fund world isn't it?
3.24.2009 5:56pm
Yancey Ward (mail):
Kid Dynamite,

Ah, the naivete of youth!
3.24.2009 8:43pm
Taunter (mail) (www):
PIMROCK has plenty of C and BAC in its equity funds. The spike in the equity value will take place as soon as the banks report - and the media trumpets - the success of the Geithner plan with 1Q earnings.

Enough leverage (out of the money options, etc) and the payoff on this golden opportunity to insider trade can pay for the $10bn ante by itself, and the losses will only trickle in over many years, if there isn't another plan to deal with them.

The goodwill engendered at Treasury for bailing out Geithner and inflating the Treasury investments in bank stocks...well, that's priceless.

More here: http://tauntermedia.com/2009/03/23/gaming-the-system
3.24.2009 11:10pm
Jamie (mail):


3.25.2009 1:31pm
> And because they hold $100B in J.P. Citi of America

the realization that pimrock will overpay because they are subsidizing _themselves_ was the deal-killer for me.

up to that point, I was somewhat supportive. now, no.
3.25.2009 4:07pm
you're spot on man. check this out "Why BlackRock wants to buy up toxic assets" fortune magazine article
3.26.2009 2:43am
not buying it:
Why does any one care so much about these bondholders. They are not the bankers. The so called old boys if they exist can go on even if the bondholders get killed.
4.5.2009 11:08pm
What is wrong with bailing out the bondholders. It is about the same as bailing out the depositors. The banks are heavily regulated to make them safe so maybe in future they should just my the bond insurance explicit.
4.6.2009 8:44pm
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