No Runny Eggs

This morning, Treasury Secretary Timothy Geithner released his plan for Toxic assets.  Geithner’s latest attempt to solve this problem is called the , Public Private Partnership Investment Program. 

In its simplest form, Geithner’s plan would have the FDIC front a program where investment companies could place their “toxic assets” up for sale in an auction process.  Private entities would be able to bid on the toxic assets and via FDIC guarantees, be able to leverage their money 6:1.  The equity investment required to purchase the assets would be shared equally between the government and the private entity purchasing the toxic asset.  Perhaps this example from Geithner’s document will help clarify how this will work:

Sample Investment Under the Legacy Loans Program

Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.
Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.
Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.
Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6.
Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis – using asset managers approved and subject to oversight by the FDIC.

Before I dissect the plan can I ask one question?  Is this it?  Is this what we waited two months for?  Is this the plan that Geithner was “uniquely qualified” for to put together?  How could this answer have taken more than about a partial weekend to come up with?

What’s not to like?  Plenty!

First, the FDIC and TARP are carrying nearly 93% of the risk of the asset program.  Obviously, if the assets are purchased at the “right” price, there is upside for these “investments.  However, with the private equity folks having to only pony up 7% and having significant return possibilities with minimal downside, isn’t it more likely that the assets get over priced in the auction rather than under priced?  Isn’t this the same kind of a scenario that lead to the toxic assets in the first place?

Second, I question how much of the debt will be placed up for auction.  Yes, the folks holding them would like to clear their books of them.  However, an auction can get you both less than you have the asset marked at as well as more than the asset is marked at.  This market is still very very thin.  Couple that with the uncertain economic environment and it would seem that there will be few players able and willing to bid on these assets.  Auctions work best when there are lots of bidders and the items being bid on have great transparency as to what’s being bid on.  I don’t see either of those situations occurring with these auctions.

Third, and perhaps most important, as it title states, this program is based on private participation.  OK, admittedly, the private participation is not much more than a way for Geithner to attempt to legitimize the government guaranteeing/buying these assets, but private companies are still required.  If the AIG kerfuffle showed nothing else, it showed that the Democrats have nothing but disdain and contempt for anyone who has made out better than whatever they think is “fair.”  The Democrats have also put private enterprise on notice that whoever uses government money is subject to retroactive “adjustments” if the Democrats think you did better than you ought to have done. 

Geithner’s new program would have private investors leveraging government funds to purchase these assets.  Isn’t that what AIG is/was doing?  If the private investors are able to drive significant returns on the toxic asset program what guarantee is there that Congress, specifically the Democrats, won’t come back afterwords and say “we want more!”  With this as the backdrop, how many private investors do you think will be willing to put their money at risk in another government supported effort?

I’ll say right now that I may be completely wrong about this program.  As I write this, the DOW is up 260+ points on the anticipation of this program.  I suspect however, that this may look a lot like last week’s announcement by the Fed to expand it’s balance sheet by over a trillion dollars, the DOW ran up on the anticipation but sold off the following two days as investors digested the implications and reality of what the Fed had done.

My take?  This is another “swing and a miss” by Geithner.  That makes a strike out on my stat sheet.

Update 3/23 10:44 AM – and if you think the disincentive of working with the government is limited only to AIG because Congress so “carefully crafted” the legislation not to have any unintended consequences, think again!  Read this about what is happening at another “failing bank.”  You can bet most of the other “failing banks” are impacted by the unintended consequences of the AIG bill as well!