The old saying goes: Set a thief to catch a thief. Today, President Obama set a Wall Street banker to catch Wall Street bankers.
His Treasury Secretary, Geithner, fresh from defending himself for not paying his taxes, has concocted a scheme which involves large risks for the government (taxpayers) and seems likely to do two things: help Wall Street financiers make lots of money off the backs of the taxpayers, and fail at achieving confidence in the system:
“Treasury Secretary Timothy Geithner laid out what he described as a “comprehensive” attack on the financial crisis, warning that administration’s strategy will “cost money, involve risk and take time.”
“The financial system is working against recovery, and that’s the dangerous dynamic we need to change,” Geithner said in excerpts of his prepared remarks for delivery today in Washington. “Without credit, economies cannot grow, and right now, critical parts of our financial system are damaged.””
What is Obama doing with this half-baked scheme?
Stripped to its essentials, it involves the government taking the first risk of default in debt parcels, with an appeal to private sector money to invest in the parcels, secure in the knowledge that the government takes the first hit.
What does this mean? And why did Obama do this?
It means that Obama – gunshy after his fight to get his $800 billion stimulus plan passed by the House and Senate – has shied away from asking the House and Senate for large sums of money to buy toxic assets from the banks, and opted for a smoke and mirrors scheme which allows him to do exactly that (move toxic assets off the balance sheets of banks onto the balance sheet of others).
But by using yet another convoluted Wall Street financial structure, Obama is trying to hide the essential part of the deal: At what price are those toxic assets to be sold?
You see, the problem is that if the banks were realistic and valued the toxic assets at their ‘real’ value, then many of those banks would be bankrupt because their minimal equity would be wiped out. Why? Because the banks are leveraged at 10 to 1 or even 20 to 1 – they put in $1 of equity and can borrow money from their customers (through taking deposits from them) of $10 or $20 or higher, and onlend that borrowed money to other customers, hoping to make money in the process. It does not take much of a bad debt to wipe out your small equity if things go wrong, as they have with bad subprime mortgages, credit card debt and derivative instruments.
So, there is a dance taking place in Washington where the Obama administration and the banks have agreed not to come up with any assistance which requires the banks to be realistic about the value of their toxic assets, but to allow them to sell those toxic assets to the government (the taxpayers) at a higher price than they are worth, with the taxpayers taking the risks.
The shareholders of the banks are therefore being bailed out by taxpayers by having their equity preserved, and the government is hoping that nobody really pays close attention to this stiffing of the taxpayers.
The problem with not putting a realistic value on the toxic assets of the banks is that nobody in their right mind would want to buy them at the inflated price.
Enter Obama and his own personal Harry Potter of Wall Street, Timothy Geithner.
Geithner is obscuring the absence of realistic valuation of the toxic assets by deflecting attention to two other items: his tough rules on banks who agree to sell toxic assets at prices which are above their real value, and his little financial scheme to have private investors provide the money which Obama is unwilling to ask the Senate and House to provide to buy those toxic assets.
But those toxic assets are still being sold and at prices above their real value. The government (taxpayers) are paying those higher prices by taking the first loss risk through their guarantee.
This scheme seems to be yet another Wall Street negative Midas touch gimmick.
Toxic assets are toxic assets, and it is time for Obama’s administration to level with the ordinary Americans who are facing yet more taxes to solve the problem. Tell them the real story, Obama, and then let the chips fall where they may.
Only then will the US start doing the proper thing: nationalize the banks and later, when the recession/depression is over, sell them again.
More details on the Obama plan:
“that the plan for the trust -- sometimes called a "bad bank" -- will encourage private investors to acquire illiquid mortgage securities from troubled financial institutions.
"We believe this program should ultimately provide up to $1 trillion in financing capacity, but we plan to start it on a scale of $500 billion and expand it based on what works," Geithner said in a speech in Washington.
This trust would use both funds from the Fed and government guarantees from the Federal Deposit Insurance Corp. to entice investors to participate in the program.
"Together with the Fed, FDIC and private sector, we will establish a Public Private Investment Fund," Geithner said Tuesday.
"This program will provide government capital and government financing to help leverage private capital to help get private markets working again for the legacy loans and assets that are now burdening the entire financial system."”
Hold on to your hats, folks: if you thought the fight in the Senate over the $800 billion stimulus plan was messy, you ain’t seen nothing yet!
