Geithner's Proposal - A Closer Look

The markets loved Geithner's plan. The talking heads touted it all day long. The market wanted an excuse to take a leg up and this was it. Possibly it was just the sense that, “They are finally doing something” that got the money flowing. This observer is not so excited.

Mr. Geithner's approaches to today's problems are reflective of his predecessor, Hank Paulson. The history books will give Treasury Secretary Paulson an A+ for keeping his fingers in the ever increasing number of cracks in the financial dike. His actions bought the next administration a small window of time to address some very big problems. Mr. Geithner is still trying to plug leaks. He has no plan to stop the rise in the water behind the levee, nor does he have a plan to truly shore it up. He is offering us more of Mr. Paulson's sand bags.

The Alt A and Sub Prime totals are in the range of $1.4 Trillion. The much larger Prime mortgage market is also stressed. Of the $12 Trillion of mortgage assets currently outstanding there is at least $2 Trillion of troubled loans. The toxic side of credit card paper coupled with bad car loans is another $1 Trillion. Then you have the commercial real estate side of the equation. An estimate of $1 trillion of questionable assets in this category would seem low. Finally there is the Commercial and Industrial loans. There is a tremendous amount of these C&I loans that are currently trading well below their par value. Add another $500 billion. There is at least $4T of paper that is looking at Mr. Geithner's $500billion bid. Talk about an order imbalance.

The most likely result is that very little will be accomplished other than the movement of some of the deck chairs. A year from now the system will still be overburdened with the Legacy Assets.

From reading the Treasury proposal one gets the sense that Mr. Geithner went to Wall Street and asked the question, “What will it take to get a deal done?” Wall Street may be bruised but it is not stupid. The obvious answer to Mr. Geithner's plea was, “If you put up most of the equity and all of the debt and agree to pay us humongous fees we might be able to get some of this done”. Bill Gross of PIMCO said this evening that the plan was a “win win”. Mr. Gross might just win twice on this deal.

Some comments from the Treasury press release:

“The excessive discounts embedded in some legacy asset prices are now straining the capital of U.S. financial institutions, limiting their ability to lend and increasing the cost of credit throughout the financial system.”

Read this sentence to mean: If the banks were to use the current market prices to mark their assets they would be out of business. Therefore our strategy is to artificially raise the price of these assets so that the banks can afford to liquidate their bad books. Our plan is to 'buy high' and hope for the best.

"Using $75 to $100 billion in TARP capital......."

It is troubling that they would provide a range of the equity they are prepared to commit. One has to wonder if the uncertainty is based on the lack of clarity as to the success of the program, or is this just a lack of funds in the remaining TARP II? Either way it is a drop in the bucket.

"Maximizing the Impact of Each Taxpayer Dollar: By using government financing in partnership with the FDIC and Federal Reserve..."

The taxpayer puts up a buck in equity and the Fed and FDIC supe it up with debt. Isn't that how we got into this mess in the first place?

Treasury 'steps' in the process:
Step 4: Of the purchase price, the FDIC would provide 86% of the financing, leaving 14% of equity.
Step 5: The Treasury would then provide 50% of the equity.
Step 6: The 50% private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis.

Some additional 'steps” that were not mentioned:

Step Backward 1: The fees paid back to the investor will be the standard 2% per annum. These fees allow the investor to amortize it's investment in the fund over four years. This is an old Wall Street trick. You earn your equity position, you do not pay for it.

Step Backward 2: The deal gives control of asset dispositions to the 'investor'. By the fourth year they are money good on this deal and will want to cash in their free equity. This puts the manager in a potential conflict with the Treasury's interests. Never a good plan.

Step Backward 3: 93% of the capitalization for the deal comes from the State. That is not a sale. That is a joke.

"Joint Financing from Treasury and FDIC:..."

Just a few questions here. If this money is coming from Treasury and at the same time Bernake has promised to buy Treasury paper does this mean that the money for all this is just being printed? When did the FDIC get unlimited authority to guarantee the indebtedness of a SPIV?

More Treasury 'steps'. This time regarding the securities side of the proposal:

Step 6: The fund manager has full discretion in investment decisions. If the fund manager so determines, they could take advantage of the TALF program.

This means that a minority investor who wants to vote with his feet can force a sale of assets back to TALF. This provision is simply not in the public interest.

"The Merits of This Approach: The plan reduces the risk of prolonging a financial crisis, as in the case of the Japanese experience."

Those are fighting words Mr. Geithner. One should never pick a fight unless there is certainty as to the outcome. You have created the ammo to deal with about 20% of the problem. This is looking more and more like that 'Japanese experience' you are trying to avoid.