Will It Work?

The Geithner Plan for Toxic Legacy Assets.

Will it work?

No...Nope...Nota...Not Happening. Back to the drawing board.

Tim Geithner's plan to use public and private funds to purchase toxic legacy assets will not work because it doesn't fix the fundamental problem of too much leverage and general bank insolvency that is the underlying cause of our economic crisis. All it does is re liquefy the credit markets with dollars. This is not the problem. If liquidity was the issue, the credit market problems would have been solved in October, and John McCain would be President right now.

I generally believe though that this strategy might be successful in rebuilding credit liquidity and, therefore, some end user consumer demand. But then again, the consumer is already showing some signs of life by looking at the retail sales figures the last few months. So they have not eliminated the economic risk.

This plan is eerily similar to Hank Paulsons original TARP Plan, although this at least has some meat to it.

But in the end, I think Barack Obama's Presidency will be decide by this one single issue, the ability for him to deal with the financial crisis. On this...he has earned a C- so far. This plan may still work, but I doubt it. Obama is betting on Tim Geithner over the urging of David Axelrod and Rahm Emanuel.

But first...what exactly is the plan?

The Financial Stability Plan will use $75-$100 billion of public funds to assist Private Equity Investors to buy at least $500 Billion to $1 Trillion of Toxic Legacy Assets from Financial Institutions. Like I said, this is similar to Hank Paulsons original idea for TARP.

*FDIC will hold a public auction for these assets. The highest bidder wins. So in realty the Private Investors like PIMCO or Blackrock will be setting the market value.
*The Treasury and Private Equity will provide the equity financing and the FDIC will provide a guarantee of debt financing issued by the Public-Private Investment Funds (PPIF) to fund asset purchases.
*The Banks will identify which loans they will sell.
*The FDIC will conduct an analysis to determine the amount of funding it will guarantee.
*The leverage used will not exceed 6-1.
*The highest bidder will have access to PPIF to fund 50% of equity required to purchase.
*Buyer of assets can then finance the remaining portion via debt guarantee by the FDIC.
*Private Equity will mange the assets until final liquidation of loans.

Pros:

*The Treasury is trying to stabilize housing prices, by pushing down long term Mortgage Rates, this on the surface is a positive as its least an attempt.
*Its an attempt to clean up bank balance sheets.
*The creation of a secondary market for these Bad Loans/Mortgages.
*Creation of price discovery for assets, as currently there are wide bid/ask spreads.
*Using Private Equity Money and expertise. This is crucial to the banks.
*May stimulate Bank Lending.

Cons:

*Doesn't change asset quality of loans, they are still crap.
*Might create a larger capital shortfall for banks if auctions don't go well.
*Would Private Equity/Hedge Funds like the regulations handed down by FDIC/UST?
*Is the plan big enough?
*The plan looks to be a little complicated, as I had to read a few times to understand it.
*It will take some time for auction process to get off the ground.
*Going back to price discovery- How will they be valued? Measured?
*How to properly create a secondary market for these assets that don't trade?

MOST IMPORTANTLY- How will they agree on price?

*If valued on the low end- Can the banks take the needed write-downs? FDIC will price via PE/HF space, if banks don't like the prices, will they sell them? If they don't sell them, will they then mark to market the assets on their books? If sold at auction prices, will other banks then mark to market similar bonds on their books? This is the single most important aspect of this plan. It could have the potential to kill this plan way before it even gets off the ground. Today's late day weakness in the financial sector was in part due to this aspect.

Personally, the cons outweigh the pros, as the pros are mere attempts to fix a situation, where the cons are actual potential problems.

Obama/Geithner must be drinking the same cool aid that the bank executives are drinking because they are not living in realty. This is mere "voodoo" economics, as the banks don't want any part of fair value accounting for these assets. The banks and Geithner have some strange notion that PIMCO/Blackrock, or any other PE firm is going to give them a break on the price discovery of these assets. These PE firms are going to low ball the FDIC, then the banks will be in no-mans-land. Do they accept whats realty, that these legacy assets are worth only .40-50 cents on the dollar? If that's the case, they will have to take further write downs, destroying further their existing Book Value, and move closer to insolvency. If they decide not to sell these, do they then mark these at the auction price set by the FDIC? Either way the banks are screwed. I am telling you the only way the banks can survive is the suspension of mark to market accounting, then they can put a arbitrary phony price to any legacy asset they have on their balance sheets.

The banks have to earn ($$$) their way out of this mess. They were beneficiaries of a great economy for years, there was tremendous competition for underwriting fees. Trading was very cut throat, they overextended and overreached, thus over-leveraged their operations. But now a huge intellectual sea change is happening in the industry. The credit cycle is over for the time being, and its going to be very difficult for the common bank to make any loans without leverage and or securitization. The new compensation rules that the banks are complaining about will not help, but again its over rated. With the economy losing 600K jobs a month, where are these guys going to go to find a better job?

The basic business model for the banks has to change. The banks need to get smaller and leaner, and fast. There is such a huge gap between loan origination and the borrower, that gaps in risk assessments are exposed. There are too many layers for these large banks to control. Currently the top five banks control 2/3 of loan/mortgage/credit card market. That is extremely unbalanced for the consumer, and too complicated for the banks to manage.

Currently the government doesn't have the infrastructure, staffing, expertise, time, and most importantly economic resources to totally manage (Nationalize) the financial system. What they are doing is biding time until these resources become available. In the end this plans failure might bring about the closure that the economy needs.

Random Thought-

Barclay's is close to selling IShares to either Private Equity or Goldman Sachs. The price tag believed to be between $5-6Billion.

The government has so far handed out $3 Trillion to the financial system, with barely any significant change.

Are today's banks tomorrows utilities? Boring investments that wont do much for decades?

Obama needs to start listening to David Axelrod and Rahm Emanuel and marginalize Tim Geithner.

The stock market cant seem to rally two days in a row. I have no clue whats happening next, but there are rumors that the Uptick Rule is being reinstated soon.

Have youy noticed that LIBOR rates are moving higher?

The biggest buyers of Treasury Securities of late... are suprise...The Banks.. Already moving on to the next bubble. They are the only buyers left.