Sunday, May 3, 2009

Geithner Plan Gets Adjustment, Silver Lining for Taxpayers?

Posted on Option ARMageddon by Rolfe Winkler:

Geithner’s plan to rid banks of their toxic assets—the Public-Private Investment Program or “PPIP”—is getting an early face-lift. The plan is still a taxpayer giveaway, but perhaps a slightly smaller one now. (Bloomberg)

[FDIC] may offer investors financing to buy distressed U.S. bank assets without requiring them to share an equity stake with the Treasury, people familiar with the matter said….

The proposal reflects officials’ efforts to make the program more attractive to hedge funds and other investors fearing government attempts to impose limits on their pay.

One idea behind Treasury sharing in the equity stake of the partnerships was to allow taxpayers to benefit if toxic assets purchased actually increased in value. The other idea was to let investors use even more government money to lever up their potential returns. The secret sauce in the plan remains the cheap, non-recourse debt offered by FDIC.

[If you don't understand the mechanics of Geithner's partnerships, consider reading this post before moving on.]

Investors, which under the original plan would have included Treasury, get to borrow FDIC’s money to buy toxic assets. This borrowed money comes with no strings attached: If the assets increase in value, investors get all the upside, proceeds of which they use to pay off the debt. If assets keep declining, then investors are out their small equity stake, but no more. FDIC is left holding the bag.

Investors, apparently, don’t have much interest investing side-by-side with Treasury. Can you blame them? Many potential partnership investors are hedge funds and as Obama made clear in his treatment of Chrysler’s secured creditors (many of them hedge funds) he’s not so friendly to their interests when they suddenly diverge from his own.

Geither and Sheila Bair have their ear to the ground and know the hedgies want nothing to do with Treasury, so they’re altering the plan to make it more attractive.

There may be a silver lining for taxpayers, though. For every partnership that is able to raise $1 of equity, it appears FDIC is still going to lend $6 to give the vehicle $7 of total capital.

As initially laid out, the FDIC plans to provide financing of as much as six times the amount of capital invested. By effectively trading illiquid loans in exchange for cash or FDIC- guaranteed notes, the selling banks would strengthen their balance sheets.

If FDIC isn’t offering more leverage, then having private investors put up a bigger portion of equity—the full $1 instead of 50¢—actually reduces their potential return. This could be good news for taxpayers to the extent it discourages investors from participating in the first place. We can only hope the plan withers on the vine; the point of the plan, after all, is simply to shift banks’ losses to taxpayers’ balance sheet.

Folks shouldn’t be too optimistic, though. If the plan is suffering from lack of interest, Geithner is likely to be accomodating elsewhere. As his plan evolves, taxpayers must remain vigilant.

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