Markets Love Geithners Plan…. Heres the catch

Posted by Dr. Michael Berry Ph.D. - Morning Notes

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1. The Plan
2. A New Reserve Currency: China

1. THE PLAN

Three strikes and you’re ….

While I was flying to Orlando on Monday Treasury Secretary Timothy Geithner unveiled the
second iteration of his plan to save the US (and global) banking system. The markets loved it they went bid in a frenzy and added 500 plus points to the DOW.

Bill Gross whose company PIMCO is likely one to be asked to invest in these assets, said it
would be a good deal for the country and a better deal for investors.  He thought that private
investors (a select group of institutions) could achieve a 15% return on the investment in toxic assets for little or no risk; such are the sweeteners in this package.

The new Geithner plan harkens back to the Bush Administration’s original plan proposed by
Secretary Paulson (with a few new bells and whistles) in October 2008.  Ah, but October
seems like decades ago in the frantic history of “Bailout Nation.” The “new” plan is that
Treasury and the FDIC will ante up $500 billion or more (a mere pittance relative to the
proposed $9 trillion budget deficit proposed) and buy up toxic assets. Investors from the
private sector will be provided with low interest loans for up to 85% of the amount.  Here’s
how the plan works.

A pool of $100 million of toxic loans is put up for auction.  Bids from private investors are
solicited.  Hypothetically, suppose the winning bid is $85 million.  The FDIC (taxpayers) will provide 85% financing and the Treasury will invest half the remaining amount, in this case $7 million. This means 92% financing on favorable terms for some lucky auction bidder. The bidder then ante’s up $7 million and manages the pool of toxic assets. Returns are split equally between Treasury and the private capital.  If the pool continues to decline in value the private investor can walk away, thus exposing the government (and the taxpayer) to the total  loss.

Here’s the catch.  There are bids today for these toxic assets. They range on average at $.30
cents on the dollar.  Theoretically this new Save the Banks deal is “sweet.”  It is as sweet as
the government can possibly make it on behalf of the US taxpayer. Theoretically wealth will
be transferred to those lucky enough to be allowed to bid on these assets. Downside for the
private investment sector is limited and knowable in advance.  This is another advantage. 
However the New York Times wrote in its Editorial yesterday, which I, in turn, have kindly
editorialized for you,

“… Investors are currently offering 30 cents on the dollar for certain toxic assets. Banks are unwilling to sell at that price, but that doesn’t mean the offer price is too low.  It may only indicate their fear that taking such losses might render the banks insolvent. With government (ed: taxpayer) subsidies (ed: direct taxation or inflation) investors will presumably offer a price more to the banks’ liking. But that in turn could expose the government (ed: mom and pop) to big losses.  Government loans are huge compared with the amount investors must put up, so even a modest decline in the value of the purchased assets would endanger repayment of the loans.”

…. HERE continue reading page 2 of 4