Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
Silver Notches Best Month Since 1979 - 12th Aug 20
Silver Shorts Get Squeezed Hard… What’s Next? - 12th Aug 20
A Tale of Two Precious Metal Bulls - 12th Aug 20
Stock Market Melt-Up Continues While Precious Metals Warn of Risks - 12th Aug 20
How Does the Gold Fit the Corona World? - 12th Aug 20
3 (free) ways to ride next big wave in EURUSD, USDJPY, gold, silver and more - 12th Aug 20
A Simple Way to Preserve Your Wealth Amid Uncertainty - 11th Aug 20
Precious Metals Complex Impulse Move : Where Is next Resistance? - 11th Aug 20
Gold Miners Junior Stcks Buying Spree - 11th Aug 20
Has the Fed Let the Inflation Genie Out of the Bottle? - 10th Aug 20
The Strange Food Trend That’s Making Investors Rich - 10th Aug 20
Supply & Demand For Money – The End of Inflation? - 10th Aug 20
Revisiting Our Silver and Gold Predictions – Get Ready For Higher Prices - 10th Aug 20
Storm Clouds Are Gathering for a Major Stock and Commodity Markets Downturn - 10th Aug 20
A 90-Year-Old Stock Market Investment Insight That's Relevant in 2020 - 10th Aug 20
Debt and Dollar Collapse Leading to Potential Stock Market Melt-Up, - 10th Aug 20
Coronavirus: UK Parents Demand ALL Schools OPEN September, 7 Million Children Abandoned by Teachers - 9th Aug 20
Computer GPU Fans Not Spinning Quick FIX - Sticky Fans Solution - 9th Aug 20
Find the Best Speech Converter for You - 9th Aug 20
Silver Bull Market Update - 7th Aug 20
This Inflation-Adjusted Silver Chart Tells An Interesting Story - 7th Aug 20
The Great American Housing Boom Has Begun - 7th Aug 20
NATURAL GAS BEGINS UPSIDE BREAKOUT MOVE - 7th Aug 20
Know About Lotteries With The Best Odds Of Winning - 7th Aug 20
Could Gold Price Reach $7,000 by 2030? - 6th Aug 20
Bananas for All! Keep Dancing… FOMC - 6th Aug 20
How to Do Bets During This Time - 6th Aug 20
How to develop your stock trading strategy - 6th Aug 20
Stock Investors What to do if Trump Bans TikTok - 5th Aug 20
Gold Trifecta of Key Signals for Gold Mining Stocks - 5th Aug 20
ARE YOU LOVING YOUR SERVITUDE? - 5th Aug 20
Stock Market Uptrend Continues? - 4th Aug 20
The Dimensions of Covid-19: The Hong Kong Flu Redux - 4th Aug 20
High Yield Junk Bonds Are Hot Again -- Despite Warning Signs - 4th Aug 20
Gold Stocks Autumn Rally - 4th Aug 20
“Government Sachs” Is Worried About the Federal Reserve Note - 4th Aug 20
Gold Miners Still Pushing That Cart of Rocks Up Hill - 4th Aug 20
UK Government to Cancel Christmas - Crazy Covid Eid 2020! - 4th Aug 20
Covid-19 Exposes NHS Institutional Racism Against Black and Asian Staff and Patients - 4th Aug 20
How Sony Is Fueling the Computer Vision Boom - 3rd Aug 20
Computer Gaming System Rig Top Tips For 6 Years Future Proofing Build Spec - 3rd Aug 20
Cornwwall Bude Caravan Park Holidays 2020 - Look Inside Holiday Resort Caravan - 3rd Aug 20
UK Caravan Park Holidays 2020 Review - Hoseasons Cayton Bay North East England - 3rd Aug 20
Best Travel Bags for 2020 Summer Holidays , Back Sling packs, water proof, money belt and tactical - 3rd Aug 20
Precious Metals Warn Of Increased Volatility Ahead - 2nd Aug 20
The Key USDX Sign for Gold and Silver - 2nd Aug 20
Corona Crisis Will Have Lasting Impact on Gold Market - 2nd Aug 20
Gold & Silver: Two Pictures - 1st Aug 20
The Bullish Case for Stocks Isn't Over Yet - 1st Aug 20
Is Gold Price Action Warning Of Imminent Monetary Collapse - Part 2? - 1st Aug 20
Will America Accept the World's Worst Pandemic Response Government - 1st Aug 20
Stock Market Technical Patterns, Future Expectations and More – Part II - 1st Aug 20
Trump White House Accelerating Toward a US Dollar Crisis - 31st Jul 20
Why US Commercial Real Estate is Set to Get Slammed - 31st Jul 20
Gold Price Blows Through Upside Resistance - The Chase Is On - 31st Jul 20
Is Crude Oil Price Setting Up for a Waterfall Decline? - 31st Jul 20
Stock Market Technical Patterns, Future Expectations and More - 30th Jul 20
Why Big Money Is Already Pouring Into Edge Computing Tech Stocks - 30th Jul 20
Economic and Geopolitical Worries Fuel Gold’s Rally - 30th Jul 20
How to Finance an Investment Property - 30th Jul 20
I Hate Banks - Including Goldman Sachs - 29th Jul 20
NASDAQ Stock Market Double Top & Price Channels Suggest Pending Price Correction - 29th Jul 20
Silver Price Surge Leaves Naysayers in the Dust - 29th Jul 20
UK Supermarket Covid-19 Shop - Few Masks, Lack of Social Distancing (Tesco) - 29th Jul 20
Budgie Clipped Wings, How Long Before it Can Fly Again? - 29th Jul 20
How To Take Advantage Of Tesla's 400% Stock Surge - 29th Jul 20
Gold Makes Record High and Targets $6,000 in New Bull Cycle - 28th Jul 20
Gold Strong Signal For A Secular Bull Market - 28th Jul 20
Anatomy of a Gold and Silver Precious Metals Bull Market - 28th Jul 20
Shopify Is Seizing an $80 Billion Pot of Gold - 28th Jul 20
Stock Market Minor Correction Underway - 28th Jul 20
Why College Is Never Coming Back - 27th Jul 20
Stocks Disconnect from Economy, Gold Responds - 27th Jul 20
Silver Begins Big Upside Rally Attempt - 27th Jul 20
The Gold and Silver Markets Have Changed… What About You? - 27th Jul 20
Google, Apple And Amazon Are Leading A $30 Trillion Assault On Wall Street - 27th Jul 20
This Stock Market Indicator Reaches "Lowest Level in Nearly 20 Years" - 26th Jul 20
New Wave of Economic Stimulus Lifts Gold Price - 26th Jul 20
Stock Market Slow Grind Higher Above the Early June Stock Highs - 26th Jul 20
How High Will Silver Go? - 25th Jul 20
If You Own Gold, Look Out Below - 25th Jul 20
Crude Oil and Energy Sets Up Near Major Resistance – Breakdown Pending - 25th Jul 20
FREE Access to Premium Market Forecasts by Elliott Wave International - 25th Jul 20
The Promise of Silver as August Approaches: Accumulation and Conversation - 25th Jul 20
The Silver Bull Gateway is at Hand - 24th Jul 20
The Prospects of S&P 500 Above the Early June Highs - 24th Jul 20
How Silver Could Surpass Its All-Time High - 24th Jul 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Geithner's Bailout Plan: Another Recipe for Financial Disaster

Politics / Credit Crisis Bailouts Feb 12, 2009 - 09:35 AM GMT

By: Money_Morning

Politics

Diamond Rated - Best Financial Markets Analysis ArticleShah Gilani writes: By relying on asset-backed securities, large amounts of leverage and unregulated hedge funds as its key elements, the U.S. Treasury Department's overhaul of the banking-system bailout plan is essentially relying on some of the same ingredients that caused the financial crisis in the first place.

This time around, someone should take the punch bowl away before the party even gets started. Otherwise, as Yogi Berra once said, it will be “ Déjà vu all over again.”


The only difference this time around is that the U.S. Treasury Department is calling the plays.

Backdrop on a Bailout

In a press conference Tuesday, U.S. Treasury Secretary Timothy F. Geithner unveiled the long-awaited successor to the Bush administration's Troubled Assets Relief Program (TARP).  The reaction was swift. Stocks plunged after the 11 a.m. press conference began when Secretary Geithner introduced a new rescue plan that was light on specifics and stated that the new program's goals would take time to achieve .

The Standard & Poor's Financial Index plunged 10% in afternoon trading, with such stocks as Bank of America Corp. ( BAC ) and Fifth Third Bancorp ( FITB ) taking particularly bad beatings.

Bank of New York Mellon Corp. ( BK ) fell 6.3% and Hudson City Bancorp ( HCBK ) 5.4%, making them among the better performers for the day.

The reaction was understandable. The government had outlined a plan that is supposed to remove $500 billion in bad assets from bank balance sheets in the near term - and $1 trillion in the long term - by leveraging $100 billion in cash to support the eventual $1 trillion in purchases.

The proposal would require the participation of private investors, such as hedge funds, and would include government guarantees to limit losses as an added enticement. How this will all work must still be explained. And since hedge funds are largely unregulated and, by nature, highly secretive about their operations, the plan as configured doesn't appear to provide the “transparency” that U.S. President Barack Obama has promised.

But the biggest problem of all is that - unfortunately for the Treasury plan - most economists estimate that it would actually take roughly $4 trillion to buy all the troubled assets that are out in the marketplace.

Clearly, the market reaction wasn't merely an expression of disappointment with the Treasury Department's plan - it was a total repudiation of a strategy that failed to deliver what the market was looking for: a new approach to the credit crisis and to the economy's depressing decline. In short, this new plan didn't represent a big enough break from the current TARP plan.

The original TARP proposal - developed by Bush Administration Treasury Secretary Henry M. “Hank” Paulson Jr. - was supposed to employ $700 billion towards buying troubled (also known as “toxic”) assets from distressed banks. As soon as Congress passed legislation authorizing the bill's implementation and funding, two things became clear:

  • First, $700 billion wouldn't be enough to buy all the toxic assets in the market.
  • And second, there was no way of determining what price to pay for troubled assets.

Once that realization occurred, Paulson & Co. shifted gears and opted to spend nearly $300 billion to make direct investments in troubled banks. Worse than being merely ineffective, it enabled banks to pay bonuses and finance buyouts - instead of increasing lending, as the government intended. Worst of all: Banks themselves refused to detail how the TARP money was being spent.

The market's “no-confidence” vote on Geithner's Tuesday announcements prompted officials in the Obama Administration to characterize the minimal details given as “intentional” and to say that they will work with Congress and the public to fully develop the plans. If there's one thing that can be counted on, it is that Congress will continue to be part of the problem and not the solution. By counting on the “public,” however, some suspect players may be included.

The new twist in implementing Geithner's plan calls for the government to partner with private investors in setting up an “investment fund,” formerly known as a “bad bank,” or an “aggregator bank.” Putting aside the underlying problems of how to value the assets the fund is going to buy and the fact that $1 trillion would be not be enough buying power, there's a fundamental question that has to be answered: Just where is this “private capital” going to come from?

While the scant details provided by Treasury on this critical component of the aggregator-investment fund drew criticism, there is actually a frightening clue as to how this fund will be capitalized and just who will be providing the private capital to what is essentially a “new old” plan.

Tackling TALF

The $200 billion Term Asset-backed Securities Loan Facility, or TALF, was announced in November 2008 after the market for securities backed by consumer debt froze . Like its sister program, the original TARP, it was never implemented. Now, like the WHO song says, “Meet the new boss, same as the old boss.” TALF is being re-floated by Secretary Geithner, and just like the resurrection of TARP, the TALF is expected to need $1 trillion to bring moribund credit facilities back from the dead.

The basic idea is that the government will lend private investors money to buy new “AAA”-rated security pools of consumer debt. If banks know that - after they make car loans, student loans or issue credit cards - they can package those loans and sell them to waiting investors with cash-in-hand, those financial institutions will start to make consumer credit available again. When the financial institutions sell the securitized pools, they get money from the buyers and can make more loans with fresh capital.

Amazingly, the TALF program is designed to allow private capital to borrow cheaply from the U.S. Federal Reserve and incorporate 20:1 leverage to buy new “AAA”-rated securitized debt instruments from distressed banks - with government guarantees that limit losses to the cash invested, and not the money borrowed. The initial capital will be provided by private investors - namely hedge funds and private equity firms - that will be only-too-happy to partner with government in the TALF investment fund.

New Investors, Same Old Story

While the public may be skeptical as to how - or if - this program will work, Blue Mountain Capital Management LLC, a multi-billion-dollar hedge fund anxious to participate in the program, probably spoke for its industry brethren when Chief Executive Officer Andrew Feldstein said: “This is exactly what the financial system needs.”

Already, several of the biggest names in “private capital” are gearing up to participate in this new TALF giveaway program; they include: Pacific Investment Management Co., BlackRock Financial Inc. ( BLK ), Citadel Investment Group LLC and D.E. Shaw & Co. LP .

In the face of all that is uncertain or unknown surrounding this new rescue plan, one thing is virtually certain: These private-capital players wouldn't be so anxious to play ball if they weren't almost absolutely sure that there was a chance to make windfall-level profits from this program.

There's still no formula as to how troubled assets are to be valued. In fact, there's not even a real definition as to what a troubled asset actually is. And that's not all: Troubled assets are actually a moving target.

While asset-backed securities of subprime residential mortgage debt were once considered “ground zero” in the financial crisis, now bankers, Congress and Obama Administration officials are including for consideration securitized pools of Alt-A residential mortgages, commercial mortgages, credit card receivables, car loans, student loans, and just about every other category of securitized debt whose values continue to sink as unemployment rises and the U.S. recession seems to deepen.

That's why it is so difficult, if not impossible, to value these securities; as unemployment spikes and the economy sinks, the underlying assets that determine the value of the securities (meaning the prices of homes, commercial buildings, offices and malls, automobiles, and the ability of borrowers to pay off their credit cards and student loans) are eroding on a daily basis.

There's an additional problem, too: As we discovered the first time around, the so-called “ratings” placed on this debt has a limited shelf life, and are not to be trusted. The worsening economy makes those ratings a moving target, too.

Like a dog chasing its tail, the Treasury's plan is going nowhere but in circles. Increasingly, it appears that Secretary Geithner's new plan isn't markedly different from the original plan proposed by Secretary Paulson, his predecessor. What's actually needed is an entirely new plan.

The Route to Follow

There are other plans that make more sense and don't facilitate the rich getting richer on the backs of taxpayers. The government should not be wasting taxpayer money several times over by infusing capital into banks while they bleed capital out of their balance sheets from mark-to-market accounting on toxic assets - only to then use that taxpayer money to pay for toxic assets to be put into a highly leveraged bad bank that will likely fail and require another bailout, a cycle that seems destined to perpetuate itself.

Here's a simple plan that will work.

  • Leave troubled assets on the balance sheets of banks.
  • Identify what truly is “troubled,” and cordon off those assets in a separate accounting category. Don't make banks use mark-to-market accounting on those assets.
  • Make all banks, hedge funds, and other financial institutions of all types, formally disclose to the Fed (on a strictly confidential basis), a report that details every asset on their balance sheets, and to formally identify which of those holdings are in the “newly created, troubled-asset” category. That will enable the central bank to carefully track the problem.
  • Have the Fed establish transparent, openly disseminated pricing models for every category of troubled assets.
  • Don't allow any derivatives trading of any benchmark or troubled asset index, or pricing-model matrix.
  • Allow investors to buy, on a reverse-auction basis, through a “blind-brokerage” facility, the troubled assets from banks.
  • Eliminate brokered deposits to help ascertain which banks don't actually possess solid deposit bases.
  • Close banks that are too weak to compete, merge those that can be merged and protect all depositors. Give that process a year to work itself out.
  • Create a bank-rating agency to openly rate banks on the basis of capital adequacy, reserve requirements, matched books and debt and investment spreads.
  • When banks get too big, based on a national model, make them spin off smaller regional units to reduce systemic risk and to better serve smaller markets.
  • As for investors buying troubled assets, create a facility for the public to buy into mutual-fund-like pools to invest in this asset class.
  • Allow 100% write-offs of all depreciation on these investments for anyone willing to take the risk of owning them, and modify the capital-gains assessment on possible gains - both moves will make these investments more attractive.

There's no reason that the Obama Administration can't create the transparency for this rescue plan that's been promised. If taxpayer money is going to be used to save the financial system, taxpayers should have the same (or better) opportunities than hedge fund and other “private capital” pools to profit from the mess that they're being asked to pay for fixing.

It's high time that attendant to all the stimulus spending on the table, sensible tax policies be addressed as a more-comprehensive and longer-term solution to a flea-ridden system that keeps us chasing our tails with no end in sight.

[ Editor's Note : Money Morning Contributing Editor Shah Gilani is a retired hedge fund manager and an internationally recognized expert on credit and financial crises that continue to sweep the globe. More than 2 million readers have perused his analyses of deregulation, problems with the debt-rating process, and the bailout and stimulus plans put forth by the Bush and Obama administrations. Indeed, just last month, in an open letter to President Barack Obama , Gilani detailed a regulatory plan that he believes would go a long way toward restoring the investor confidence that most experts say is needed if the crisis is to be brought to a close. Gilani is also the editor of The Trigger Event Strategist , which identifies profit plays that continue to be created by "aftershocks" from the financial crisis.]

Money Morning/The Money Map Report

©2009 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules