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Time to Break Up the Big Banks

Politics / Credit Crisis Bailouts Feb 25, 2009 - 01:57 PM GMT

By: Mike_Whitney

Politics Best Financial Markets Analysis ArticleTimothy Geithner is putting the finishing touches on a plan that will dump $1 trillion of toxic assets onto the US taxpayer. The plan, which goes by the opaque moniker the "Public-Private Investment Fund" (PPIF), is designed to provide lavish incentives to hedge funds and private equity firms to purchase bad assets from failing banks. It is a sweetheart deal that provides government financing and guarantees for illiquid mortgage-backed junk for which there is currently no active market.


What's got Geithner worried, is the fear that the public will see through this latest boondoggle and set off a political firestorm. If that happens, the markets will go into a swan-dive and Geithner's career at Treasury will come to an abrubt end.

Details of the plan remain sketchy, but the PPIF will work in concert with the Fed's new lending facility, the Term Asset-Backed Securities Loan Facility, or TALF, which will start operating in March and will provide up to $1 trillion of financing for buyers of new securities backed by credit card, auto and small-business loans. In contrast, Geithner's financial rescue "partnership" will focus on cleaning up banks balance sheets by purging mortgage-backed securities. (MBS)

In Monday's New york Times, Paul Krugman summed up the Geithner plan like this:

"Now the administration is talking about a “public-private partnership” to buy troubled assets from the banks, with the government lending money to private investors for that purpose. This would offer investors a one-way bet: if the assets rise in price, investors win; if they fall substantially, investors walk away and leave the government holding the bag. Again, heads they win, tails we lose.
Why not just go ahead and nationalize?"

Why not, indeed, except for the fact that Geithner's main objective is to "keep the banks in private hands" regardless of the cost to the taxpayer. The Treasury Secretary believes that if he presents his plan a "lending program" rather than another trillion dollar "freebie" from Uncle Sam he'll have a better chance slipping it by Congress and thereby preserving the present management structure at the banks. Keeping the banking giants in one piece is "Job 1" at Treasury, which explains why bank-loyalist Geithner was chosen in the first place.

Geithner's PPIF is a way of showering speculators with subsidies to purchase non-performing loans at bargain-basement prices. The Fed is using a similar strategy with the TALF which, according to the New York Times, could easily generate "annual returns of 20 percent or more" for those who borrow from the facility.

From the New York Times:

"Under the program, the Fed will lend to investors who acquire new securities backed by auto loans, credit card balances, student loans and small-business loans at rates ranging from roughly 1.5 percent to 3 percent.

Depending on the type of security they are borrowing against, investors will be able to borrow 84 percent to 95 percent of the face value of the bonds. Investors would not be liable for any losses beyond the 5 percent to 16 percent equity that they retain in the investment.

In the initial phase, the Treasury will provide $20 billion and the Fed will provide $180 billion. Treasury Secretary Timothy Geithner said last week that the Treasury could increase its commitment to $100 billion to allow the Fed to lend up to $1 trillion." (NY Times)

This is a blatant ripoff, which is why the plan has been painstakingly concealed behind abstruse acronyms and complex explanations of how the transactions actually work. The only way investors can lose money is if they hold on to the securities after they fall below 16 percent of their original value which, won't happen, since investors can bail out at any time and leave the taxpayer holding the bag. Call it the "Geithner Put", another gift from Uncle Sugar to the Wall Street land-sharks.

Geithner's thinks that if he obfuscates the details of his plan as much as possible, he'll be able to get what he wants with no one the wiser. But he's mistaken. His credibility has already been battered by his chronic evasiveness. Now the pundits are blaming him for falling consumer confidence and the plummeting stock market. Whatever plan Geithner proposes, will be put under a microscope and dissected one molecule at a time. He won't get the opportunity to pull the wool over the public's eyes again. He's got one chance to make good, and if he botches it, Obama will be forced to send him packing. The political furor will be too much to handle.

It is no coincidence that the Fed announced its expansion of the TALF on the same day that Geithner presented his outline for a "public-private partnership". The two plans represent the Obama Team's strategy for "squaring the circle", that is, for keeping the big banks in private hands while purging their balance sheets of worthless assets at the public's expense. Here's how it's presented on the Fed's website:

"Under the TALF, the Federal Reserve Bank of New York will provide non-recourse funding to any eligible borrower owning eligible collateral... As the loan is non-recourse, if the borrower does not repay the loan, the New York Fed will enforce its rights in the collateral and sell the collateral to a special purpose vehicle (SPV) established specifically for the purpose of managing such assets... The TALF loan is non-recourse except for breaches of representations, warranties and covenants, as further specified in the MLSA"

Non-recourse funding? You mean, like a mortgage, where if the homeowner finds that he is underwater, he can just walk away and leave the bank to cover the losses?

That's right. The Fed and Treasury are planning to provide roughly 90 percent of the funding for toxic assets (for which Geithner will certainly pay "full price", making the banks "whole" again) which they will sell at firesale prices to their dodgy friends at the hedge funds and private equity firms giving them an opportunity to make boatloads of capital if the investments appreciate and, if they don't, just "return to sender". And it's all "risk free".

Is Geithner really so confident in his powers of persuasion that he thinks he can sneak this by the American people? Or will the task of selling the idea to the public be passed on to the banking lobby's number 1 "go to guy", Barak Hussein Obama?

The markets are not going to like the idea of recapitalizing the banks through the backdoor. Wall Street will see right through the smoke n' mirrors and react accordingly. The toxic assets have to be fairly valued; price discovery is basic to any functioning market. If the banks need recapitalizing, they will have to do it the old fashion way. They'll have to restructure their capital, which means shareholders get the ax, bond holders get a haircut, management gets the door, and the American people become majority shareholders. That's how it works in a free market. When businesses are insolvent; they file for bankruptcy and the debts are written down. Period. No exceptions. Geithner wants to rewrite the rules to help his buddies, but it isn't going to fly.
The Baseline Scenario's Simon Johnson put it perfectly when he said:

"Above all, we need to encourage or, most likely, force the large insolvent banks to break up. Their political power needs to be broken, and the only way to do that is to pull apart their economic empires. It doesn't have to be done immediately, but it needs to be a clearly stated goal and metric for the entire reprivatization process."

By Mike Whitney

Email: fergiewhitney@msn.com

Mike is a well respected freelance writer living in Washington state, interested in politics and economics from a libertarian perspective.

Mike Whitney Archive

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


Comments

codex
26 Feb 09, 06:25
Time to Break Up the Big Banks

It's called a 'scam' -- old boy.


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