Under the Treasury Department's toxic asset proposal, the government puts in 85% of the investment in these assets through a loan given by the FDIC. The Treasury puts in another 7.5% of the money and the private investor contributes the final 7.5%
This is a guaranteed way of transferring money from the American taxpayer to the private investors. Let me show you how.
Let's take two assets that the government and investors buy together, both at the purchase price of $100 million. Now, assume that one investment does great and goes up by 50% (to $150 million) and the other one does poorly and goes down by 50% (to $50 million).
Well, the combined assets would still be worth $200 million, so the investors and the government should be exactly where they started, right? Nope. Look at the financial magic in this plan that makes the money disappear from the taxpayer and appear in the private investor's pocket.
In the investment that went down, since the private investor is part of the original 15% deposit, he actually gets wiped out when the loan cannot be paid back. That's really bad for the investor and he has lost his whole $7.5 million. This is the risk that Geithner is talking about to the private investor.
The government on the other hand does not lose all of their money. They had put in $92.5 million, but now that's down to $50 million, so they lose $42.5 million. Unlike the private investor, they got something back. But they lost a lot more money.
Now, when you look at the investment that went up in value, the government has done well. They get 50% of the profits because they put in 50% of the deposit (the loan from the FDIC does not count toward divvying up the profit from these assets). So, the asset went up $50 million and the government gets $25 million in their pocket.
But when you look at the private investor he has done even better. He gets the same $25 million for his 50%, except he only put in $7.5 million to begin with. Why does that matter? Because when you add up the profits and losses for both investments, something funny and tragic happens.
The private investor put in an initial $15 million in to the two assets. He lost $7.5 million in one and wound up with $32.5 million in the other (profit plus initial investment). So, he's at $17.5 million profit overall.
The government on the other hand put in a combined $185 million into the two assets. They lost $42.5 million in one of them and made $25 million in another. Will you look at that? The government lost $17.5 million from the same exact investments with the same exact results. The $17.5 million magically got transferred from the government to the private investors.
Well, that's the magic of leverage. If you put in the great bulk of the money, you take the great bulk of the risk. If I put in a small amount of money but share equally in the rewards, then I make money while you lose money.
Oh, one final thing. Do you know who the government is? That's us. The American taxpayer. This will literally be coming out of the taxes you pay on the money you work so hard for. This toxic asset plan will pick your pocket to pay off some of the richest people in America. If you think that makes sense, then you deserve to have your pocket picked. What's that about a fool and his money ...