One Small Problem With Geithner's Plan: It Will Bankrupt The Banks

The big problem with Tim Geithner's plan to fix the banks is the same as it ever was: The gap between what banks say their assets are worth and what the market says they are worth.

When a bank says an asset is worth 60 cents and the market says it's worth 30 cents, someone has to cover that spread. The genius of Geithner's plan is that it pawns most of the cost (and most of the risk) off on the taxpayer without the taxpayer noticing.

But unless the taxpayer gets stuck with the entire spread, which is probably what Geithner is hoping, banks that sell assets will have to take massive writedowns. This will start the whole cycle of violence again.

This risk to the banks is particularly acute when dealing with whole loans that the banks currently say they have no plans to sell. These loans are often carried at 100 cents on the dollar, because loans classified as held to maturity don't have to be marked to market. Even subsidized buyers won't likely be willing to pay anywhere near 100 cents on the dollar for these loans. So, here, the writedowns could potentially be huge.

And then there's another problem:

If the banks go through the exercise of putting assets up for sale only to have the bids come in at, say, 40 cents instead of the 60 cents on the books, the banks' accountants and/or federal regulators might notice. So even if the banks recoil in horror and refuse to sell at 40 cents, someone somewhere might insist that assets now carried at 60 cents be written down to 40 cents (after all, they won't have the "temporary illiquidity discount" excuse anymore, will they?). This will blow another huge hole in the banks' balance sheets.

Given this, banks would probably be wise not to participate in Geithner's plan. Which is why the government is already talking about forcing them to:

As the FT reports: "The unspoken fear here is that selling off loan portfolios would lead to more government capital injections into major banks," said an executive at a large bank...

Richard Bove, an analyst at Rochdale Research, wrote in a note to clients: "[The plan] will not happen because it would destroy bank capital. It might cause a bank to fail the new stress tests under way. Banks will not take this risk."

But while banks in theory have discretion over whether to sell loans, Sheila Bair, chairman of the Federal Deposit Insurance Corporation, said this decision would be made "in consultation with regulators" - a sign that the authorities might put pressure on banks to sell toxic assets.

It's time to face the fact that we have already de facto nationalized the big banks -- and that the way we've done it is worse than standard receivership and restructuring. The longer we remain in denial about this, the worse off we'll be. But that's another story...

See Also: Magna Cum Lousy: Where Today's Bad CEOs Went To School

 

 

Follow Henry Blodget on Twitter: www.twitter.com/hblodget

Comments

[Roger Smith - Huffpost Blogger]

Mr. Blodget overlooks one simple fact: what he so greatly fears--the exposure of this gap between the stated net worth of banks and their actual net worth--will not do anything beyond recognize an existing reality. If some of these banks are indeed overstating their true capital, then better to have this fact out in the open, combined with a way to make those assets liquid--even if at an unappealing price. Those banks that have only a portion of of their capital tied up in such "toxic assets" will find a market for them and dispose of them, enabling them to recycle the proceeds in new and productive loans. Those banks that will experience the exposure as seriously undercapitalized that Mr. Blodget so fears will, in all likelihood, begin the much-needed process of an orderly liquidation, under the FDIC's supervision. This will, deservedly, wipe out the investment of the old equity holders--and possibly some or all of the value of their debt instruments as well. This is the "punishment" that so many wish to see, but done in an orderly way that avoids the meltdown risk that Mr. Geithner is so wisely trying to steer past. As for Mr. Blodget, he should understand that calling a "solution" unworkable comes with at least some responsibility for indicating what approach just might be more workable.

[BubbaC33]

Here is a better plan for saving this nation from the economic crisis.
Have a Jubilee Day where all debts is forgiven for all individual US taxpayers. Have each person list all their debts and the government pays those debts. It gives money to banks, rescues credit card companies, takes care of freclosures, and heals the market. It will not cost more than the oney the government is throwing away now.
As for AIG and other banks, they made their bed, let them sleep in them. The folks in charge of these companies took big risks and failed, Let them pay or wrok it out for themselves. If individual tax payers are forgiven their debts what happens to AIG and others will not matter.

[katekid]

huh?

[jerrypl]

Come on everyone. Wake up!!!

Obama, Geither, Summers are serving the financial needs of the financial banking crime syndicate. If they had spent the trillions of dollars rebuilding manufacturing, the trade deficit would drop, workers would be re-employed, they would resume spending, home buying, and borrowing.

http://eye-on-washington.blogspot.com

[WierdWookie]

Henry, What are you thinking. According to the banks themselves, they are standing only because of the pricy bailout money they recieved.
Many banks already closed their doors.

[TheMadHedgeFundTrader]

There's a better way to do this. There is an easier, cheaper, and faster way to solve the banking crisis which no one is talking about on Capitol Hill. If collateralized debt obligations (CDO’s) are the problem, just get rid of them! Desecuritize them! Just convert them back into the underlying loans. There are $1.4 trillion in CDO’s outstanding backed by Alt-A and subprime loans in the form of 3,700 individual securitizations of perhaps 3.7 million loans. Over 68% of the loans backing these bonds are current. Mark to market rules are forcing the banks to carry this paper on their balance sheets at 50%-80% discounts. The problem is that mark to market is a meaningless accounting fiction when there is no market. If you break up these securities and place the underlying loans back on the banks’ balance sheets, the good mortgages can be valued at 100% of face, and those behind in their payments or in default can be discounted to maybe 70% because they are still secured by the value of the homes. This would boost the value of the entire asset class from the current 20-50 cents up to 90 cents on the dollar. Restored balance sheets would enable banks to resume lending. Of course it would be a massive admin job unwinding the rats’ nests behind some of these securities, but Heaven knows there is abundant subprime and Alt-A expertise available for hire these days. www.madhedgefundtrader.com.

[watchTVgetSTUPID]

Mortgages that have been rolled into one big toxic doobie and then sliced into ten pieces based on risk should be restricted from legal actions as the owner, because the owner of one piece can not identify which home mortgages he owns. Thus, the delinquant home owners should not be evictable.

The judges should make this stick. The result would be rapid restructuring the parsed doobie into traditional mortgage instruments. The current owners and administrater of the pieces will not restructure unless they are threatened to lose everything. This will allow mortgages to be given a higher market valuation which would help the financial institutions. Also the mortgage holder would be able to re-negoyiate where it made sense. (this is impossible now with the parsed doobie debts). Everyone wins except a few institutions who are currently guaranteed a steady stream of money for managing the parsed doobie debt instrument.

[ruberube]

The banks are all ready broke...

[peterg76]

"without the taxpayer noticing."

That part of the plan is already breaking down. No amount of financial techno-babble can disguise that much theft.

[DFL]

Sounds like more GOP f.e.a.r. mongering, they are out of material and all they got left is scaring everyone.

[Genep34]

Yes - repubs think of how they want things to be - always negative when it comes to what dems are actually trying to do positively - and then they speak as if it is true.

[noesis]

The post WW II, Bretton Woods system, was around for over half a century, but it'll soon be dust in the wind. American leaders still can't come to terms with the fact {at least publicly}.­...the financial system is insolvent. Our debtors are looking for a way out of the dollar. It's days as the worlds reserve currency are numbered.

[Tom95134]

Many of the banks are already bankrupt because they decided to play the investment game instead of the banking game. Those that are just hope you won't notice as they run around trying to get things sorted out.

[sposton]

"It's time to face the fact that we have already de facto nationalized the big banks -- and that the way we've done it is worse than standard receivership and restructur­ing."

Sure, most would agree with this, but I'd like to know what are the possible motivations for this course of action vs. something more rational? Why are they doing this?

BTW, read Jeffrey Sachs's opinion piece in todays' FT at

http://www.ft.com/cms/s/0/b3e99880-1991-11de-9d34-0000779fd2ac.html

"The Geithner-Summers plan, officially called the public/private investment programme, is a thinly veiled attempt to transfer up to hundreds of billions of dollars of US taxpayer funds to the commercial banks, by buying toxic assets from the banks at far above their market value. It is dressed up as a market transaction but that is a fig-leaf, since the government will put in 90 per cent or more of the funds and the “price discovery” process is not genuine."

[kid5rivers2]

Question! "How does one bankrupt a bankrupt?"

[kevinw]

Right now the assets are worth 0. Because the banks want them sold at bubble rates. The value they used when doing their 40 to 1 leveraging. Geithner has proposed a method to begin setting a realistic price for the faulty investment instruments. Some third parties will make a good deal of money off of this trade. The banks will lose some money, but will gain the advantage of having the unkown debt removed from their balance sheet. These assets must be addressed before the banks can recover. The only real solutions right now are for the taxpayer to eat the whole cost, provide leverage for third party sale, or wait the twenty years or so to see how many CDOs are backed by successful loans.

It seems that you are arguing both sides, so you can make some attack points against Geithner. It would be better if you were trying to move toward a better solution if you had one.

[Ozarks]

Your statement "But unless the taxpayer gets stuck with the entire spread, which is probably what Geithner is hoping, banks that sell assets will have to take massive writedowns. This will start the whole cycle of violence again" is flawed. The buyer of these assets will price these assets at an auction/market price. The buyer driving/initiating the offer is private not the government. If a private sector buyer stands up and offers to buy, say a house, the government matches his offer. So the taxpayer eating "spread" would not occur. . You are right "Even subsidized buyers won't likely be willing to pay anywhere near 100 cents on the dollar for these loans".. If however a buyer offers a price then the actual "balance sheet' value becomes transparent. The phony balance sheet "value" will be reduced to the price the market is willing to pay. The market place will set the price then reflected on banks' balance sheet. The bank will get stuck with the "spread" . And, like Kruger says, it will be evident which are "dead banks walking". Geitner is letting the market set the price on houses. What in the world makes you think the only way this hugh abundance of mortgaged houses will enter the market place as "bundled derivatives". I think no rational private buyer would buy a bundled derivative . The only way private auctions will work is if these bundled derivatives are broken up and houses be sold individually.