Tuesday, March 24, 2009
PPIP bids and the geithner put
chanos remains skeptical that banks will want to lower the offer to complete much in the way of deal flow, but steve waldman on interfluidity illustrates a conspiracy theory involving a quid pro quo between the bank-directed treasury and the PIMCOs and blackstones of the world which would, by virtue of ridiculous bids, seal the deal.
My guess is that behind the scenes, Geithner has arranged a kind of J.P. Morgan moment. ...
I think that Treasury has already lined up participants for the "Legacy Loans Public-Private Investment Fund" and persuaded them to offer prices so high that despite the put, investors will expect to take a major loss. My little conspiracy theory is that the Blackrocks and PIMCOs of the world, the asset managers who do well by "shaking hands with the government", will agree to take a hit on relatively small investments in order first to help make banks smell solvent, and then to compel and provide "good optics" for a maximal transfer from government to key financial institutions. ...
Why would PIMROCK go along with this? Because they feel it is their patriotic duty to work with the government for the good of the financial system, even if that involves accepting some sacrifices. And because they hold $100B in J.P. Citi of America bonds, and they've received assurances that if we can get the nation out of the financial pickle it's in, there will be no haircuts on those bonds. "Shaking hands with the government" means that nothing ever has to be put in writing.
i have to admit, with so many hypothetical games afloat, that i'm skeptical enough of the PPIP to consider the possibility of such things if bids come in anywhere close to bank marks.
but the reality is that you don't need to get anywhere near such conspiratorial fraudulence to posit inflated bids because the embedded put option of non-recourse finance will support unrealistic bids. nemo at self-evident illustrates how, over a series of deals of varying value, overbidding on price is a reasonable outcome that realizes a high probability of investor return and guaranteed losses for the provider of leverage, ie the FDIC.
So say a bank has 100 of these $100 loan pools. And just by way of example, suppose half of them are actually worth $100 and half of them are actually worth zero, and nobody knows which are which. (These numbers are made up but the principle is sound. Nobody knows what the assets are really worth because it depends on future events, like who actually defaults on their mortgages.)
Thus, on average the pools are worth $50 each and the true value of all 100 pools is $5000.
The FDIC provides 6:1 leverage to purchase each pool, and some investor (e.g., a private equity firm) takes them up on it, bidding $84 apiece. Between the FDIC leverage and the Treasury matching funds, the private equity firm thus offers $8400 for all 100 pools but only puts in $600 of its own money.
Half of the pools wind up worthless, so the investor loses $300 total on those. But the other half wind up worth $100 each for a $16 profit. $16 times 50 pools equals $800 total profit which is split 1:1 with the Treasury. So the investor gains $400 on these winning pools. A $400 gain plus a $300 loss equals a $100 net gain, so the investor risked $600 to make $100, a tidy 16.7% return.
The bank unloaded assets worth $5000 for $8400. So the private investor gained $100, the Treasury gained $100, and the bank gained $3400. Somebody must therefore have lost $3600…
…and that would be the FDIC, who was so foolish as to offer 6:1 leverage to purchase assets with a 50% chance of being worthless. But no worries. As long as the FDIC has more expertise in evaluating the risk of toxic assets than the entire private equity and banking worlds combined, there is no way they could be taken to the cleaners like this. What could possibly go wrong?
in spite of this, it might fail anyway -- a lot of risk capital is gone, for one, and geithner needs to move well north of a trillion dollars in impaired assets.
the sad part is that this needn't be attempted. the senior noteholders can stay whole and the banks survive if they are given time and forbearance in a wide net interest differential environment. meanwhile aggregate demand can be managed by dredging excess domestic savings out of the banks in the form of government borrowing. it'll take time, but private sector balance sheet repair can be effected.
this sort of giveaway, however, is terribly dangerous. because you're going beyond managing demand by redirecting private savings through government to consumption, you need to either float debt internationally or accept a demand contraction. that means potential currency trouble.
and for what? not so the banks can be solvent -- they can get there in time anyway. no, so that the banks can be PROFITABLE, and quickly. it's perhaps the worst example yet of the avarice of a system that sees itself as beyond good and evil.
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