On Mon, 23 Mar 2009, SA wrote:
>> The Treasury will match the equity the private hedge funds put in
>> dollar for dollar. And all leveraging is applied will apply to both
>> equity returns proportionately. So whatever upside they make, we'll
>> make.
>>
>> The private investors will have an incentive to bid as low as possible
>> to make the most amount of money, and we'll make the same.
>>
>> What am I missing?
>
> You're missing the fact that most of the purchase price is not financed by
> those dollar-for-dollar, public-private equity investments. Most of the
> price is financed by *non-recourse* loans from the Treasury, secured by
> the bad assets.
Not in this program. Leverage on the Legacy Loans program comes from debt issued by the PPIP, backed by the joint capital, guaranteed by the FDIC (after they they do an inspection to see how much they'd be willing to guarantee, with a limit of 6-1 leverage.)
In the Legacy Securities program, the Treasury provides loans up to 2 or 3-1, and then the program can use TALF from the Fed (terms yet to be assigned).
> So yes, if the assets perform great, the taxpayer will profit along with
> the hedge funds. But if the assets decline in value, the hedge funds
> will default on the loans and all the Treasury gets is the bad
> collateral.
Well obviously if the assets decline, there is no upside. But are you saying you'd rather we put up all the money up front just so we could benefit from the huge coming upside?
To be honest, I think it's kind of misleading to even talk about upside. Bank crises cost money. The strategy is to minimize how much it costs us, not to maximize how much we make.
> So the hedge funds' downside exposure is limited to their small equity
> investments, whereas the Treasury's downside exposure equals its small
> equity investments *plus* the entire value of the loan (minus the
> recovery value of the bad assets).
This is how a bad bank aka Asset Management Fund works: the government take the bad assets out of the banks, and if they go bad, the governmetn eats it.
I fail to see how our risk of suffering loss is any larger in this arrangement than in a normal bad bank arrangement.
> The only way it's not a giant give away to Obama's hedge fund donors is
> if the assets all perform great, which is precisely the premise of
> Geithner's plan. However, if, as informed people believe, the assets do
> badly then the Treasury will be on the hook for lots of money while the
> hedge funds get off almost unscathed.
This is what everyone says, but I don't understand it at all. If there's an upside, we share it 50/50. If they go bad, then (a) at least we've removed them from the banks, which is huge plus for the economy, and largely solves the banking crisis; and (b) we've conned hedge funds into taking a multi-billion dollar hit with us on something that normally we'd have to take ourselves.
If hedge funds are simply willing to co-invest on these terms it would be a huge vote of confidence. They'd only do it if they thought they'd make money. In which case, so would we.
Again, I'm still failing to see the scandal. Even though it's echoing throughout the blogosphere like I'm in an alpha helmet.
AFAICT, the real possibility of failure is that private investors won't bid high enough for the banks to be willing to sell. But as I said before, if that happens, it costs no money, and it sets the stage for something more intrusive. If would pretty much prove the market price that was less than the book price, and the banks would pretty much be cornered.
Michael