'Intelligent discontent is the mainspring of civilization.' -- Eugene V. Debs

Friday, March 27, 2009

Gaming the System 

On Monday, Treasury Secretary Timothy Geithner announced his plan, long anticipated, for addressing the trillions of dollars in toxic debt held by US financial institutions:

Administration officials outlined a three-part Public-Private Investment Program that offers private investors vast amounts of cheap, taxpayer-supported financing for every dollar they put up of their own money.

In essence, the Treasury and the Federal Reserve will be offering at least a tablespoon of financial sugar for every teaspoon of risk that investors agree to swallow.

“There is no doubt the government is taking a risk,” Mr. Geithner acknowledged at a briefing for reporters. “The question is how best to do it.”

Under one main component of the plan, the Federal Deposit Insurance Corporation would oversee a program in which banks offer bundles of whole mortgages for sale to investors. The F.D.I.C. would set up an auction for each bank portfolio, allowing a bank to sell the mortgages to the investor that offers the highest bid.

But the crucial incentive for investors — traditional fund managers, hedge funds, private equity funds, pension funds and possibly even banks — is that the government would lend as much as 85 percent of the purchase price for each portfolio of mortgages.

On top of that, the Treasury would invest one dollar of taxpayer money for every dollar of private equity capital to cover the remaining 15 percent of the portfolio’s purchase price.

The arrangement is similar to some of the distressed-asset sales arranged by the Resolution Trust Corporation, the federal agency that was responsible for cleaning up the savings-and-loan debacle of the early 1990s.

But the scale of the new program is much bigger.

In addition to the F.D.I.C.’s program, the Treasury would help finance a series of public-private investment funds to buy up unwanted mortgage-backed securities, or pools of mortgages that have been packaged into bonds with a credit rating.

Those two programs alone could buy $500 billion to $1 trillion worth of troubled assets, according to Mr. Geithner. The Treasury would kick in $75 billion to $100 billion from the Troubled Asset Relief Program as equity.

But the Treasury could pump almost $1 trillion more into the toxic-asset effort through a program called the Term Asset-Backed Securities Loan Facility, or TALF, a joint venture with the Federal Reserve.

Joseph Stiglitz was not impressed, and probably lost any future invitations to Obama administration economic policy forums with his scathing remarks:

The U.S. government plan to rid banks of toxic assets will rob American taxpayers by exposing them to too much risk and is unlikely to work as long as the economy remains weak, Nobel Prize-winning economist Joseph Stiglitz said on Tuesday.

"The Geithner plan is very badly flawed," Stiglitz told Reuters in an interview during a Credit Suisse Asian Investment Conference in Hong Kong.

U.S. Treasury Secretary Timothy Geithner's plan to wipe up to US$1 trillion in bad debt off banks' balance sheets, unveiled on Monday, offered "perverse incentives," Stiglitz said.

The U.S. government is basically using the taxpayer to guarantee against downside risk on the value of these assets, while giving the upside, or potential profits, to private investors, he said.

"Quite frankly, this amounts to robbery of the American people. I don't think it's going to work because I think there'll be a lot of anger about putting the losses so much on the shoulder of the American taxpayer."

Even if the plan clears banks of massive toxic debt, worries about the economic outlook mean banks could still be unwilling to make fresh loans, while the prospect of a higher tax burden to pay for various government stimulus plans could further undermine U.S. consumers, he said.

But you really didn't need a Nobel Prize winning economist to tell you that, did you? And, of course, you must already know that the banks that went broke making these loans have already figured out how to game the system:

As Treasury Secretary Tim Geithner orchestrated a plan to help the nation's largest banks purge themselves of toxic mortgage assets, Citigroup and Bank of America have been aggressively scooping up those same securities in the secondary market, sources told The Post.

Both Citi and BofA each have received $45 billion in federal rescue cash meant to help prop up the economy and jumpstart the housing market.

But the banks' purchase of so-called AAA-rated mortgage-backed securities, including some that use alt-A and option ARM as collateral, is raising eyebrows among even the most seasoned traders. Alt-A and option ARM loans have widely been seen as the next mortgage type to see increases in defaults.

One Wall Street trader told The Post that what's been most puzzling about the purchases is how aggressive both banks have been in their buying, sometimes paying higher prices than competing bidders are willing to pay.

Recently, securities rated AAA have changed hands for roughly 30 cents on the dollar, and most of the buyers have been hedge funds acting opportunistically on a bet that prices will rise over time. However, sources said Citi and BofA have trumped those bids.

The secondary market represents a key cog in the mortgage market, and serves as a platform where mortgage originators can offload mortgages in bulk that have been converted into bonds.

Yields on such securities can be as high as 22 percent, one trader noted.

BofA said its purchases of secondary-mortgage paper are part of its plans to breathe life back into the moribund securitization market.

"Our purchases in [mortgage-backed securities] increase liquidity in the mortgage market allowing people to buy a home," said BofA spokesman Scott Silvestri.

A Citi spokesman declined to comment, though people familiar with the bank say it argues the same point.

Citi's and BofA's purchases highlight the challenges both banks face while operating under intense public scrutiny.

While some observers concur that the buying helps revive a frozen market, others argue the banks are gambling away taxpayer funds instead of lending.

Michael Hudson describes in this informative article why the government subsidy for this program induces banks to engage in the behaviour already attributed to Bank of America and Citigroup.

As for long term consequences, Mike Whitney nails it, connecting the toxic assets plan with Geithner's request for more regulatory powers that would enable him to seize non-bank financial companies, such as insurance companies, hedge funds and investment firms:

Prediction: If Geithner is granted these special powers by the braindead Congress, the country will undergo the greatest period of bank consolidation in its 230 year history. This is a blatant power grab by a shifty character who has risen to his present pay-grade by nosing his way up the political stepladder. Congress had better get its act together and put an end to this nonsense or the nation will continue its fast-paced metamorphosis into a feudal oligarchy run by the Bank Mafia and Wall Street racketeers.

Geithner, Summers and Bernanke aren't just allowing transnational financial institutions to game government assistance programs purportedly required to stabilize the economy, no, it is bigger than that. They are allowing them to game the entire American political system, with the intention of consolidating even more power within a small financial elite.

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