Bailing out Citi

When people say that Geithner’s plan is needed or that mark-to-market is “unfair” because the banks have assets that they have to price at $0, they are telling untruths.  This may be because they wish to exaggerate for rhetorical effect, are ignorant, or else are lying.  Geither’s plan and the rollback of mark-to-market transparency both exist because banks bought assets at bubble-era prices, and but they can no longer sell them at bubble-era prices.

Tim Geithner is trying to change this. 

. Despite bank and Administration smoke-blowing to the contrary, the problem with the so-called toxic assets on bank balance sheets is NOT that they cannot be priced, but that banks do not like the prices on offer from willing buyers. We have read anecdotes suggesting that the gap is as big as bank valuation 90-95 cents on the dollar versus market prices of 30 cents, but the typical example is bank holding price of 80 cents versus market of 30 cents.

So let us repeat, the purpose of this program is NOT price discovery, and any claim along those lines is a lie. The purpose is to keep the banks from recognizing losses that already exist, by reversing them via unloading the paper at a fictitious high price and dumping the loss on the taxpayer.

via naked capitalism: Treasury Trying to Defend Bank Gaming of Public-Private Partnership.

With our corrupt politicians serving zombie banks, it’s no wonder the top three banks in the world are now Chinese.

9 thoughts on “Bailing out Citi”

  1. i think the point is, what would we do instead? take over each “zombie” institution? ok. how do you do that? we can take over the FDIC insured accounts, but what legal mechanism do we have to take over prop desks, etc. of these institutions? i don’t think there is one. so we need to get one. once it is taken over, we sell the assets for whatever price we can get. guess what happens to the prices in that scenario? they go down. supply / demand.

    so this idea that geithner is dishonestly dumping the losses on the taxpayer, is in my view, radically untrue. in the takeover scenario, the losses are much higher. there is no way for the feds in that scenario to limit their losses beyond holding them on the sheets in perpetuity… which would cost the economy in other ways.

    it is quite probable that the banks will never get the prices they demand, and that is probably why there are rumors of price collusion going on. if this happens, it only makes takeover more likely. if it doesn’t happen, it means some losses are less than what they would have been.

    but there are still losses. no one disputes that. the question is at what price.

  2. Fed. X,

    Thank you for your comment.

    i think the point is, what would we do instead? take over each “zombie” institution? ok. how do you do that?

    Certainly, Obama+Geithner’s efforts to sabotage future attempts to roll-back their bailouts complicate this, but off the top of my a couple of methods are obvious.

    1. Allow the FDIC to seize the banking assets of the zombie banks. This is not limited to FDIC accounts, but typically involves the seizure of the entire institution in order to pay back the FDIC. While the conglomerate-nature of some of these institutions would complicate nature, as they would be insolvent without ongoing federal bailouts, it is hard to imagine they would long stay solvent without their deposit-taking institutions. At that point, the institutiosn would fail, Treasury could become the debtor-in-possession in bankruptcy court, etc.

    2. The assets that Geither is loaning speculators on to overbid on could instead be purchased under the eminent domain process. Assets that are marked-down 70% because of market conditions coudl be purchased for 70% off their face value. This forces the zombies to recognize losses, they become insolvent, the Treasury becomes the debtor-in-possession, etc.

    3. Obama could urge the US congress to pass a 90% marginal tax-rate (after gross income of $250,000) on all income (earned or unearned) accrued from institutions in possession of TARP funds as of May 1, 2009 (or some other appropriate date). This would be expected to create an insurmountable crisis for those firms that cannot pay back TARP loans. At which point, the Treasury can provide needed capital or else become the debtor-in-possession, etc.

    There are many mechanisms Geithern could use. But his priority is to save the oligarchs, not to prevent future raids on the Treasury.

    so this idea that geithner is dishonestly dumping the losses on the taxpayer, is in my view, radically untrue. in the takeover scenario, the losses are much higher. there is no way for the feds in that scenario to limit their losses beyond holding them on the sheets in perpetuity… which would cost the economy in other ways.

    I am not sure what the logic here is.

    If the MBSs perform, then the government has essentially a lump of 20 year annuities. Federal cash flow is presumably not a problem here, and the Treasury is repaid.

    If the MBses do not perform, then the Treasury takes this loss over time, instead of immediately (when the speculators cannot pay back the purchase price to the Treasury).

    it is quite probable that the banks will never get the prices they demand, and that is probably why there are rumors of price collusion going on. if this happens, it only makes takeover more likely. if it doesn’t happen, it means some losses are less than what they would have been.

    A report on an example of such collusion, from FT and CR [1,2]

    but there are still losses. no one disputes that. the question is at what price.

    Agreed. The oligarchs and their supporters wish the loss to be as small as possible, and heavily mediated by welfare checks from the Treasury.

    I disagree with that position.

    [1] http://www.ft.com/cms/s/0/358e479a-1fbf-11de-a1df-00144feabdc0.html?nclick_check=1
    [2] http://www.calculatedriskblog.com/2009/04/report-banks-considering-gaming-ppip.html

  3. tdaxp: if you don’t see the logic involved in the notion that taking over an insolvent institution generates an immediate loss, then i’m not sure how to convince you. also, i don’t think you are appreciating the transaction costs involved in nationalization. they are significant. they are a key reason why, in the c.11 process, you don’t typically see creditors coming in an running the company… instead you see a DIP loan to the existing management, with maybe a token replacement at the head level here and there. (see Obama in the car industry – he’s operating like a DIP lender… indeed somewhat more advanced that the financial industry right now because although a GM 11 would be massive, it is mainly the same plays we’ve all grown up on.)

    now… as to what is going on in the financial industry. we don’t have a clean 11 process for banks. the reason for this is their entanglement in so many other industries. they are not really the heart of our economy, but they are akin to the entire vascular system. killing off that system (which is what 11 is) kills the patient. whereas in a GM 11, you don’t kill the industrial system, but rather cleanse it.

    so we can’t let an 11 happen (or if we do, it must be pre-packaged, orderly, and concise). what we really need, and what is universally acknowledged as a pre-requisite going forward, is a chapter 11 analogue… call it chapter 15 of the bankruptcy code… which is used only for systemically significant financial institutions. remember, what bankruptcy does is twofold: it winds down the debtor without causing strife and civil unrest, and it creates a market for distressed assets that is orderly. it does this by using the incredible leverage creditors gain in a chapter 11 process.

    so obama needs leverage (not the kind that got us in the mess, but shear bargaining power).

    here is an article that i believe adequately characterizes the evolution of the situation today…

    http://www.bloomberg.com/apps/news?pid=20601103&sid=aylbeokVZaWo&refer=us

    Most believe the price of these assets to presently be in the quarter to 35 cent range.

    Banks say bullshit. well, they do so at their own peril, but then again they know that an 11 for is an 11 for all and we aren’t going to be able to withstand that. they have their hands on the toaster over, its plugged in, and we’re in the bathtub with them.

    how do we kill off the banks without frying ourselves? carefully. and obama is really doing this. i no it doesn’t look like it because of the overt political displays, but it is really what they are doing. they are getting the banks to the point where they can either write down their assets now, sell them now for current prices, or go see the undertaker. but it won’t be all of them that go see the undertaker. we’ve rehabbed enough of them to the point where they are marching to our beat. so its not such a great place to be a bank ceo these days. the gig is almost up.

  4. Weird question just came to mind: If you dissected these “toxic assets” like an owl pellet, what would you find? Are some of the components cleanable with resources the government has? Will the toxic nature of some of the components fade with time until they’re salable again? Is it possible that some of the components can’t be cleaned or otherwise rehabilitated and have to be destroyed (hit on the economy and all)?

  5. Fed. X,

    Thank you for your comment

    Perhaps you could explain what you meant by “in the takeover scenario, the losses are much higher. there is no way for the feds in that scenario to limit their losses beyond holding them on the sheets in perpetuity.”

    instead you see a DIP loan to the existing management, with maybe a token replacement at the head level here and there

    I have been able to witness this uncomfortable closely before. It strikes me as the clearest example possible of the principal-agent problem.

    I have been thinking bankruptcy laws should be changed to prohibit this,.

    so we can’t let an 11 happen (or if we do, it must be pre-packaged, orderly, and concise).

    You didn’t establish this, so you can’t say “so.” You gave an analogy, that’s all.

    . what we really need, and what is universally acknowledged as a pre-requisite going forward, is a chapter 11 analogue… call it chapter 15 of the bankruptcy code… which is used only for systemically significant financial institutions.

    I agree.

    how do we kill off the banks without frying ourselves? carefully. and obama is really doing this. i no it doesn’t look like it because of the overt political displays, but it is really what they are doing. they are getting the banks to the point where they can either write down their assets now, sell them now for current prices, or go see the undertaker. but it won’t be all of them that go see the undertaker. we’ve rehabbed enough of them to the point where they are marching to our beat. so its not such a great place to be a bank ceo these days. the gig is almost up.

    I hope this true. I am not sure it is, though. Obama has purposefully constrained his own leverage, maintaining as much operational independence by the banks as possible and giving them sources of capital that allow them to stagger on as zombies.

    I hope Obama is better than this.

    Like with Bush in the Iraq War, there is no way to tell until the effects come in. Conservatives and Republicans made a great mistake by following the Bush line that the War was being won in 2004 and 2005.

    Michael,

    “Toxic assets” are refer to a large class of assets where (a) the current market price is approximately 50% below the purchase price and (b) the current owners of the assets are politically powerful.

    So an oil speculator is not sitting on a lake of “toxic assets,” because he is not politically powerful.

    A banker sitting on assets which experienced exactly the same decline as oil has a “toxic asset,” because he is politically powerful.

  6. alirght… i’ll try to explain. lets say you own a gas station. your gas station has a snack counter, a coca-cola machine (glass bottles of course, so you get deposits for returns), a repair shop, and four gasoline pumps.

    your gasoline pumps are the bread and butter of your business. they keep the lights on. but your margins are best on the candy, pop, and snacks you sell. those sweet tooths of american roadsters have provided many a vacation for you and the mrs.

    then there’s the repair shop. you keep customers happy here. it allows you to afford to keep a mechanic on site 24 hours a day, which keeps the cars coming in. occassionally you fix a wrecker and sell it for good coin, but that’s really occasional. it more or less pays for itself.

    then one day your realize that your mechanic can not only work on car engines, he can work on boat engines, and with a popular fishing lake near by, this is big business.

    you convince a few of your fisherman friends to spread the word about your mechanic’s ability to service boat mtors. they bring some problem outboards by and sure enough he gets them serviced. soon, a line forms, then a longer line, you have to higher more boat engine mechanics to keep the line down. this goes on for awhile an dyou pocket a decent profit.

    you get the idea that when not in fishing season, you can keep this boat repairmen occupied by fixing junked outboards and selling them. you do this for 10s, then 100s, then 1000s of them during the off season and find plenty of buyers out there.

    you even change the name on your sign from “TDAXP’s Pump & Dump” to “TDAXP’s Outboards and Repair” reflecting the change in your business strategy. with demand so high for outboards, and concurrent demand for outboard repair, you are making money hand over fist. you even have one of the largest inventories of repaired outboard motors in the world. you have pricing power over everyone on the lake. you rule the outboard motor world (at least at this particular lake). you’re a regular master of the universe, only no jets.

    then one day, some liberal do-gooder takes a water sample from the lake, and finds out that the lake is filled with carcinogens. so many that you might as well take a bath in a toxic waste dump as soon as boat around this lake. this long haired, obama-voting, pot-smoking, do-gooder sends the test results to the NY times. and boom, overnight, the lake pretty much dries up. “No fishing” signs posted everywhere. Boat ramps shut down by the state. The place is a virtual ghost town.

    Now you’re in trouble. You lay off some of the outboard repair men, and staff the gas stsation yourself. Your’e still making money selling gas (not quite as much of course, volume is down, but people still drive on the roads, they just don’t fish anymore). You’re still making money selling candy (everybody has a sweet tooth). You just aren’t making any money, and indeed were losing money as the trades you purchased a month ago just recently came in and are still due, on the outboard business.

    YOu need capital, gotta pay the payables. What to do? Well if you tried to sell all your outboards right now, you’d get nothing for them. Everyone is selling right now, they’re essentially worthless… even though yours are the most crafted and elegant ones ever made, its a buyer’s market baby.

    You ask me if I want to take you over. I say: “hell no, I won’t take you over, but I will help you unload those outboards.”

    Do you see why I would say that? The reason I would say that is, I don’t shit about gas stations. And I ran your gas station, I would have to immediately mark down all your outboards as liabilities given the local market conditions. BUt, I do know that your problem is simple: you don’t have a local market for your outboards, and if I can get your outboards to a larger market without much of a mark-up, I can clean up for you and me.

    The old saying: Diamonds are girl’s best friend…. well, we’re going where the girl’s are. I rent a trailer, haul your outboards to Florida’s lakes, and sell them all summer long for a huge profit. The only operating capital I needed was for a driver, a girl with a TDAXP’s t-shirt to sell the outboards, and some gas money (which you floated me being your line of work and all).

    Had I taken over you company, I would have had to deal with your employees and all their liabilities (which would be immense, as they aren’t finding gainful employment anytime soon and I’d be on the hook for their unemployment benefits), I would have had to deal with all those stupid commercials you placed for the upcoming fishing season, I would have had to deal with all sorts of things I don’t want to deal with, nor have the resources to deal with.

    Now, you got your cash and I got a profit for taking a hot little thing in a t-shirt around the lakes of Florida for a summer selling out boards with all my gas money paid!

  7. Fed X.,

    Thanks for your comment.

    I’m not sure what the purpose of your comment is. It describes a business that went from a low-risk, low-profit strategy to a higher-risk, higher-profit strategy. The business ran into hard times it would not have experienced, and learns first hand that most painful of business realities: “profit is theory, cash is fact.”

  8. well, this is why i’m not a professor. i was trying toe xplain why it is that operating an insolvent, or temporarily insolvent (call it “impaired”) business is always a more costly endeavor than trying to shed its legacy assets. it isn’t a problem in the bankruptcy process by the way. it works out quite well. the management effectively works for the creditors until the 11 is completed, and then new equity is issued (which is mostly owned by us GUCs btw).

    lets make it simpler. each TBTF has an asset base of $A. the toxic assets represent a percentage of $A. How much by the way do you suppose they are worth?

    For the costs of PPIP (which by the way is: $A-TA -> MV – nrl) to be the nearly the same cost as nationalization, then the TA% must be 100% of $A or more.

    of course, if thats true, which is highly unlikely, then it doesn’t matter which option we choose as they would cost the same since under either scenario there is nothing left for equity.

    The more probable result is that TA as a % of A is well less than half. which means as long as liabilities are are not more than 50% of assets, then there’s still plenty of equity.

    Lastly, there’s the burn… the cash necessary to operate these entities. It takes a lot to run a bank, and you lose that as soon as you nationalize until you finally triage the healthy parts of the bank and firesale the TAs.

    I guess all I’m trying to say is, you are looking only at the asset side of the equation. But if you nationalization, you need to also look at the liabilities which you’ll be taking on.

  9. Fed X.,

    I guess all I’m trying to say is, you are looking only at the asset side of the equation. But if you nationalization, you need to also look at the liabilities which you’ll be taking on.

    This is a good point.

    The Treasury should signal and unwillingness to bail-out creditors of nationalized banks indirectly, in the manner you are suggesting. Rather, if they require assistance, the Treasury should use the already existing TARP mechanism.

    The Treasury has already provided a back-door bailout for Goldman Sachs and others [1]. This is damage that will be difficult to undo.

    [1] http://www.tdaxp.com/archive/2009/03/29/welfare-queens.html

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