Second Verse, Same As The First
The Treasury today unveiled a fourth pillar in the battle to re-inflate the bubble to provide us with the asset prices to which we have grown accustomed. This one is focused on legacy assets, that is, mortgage backed securities and loans that have gone to custard, and a public-private partnership to pull them off the books. The idea is that the FDIC will evaluate the loans and assign a leverage ratio it feels acceptable. The FDIC will then backstop non-recourse loans to cover up to 85% of the purchase price for the securities. Or the Fed will provide loans directly, in the case of securities. The rest of the purchase price will be a 50%/50% split with the government matching private investors dollar for dollar to fill in the equity capital.
Of course, lest you forget, the other pillars of the crisis are:
- Falling Home Prices
- Frozen Credit
- Bank Capital Strength
I am struck by the notion that the second order effects here have been totally ignored and, when you factor that in, this makes the plan look more like price manipulation than anything else. Sure, it is great that the government plans to get "real market pricing data" in this way. (The comment on this morning's conference call was that the Treasury guys thought themselves clever but "not that clever." Very reassuring, no?) Of course, what data does or does not fall out of this little auction isn't "real market pricing data" any more than the old marks during the the high flying days of cheap government leverage and backstop fueled real estate bubbles were "real market pricing data." Any data that comes out of this process is pricing data with very cheap leverage. We don't know the interest rate of the loans but I expect them to look pretty cheap. The program will buy two kinds of assets. "Legacy Loans," and "Legacy Securities." In the case of the former, the buyer will fund the purchase by issuing debt which the FDIC will guarantee. In the case of the Legacy Securities, the Fed will loan directly to provide the leverage. Of course, in the case of Legacy Loans, this permits the bank holding toxic debt to replace it with low-risk FDIC backed paper and take advantage of the mark inflation as well as the difference between the debt portion and the purchase price- a little cash infusion.
So, this is really a subsidy. These assets are bought at above fair market value (since fair market value would not include the generous lending terms and low cost of capital of the government loans or backing) and this, surprise, pumps up any similar assets that are subject to mark-to-market accounting treatment. This is, of course, only the most recent attempt by the Treasury and the Fed to manipulate that particular dynamic.1
But what happens to these assets once we've used this mechanism? We are supposed to think that the efforts by the Treasury and the Fed to deal with "Falling Home Prices" will inflate the underlying assets, improve collateral and permit private investors to unload the assets on dumber money after enjoying the gains. It is not clear how this process is not directly at cross purposes with the other efforts by the powers that be to "make affordable to responsible borrowers, the American Dream of Home Ownership." So, we are going to inflate the assets again, and make them more affordable? With debt. Outstanding work!
We've seen this before, of course. For the last 10 years. What exactly is the endgame here? Just the hope that we can re-inflate the asset bubble and, before the day of reckoning, pawn these assets off on... who? The public? The Chinese?
- 1. This is no mystery. Clusterstock cites Paul Krugman's analysis pointing out basically the same thing.