Page 2 of 2 Down the dark path
By Julian Delasantellis
It is when the $12 reaches the FDIC that the magic begins. There, the $12 used
as collateral for loans, will be "leveraged" up to six times, to create $72 of
new money to buy toxics. Adding that to the original $12, the PPIP now has $84
that could be used to make bids for toxics that the banks might find more
acceptable.
Let's say that's exactly what happens - that the PPIP buys a package of toxics
from a bank for $84. Let's also stipulate that, as the real estate sector
improves, the value of the toxic asset rises to $100. In terms of the face
value of the toxic, its value has gone up 19%, but that $16 return, shared
50-50 with the government, means that the value of the original $6 put in by
private equity has risen by 133%, to $14. It is these huge potential returns
that the
Geithner plan believes will spur the competitive bidding that will drive prices
up to levels to which the banks will agree.
What if the reverse happens, if real estate and toxic prices continue to fall?
If the value of the toxic security purchased by the PPIP declines by, say, $12,
then the PPIP is essentially wiped out. The government seizes the interest of
the private party, who walks away, freed from any further obligation. In that
case, the government is stuck with full ownership of a dud of a toxic security,
with the taxpayers fully on the hook for all further losses.
Anybody who has ever purchased a stock on margin can recognize this process -
you can buy a $100 stock with $10 in actual equity and $90 in margin, but don't
be surprised when a $10 decline in the stock totally wipes out your entire
investment.
But after the taking apart of the plan in the blogosphere, many of its happy
assumptions seem to ring hollow. On the Calculated Risk blog it is noted that,
although the plan spotlights the desired 50-50 split between public and private
capital commitments, the actual plan has the private commitment possibly much
less, possibly 20% private and 80% public. In that case, the private commitment
to the plan essentially becomes a fig leaf - the government, through the TARP
and FDIC commitments, becomes liable for up to 97% of the losses of any package
of toxics purchased in this manner. Other blog observers claim that, in all the
Geithner plan, the government, the taxpayer, is on the hook for up to 80% of
all losses, but for only 50% of the gains.
Personally, I can't see the logic in assuming that the various PPIPs will
commence such a frenzied round of bidding that prices for the toxics will be
driven to levels that the banks will be willing to let them go .
Assuming that a PPIP wins an auction for a basket of toxics, what then,
particularly for the private sector component of the partnership? Hold on to
the mortgages in the securities until they hopefully mature in two, five, 10 or
30 years? Nobody wants to do that - being able to package securities and shoot
them out the door to the next sucker, err, buyer, was what securitization was
created for in the first place.
No, what any private equity partnership or hedge fund worth its red suspenders
is going to want to do is report profits to its principals really fast, like in
the next quarter. For that, they'll need the value of whatever stake they took
in the basket, be it the 3% in the Calculated Risk scenario, or the 7% in the
government best-case scenario, rise to a level representing more in value than
what they put in.
A sharp, near-term rise in real-estate values could accomplish that, but very
few people, if anybody, are expecting that. Should real-estate prices continue
to decline at their current rate of around 3% a month, it will be all but
impossible for these deals to make money for the private investors. They will
walk away from the deals, leaving the government on the hook for the whole
loss.
The private sector interests in the PPIPs had the big government assistance
that allowed them to bid as high as they did. The next round of buyers won't,
so it is reasonable to expect that their bids will be concomitantly that much
lower.
It is vital to remember the banks' crucial role at the start of this process.
They decide which toxics are going to be thrown into the sale pool. It is
reasonable to assume that the banks know better than anyone which of their
mortgages will pay off like slot machines and which are the foulest of lemons.
Everyone will assume that the banks will only throw into the pot their most
malodorous, fetid foul and fusty toxics, choosing to hold on to the good ones
until they can once again be sold for par. That should certainly inhibit
secondary sales of the toxics out of the PPIP; for that matter, it won't do a
lot for the prices attainable at the first sales, either.
Some bloggers are suggesting that the Geithner plan may have a better chance of
success should the Treasury use the current bank capital adequacy "stress
tests" to strong-arm the weak banks into letting the toxics go at prices the
private entities can make money with at resale. I suggested this early this
year (see Perhaps
a cool hand, Asia Times Online, February 18, 2009) but the
Obama/Geithner team has shown no indication to utilize that strategy, not then,
not now. That it hasn't speaks volumes about the reality of the current
situation.
Fiddle with the radio dial, or do a quick perusal of the Internet and you'll
quickly see America's new president variously described as a socialist,a
communist, a Marxist, a Leninist,a Marxist-Leninist, a Trotskyite, a Stalinist,
a Maoist, a Shining Path, a Khmer Rouge, a Marcusian, an anti-gun, a bad bowler
- all right, that last one's by his own admission.
The truth is far more pedestrian. Actions, such as the Geithner plan, when he
could have opted for the perhaps much more effective strategy of bank
nationalization, prove that what Obama is becoming is, in fact, a rather
ordinary left-wing contemporaneous politician.
There hasn't been a real leftist in power in any major industrial democracy
since the first days of Francois Mitterrand's rule in France in 1981. The
French leader's early policies of income redistribution and government control
over the economy were bitterly resisted by the business elite, which then took
to selling the French franc hard against the then currency king, the
deutschmark. Mitterrand soon relented on his dreams of socialist utopia; for
the rest of his 14-year term, he entered the mold of what we now expect from
leftist leaders - helpmates, buddies, partners to big business, not
antagonists.
It was certainly that way with the triangulation politics of Bill Clinton in
America , and the "third way" socialism of Tony Blair in Britain, of Gerhardt
Schroeder in Germany, of Bettino Craxi in Italy and Jean Chretien in Canada.
In choosing to go down this course, favoring banks over his own taxpayers,
Obama seems to be starting down this sad path. "Beware!" Yoda warned Luke
Skywalker. "Once you start down the dark path, forever will it dominate your
destiny." That was certainly true with Bill Clinton, elected on waves of hope
but leaving office putting his signature on the accursed 2000 Commodity Futures
Modernization Act, which whelped the derivatives nightmares of today.
At the very least, Obama's detractors should choose a new insulting moniker
other than "socialist" for a man who favors his banks over his taxpayers - or
are they, perhaps inadvertently, in actuality displaying a greater
understanding of the real experience of socialism than we first thought?
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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