Thursday, March 26, 2009

Banks Buying Assets to Sell Through Gov't Programs... Does It Even Matter?

FT Alphaville (via Zero Hedge):

Shows Goldman’s estimates for how banks are carrying assets like commercial mortgages and consumer loans on their books. According to the table, they’re carrying those assets at ludicrously optimistic averages of between 89 per cent and 96 per cent of their original purchase price. Yeah. Right.

That preposterous positivity has huge implications for Tim Geithner’s toxic asset plan, or PPIP.
The chart below details one such asset, commercial mortgages, are still priced at or near par, which I'll agree is a joke...

BUT, (fortunately or unfortunately), I don't think this will have any impact on the Public Private Investment Program "PPIP". Why? Because it turns out banks may have no intention of using the program for these assets. Dealbook with the details:
The Treasury Department recently unveiled its plan to lift mortgage-linked securities off banks’ balance sheets. But Citigroup and Bank of America have been buying those assets in a hurry from the secondary market, The New York Post reported.

The two banks, which have each received $45 billion in federal bailout money, have been buying up AAA rated securities, including some based on alt-A and option adjustable-rate mortgages, the paper said.

One trader told The Post that Citi and Bank of America were sometimes paying higher than market rate for the securities. A Bank of America spokesman said that the purchases would help increase liquidity in the mortgage market.
But does it even matter? Lets visit both sides.

"Yes... it Does matter!" Camp

Yves at Naked Capitalism has a view similar to my initial reaction:
It certainly looks as if Citigroup and Bank of America are using TARP funds, not to lending, which was one of the primary goals of the program, but to scoop up secondary market dreck assets to game the public private investment partnership.

And it fleeces the taxpayer a second way: the public has spent enough money on both banks so that in an economic sense, they ought to have been nationalized, yet for reasons that are largely ideological and cosmetic (the banks' debt would need to be consolidated were nationalized), they remain private. So not only are they seeking to extract far more than was intended even with the already generous subsidies embodied in this program, but this activity is also speculating with taxpayer money.
While I do understand why Yves is so critical and my personal distaste for the system (and banks in particular) is growing each and every day, lets go to the opposing camp as played by my alter-ego...

"Only Injecting Liquidity and Propping Up Prices" Matters Camp

According to the Treasury, the goal of the PPIP is:
To restart the market for legacy securities, allowing banks and other financial institutions to free up capital and stimulate the extension of new credit. The resulting process of price discovery will also reduce the uncertainty surrounding the financial institutions holding these securities, potentially enabling them to raise new private capital.
How can this be accomplished by banks selling legacy assets at above market value and not by banks buying assets at above market value, only to sell to investors at an even higher value (all made possible by subsidized loans)? My view is it works in either or neither scenario. In both cases the PPIP is able to transfer liquidity into the market, which props up asset prices. The main difference is whether the process is contained in the banking system or not. In the latter, if a pension plan and/or mutual fund can sell assets at an above market price to the banks, then those pension plans and/or mutual funds were provided "liquidity". If this results in a higher clearing price and additional cash to spend on new issues... great!

As detailed at the start of this post, in either scenario banks weren't going to sell assets held on their books for remotely their fair value. In the first scenario, the clear winners involved were:
  • Banks (they were provided a way to recapitalize via selling assets at above market prices)
  • Investment managers (they get to market a new revenue generating fund to investors)
  • Wealthy investors (they receive a taxpayer subsidized loan - I say wealthy because like investing in a hedge fund, to qualify you will likely need to be wealthy)
It is clear who were not the big winners. The average investor who owns a lot of these "toxic assets" in their pension plan or in a mutual fund. They likely would have only seen the benefit if and when the PPIP helped increase the performance of the security via secondary effects to the broader economy.

In other words, this only shifts around when and where the money is going, not the mechanism created to add liquidity. Assuming the banks aren't just buying / selling from each other (I don't see the benefit of that), but accumulating these assets for the PPIP, then it may also result in the following:
  1. The liquidity in the market increases (i.e. it becomes not only a one-way seller's market)
  2. The market value of these securities increases (more buyers = increased demand = higher prices)
  3. The banks will in turn sell these new assets at a premium through the PPIP to those that would not have been natural buyers of these securities
  4. Rinse repeat, until asset values reach a new equilibrium price
  5. Marginal assets previously overstated on balance sheets are now closer to the new equilibrium (refer back to #2)
Trust me, things will never work out this perfectly, but why should the banks and "wealthy" investors have all the fun?


  1. Jake,

    i understand yopur logic here.

    this whole thing may indeed increase liquidity.

    but that doesn´t change the simple fact the outcome of this thing will be a steady silent transfer of toxic assets from the fincnial sector to the PPIP hence the taxpayer.

    the official is that the lack of credit is the main reason for the current low prices of theses assets.

    so they provide the credit to manufacture significant leverage.

    fine by me.

    but here´s the thing:

    if the lack of financing is the real problem - then why do we provide the loans on a NON RECOURSE basis?

    why not on recourse basis or at least at 50-50?

    there´s only one reason...

  2. trust me... we're in agreement.

    but, there is another reason. the non-recourse nature makes certain investors that would not be interested... interested. the result is more participants.

  3. "the non-recourse nature makes certain investors that would not be interested... interested."

    who wouldn´t want a near free lunch? ;)

  4. i do! if anyone out there comes across a close-end fund for retail investors to take advantage of the TALF or PPIP... LET ME KNOW

  5. Actually there was an interview on CNBC today with someone who was forming a new closed end fund that would allow public participation in Toxic Assets. If I can find a link I will post it for you later... odd thing was that at the time I was listening I thought "That's dumb", then I came across this post and now see what the attraction would/might be!

  6. OK, that was easier to find than I thought it would be - It is an interview with Mark Fetting, CEO of Legg Mason:

    "Toxic" Opportunities at CNBC Video

  7. i appreciate the link!

    unfortunately i think this may end up being one of those funds that you need to be an accredited investor (i.e. $1mm in net wealth). we shall see.