So What Do We Think Of Geithner's Toxic Asset Plan?
I've spent some time in the past few days looking at Geithner's plan to stimulate the purchase of toxic assets from banks. I've also spent some time reading what my favorite finance bloggers think of it. My friend Roger Ehrenberg is mildly impressed but concerned that there is no forcing function to make the banks sell. I have not spent much time reading the opinion pages other than to note that Krugman hates it (surprise surprise - he wants us to take over the banks).
But I am most interested in what you all think of it. We've got plenty of sharp investors and smart people who can read, think, and analyze here at AVC and I'd really like to know what you all think. You can leave a comment with your thoughts and if you leave a link to a post of your own, I'll link to it here.
To get the conversation going, I've turned to no other than my "treasury secretary" Jeff Minch (who I disagree with on all things politcal, but agree with on most everything else). You all know him as JLM and he was our first guest blogger a month or so ago. Here's his thoughts on the Geithner plan. Please let us know yours.
Dr Tim’s Excellent Elixir
The circus is back in town and Dr Tim is peddling a new potion promised to cure the problem of “legacy loans and securities” or toxic assets. These bad boys have been creating gas and obstructing digestion at the banks and thereby have prevented the flow of loans as current values have caused painful deleveraging of balance sheets absorbing available capital and have exacerbated the natural unwillingness of these banks to extend credit to jump start the economy. Whew!
The call to action of this plan is to finally and bravely (well, a four martini kind of bravery) attempt to PRICE the toxic assets. There is a real timid, coy element at work here, not a bit unlike winking at the pretty girl across the bar.
To dispel the suspense, the plan --- The Five Guys Toxic Assets Auction Plan --- intends to do this by conducting a beauty contest to select five (5) Fund Managers to form, fund and manage Public-Private Investment Funds to competitively bid on packages of loans and securities offered for auction by banks which currently hold the toxic assets. That’s it. That’s all there is!
The rest of the plan is simply about how the government intends to co-invest on the equity side (match the equity raised), loan money to finance the transactions (up to 85%) and participate in the upside on the sale side (pari passu w/ the private equity).
As a plan, it is the recognizable journeyman-like work product of a competent investment banker complete with an executive summary, white paper, term sheet, FAQ and application to participate. It is not a prospectus, it is a deal sheet. You have to give them good marks for the general thoroughness of the communication. Take a look at the Treasury’s website and you will see all of this. The only thing missing is the Power Point presentation. Hell, they even have an e-mail address to ask questions.
There are things to like, a few to dislike and a few to question. In no particular order:
1. We are finally doing something about the 800 lbs gorilla sitting in the corner and frankly the plan is well laid out from a communication perspective. Any reasonably perceptive financier could understand and model the plan. I leave it to you, the markets, the economy and the banks to decide whether it is a good plan. It is an understandable plan.
2. The toxic assets initially are only assets which were once upon a time rated AAA. Huh? This is not a huge portion of the universe of toxic assets and this is likely the low hanging fruit. So I wonder how effective the process is really going to be.
3. The big job of the “private” participants is to price the toxic assets. This has always been the object floating in the punchbowl. I don’t like the idea that only five (5) bidders will attend the auction. My sense is that at a certain level of pricing there could be many more folks who would make a bid. My market sense is that more bidders means higher auction prices.
4. Here is a subtle point --- as bidders exhaust their funds available, isn’t there the possibility that realized auction prices will go down dramatically? Simple liquidity trap. This argues for a wider set of bidders and a more expansive embrace of bidders who might bring their own financing. Should a deal be viewed differently if NO public money is involved?
5. In addition to the auction not being very broad, the sellers can withdraw the toxic assets from the auction if they do not like the prices. Hmmmm, this kind of feels like a cheap way for a bank to get an appraisal on their toxic assets. Maybe I am overly suspicious.
6. The government financial leverage is huge. The government will match the equity raised and will fund up to 85% of the deal. The private Fund Managers therefore only have to contribute about 7% of all the money in order to get half of the upside and some negotiable fees.
7. There even seems to be an argument that the private money could use NO public money on the equity side and thereby achieve a 6:1 leverage by providing up to 15% of the funding. A 15% equity investment earns 100% of the upside. That would be my personal favorite. In for 7% to get 50% or in for 15% to get 100%?
8. The expansiveness of the government’s funding also argues for a broader field of auction bidders because the government is “non-recourse” and secured solely by the assets.
9. The Fund Managers --- picked by the swimsuit and talent portions of a Treasury run beauty contest --- are sure to be large firms and I worry that they are not nimble enough to deal with the vagaries of litigation, foreclosure, renegotiation or obtaining payment on a huge, huge, huge number of individual mortgages. There is a skill set required to liquidate the underlying assets which is not the normal ken of big asset management firms. Isn’t that how we got into this problem in part?
10. OK, the line forms to the right for all folks who WANT to be partners with the government given the recent AIG/Wall Street demonization. What happens if you make too much money? Sure, the government gets their chunk but who wants to be successful and get demonized? Perhaps there is a derivative security that can be developed to hedge this risk? LOL
11. It is not clear how this plan will coordinate with HASP and other mortgage plans.
12. The Fund Managers can charge fees to run the deal with almost no restrictions on what they can charge the private money but the government --- in a welcome display of savvy deal making --- will only pay fixed fees from its share of the distributions or winnings. Bravo!
13. The banks find themselves in a very odd situation as it relates to their regulatory capital. Without boring you with the details most of these assets are going to be Class II or III assets for regulatory purposes and if the selling prices are very low could cause real regulatory capital problems. On one hand, the government flushes out the toxins and on the other hand the government must subsequently further shore up the bank’s capital. Proving that no good deed goes unpunished.
14. There is a 10-year mind set at work here while the real engagement phase of the RTC/S&L crisis was more like 5 years. Note that almost everything this Administration tackles has a 10-year time frame involved.
15. This needs to happen quickly to be effective and it clearly will not happen quickly. There is a chemotherapy element to the timeline which troubles me greatly. Right now, unfortunately, I would be long cancer. A ghoulish analogy for which I apologize.
Let me conclude by saying --- this COULD work. This is the RTC but with a public-private wrinkle and with the financing pre-arranged. The paltry list of bidders seems a real flaw to me. It is difficult to imagine a rallying cry being: “Rally around the asset managers, boys! And give them hell!” But, hey, it COULD just work.
Let’s give credit where credit is due. While it has been easy to take cheap shots at the Secretary of the Treasury and he added a bit of fuel to the fire with his timing, this plan is the best piece of work that has been presented thus far indicating that he is teachable.
Who would have expected less from a guy who grew up in Zimbabwe, India and Thailand and has an Ivy League degree in Asian studies and government with a graduate degree in international economics and East Asian studies? BTW, did you know that his father while in the employ of the Ford Foundation worked with Ann Dunham-Soetoro on Indonesian microfinance programs? Who is AD-S, you ask? Barack Obama’s momma! Karma, kismet! We are saved!