Geithner Plan: Details To Remove Toxic Assets

The problem with the ridding of toxic assets is getting someone to bid for it.  They want private capital to be used, which rightly or wrongly has potential investors skeptical.

Lets backtrack.  In September, the original plan was the government to buy the toxic assets from the banks to open up lending.  Pundits all said it would be a bargain.  That the taxpayer would not be hurt.  That this would open up the financial system.  The assets would be priced in an auction process.  Those auctions were to take place in a few weeks from the time of the plan.

As time went on, no auctions.  Instead the goverenment added capital to the banks via direct injections.  This was to open up the lending.  What they found out, however, is you can not re-leverage an economy when it does not want to re-leverage.    Instead consumers pulled back.  Why?  The IRA is halved.  The stock portfolio is halved.   The home price is down sharply.  The baby boomer kids are in college and tuitions are going up.   So, the kitchen remodel is not being done.  The new cars are not being bought.  Velocity of purchases has slowed.  Consumers don’t want debt.

From the bank side, they too continue to de-leverage.  They see added risk in lending to a consumer who’s balance sheet is shot.  Who have less net worth.  Who may have a job today, but may not have one tomorrow.  Each month that shows 600K  jobs lost, means more homes will be foreclosed.  It means lower prices on the assests that are behind the toxic paper.

So with that said, what is the value of this toxic paper?.  As 600 jobs get eliminated a month, the toxic banks own may be getting more toxic (if that is possible) .   So the price they auction the toxic assets may well be a big surprise.   The bid in the auction may not be acceptable to the banks.

To try and get around this, the government will put a floor on the potential losses and provide financing help (i.e. leverage the purchase).   This may in fact help the pricing a bit.  However, in evaluating a potential purchase as an investor, I would be more concerned about what I was buying and whether its cash flow will continue to be paid.  In a booming market, the value is easy to price - after all the assets are moving higher.  In a declining market that has job losses piling on, stock prices declining, and house prices falling, get the crystal ball out and hope the pool of mortgages in that instrument don’t include people who lose their jobs or foreclose on their home, who aren’t exposed to larger than normal stock losses.  Who’s kids tuition costs are not rising.

Maybe the price can be found?  Maybe that price is not as low as I fear?  Maybe the incentives provided will lift the tide for all mortgage pools in the secondary market which will increase bank strength and make them more sound?  And all of this slows the decline.

Time will tell.  In the meantime there is a US Treasure Auction  of 32 billion 3 year t-notes today.  Tomorrow they auction 21 billion of 10 year notes, and 14 billion of 30 year bonds on Thursday.  The record auction is a stark reminder of the cost of the initiatives.  The results will be a barometer for the demand for the highest quality debt.  If the auction does not go well, how good will a toxic auction go?

Subscribe by RSS Subscribe by Email

Comment by Bo Moran

2009-02-12 03:56:03

Pricing toxic assets and non-performing assets is very tricky. What I have been reading about the Mo Mod platform built by Smithfield & Wainwright addresses both aspects. If the “true underlying value” is not properly determined by un-biased appraisal, the taxpayer will be totally exposed. We need to know value “QUICK” which will allow markets to start the healing. I would like to know the full details of Mo Mod and if it does provide an exit strategy to the taxpayers!

Reply to this comment