At the risk of costing us the noise-to-signal ratio record, an asset purchase plan post:

[Kurt_and_Hunter]

Re-posting what was voted the least interesting thread from yesterday despite the fact that it discusses a genuinely surprising aspect of the Geithner asset auction plan of which 99% of DUers (myself included) were most likey unaware.
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One of the chief defenses of the Geithner plan is that though it won't be super effective it represents an advance in the much needed process of price discovery on the obscure and unpredictable assets that weigh down bank balance sheets.

If that were true it would indeed be useful. But since the entire price discovery framework is based on paying people to offer prices they would never offer if you were not paying them to do so it's kind of silly. BUT at the very least it offers a framework that will result in sales at "market" prices, right? Even "market" pricing is better than nothing.

Whoops! Not so fast... Here is the process. Banks contact the FDIC to offer assets of the bank's choosing for auction. This is entirely voluntary on the part of the banks. All that stuff about how this will allow examination of the banks' assets is nonsense. The FDIC already knows everything there is to know about these banks assets except how they will perform, which nobody knows. And there is no aspect of the Geithner plan that compels any bank to disclose anything whatsoever. Turning things over to the FDIC for auction is voluntary on an asset by asset basis.

But even that might lead to some sort of pricing which is better than nothing.

So imagine my surprise to read that the banks do not have to sell at the auction price. After the auction is held the bank can go through lot-by-lot and pick which offers the feel like accepting.

This makes the term "auction" somewhat misleading. Auctions are unique because "acceptance" (as in "offer and acceptance") has already happened. Once the auction begins the seller has accepted a sale price yet to be determined. All parties agree to that in advance. In an unreserved auction if the crown jewels are hammered down at $5.00 then somebody got the crown jewels for $5. In a reserved auction there is a secret minimum bid, the "reserve", known to the auctioneer and the consignor, but not the bidders. But it is still set before the fact. The seller cannot (legally) change the reserve during the auction. Any bid that hits the reserve constitutes a sale... not an offer, a SALE. (An auction can also have a public reserve, usually caled a minimum bid. Again, any winning bid that meets the minimum is a sale.)

But it turns out that these Geithner "auctions" are not even reserved... they are not auctions at all! There is no predetermined bid-level that will result in a sale. They are just solicitations of bids with no obligation to accept any bid at any price. The seller looks over the bids after the fact and decides whether he feels like accepting any of them.

That is called "fishing." Soliciting non-binding bids on the chance someone offers too much. It's like someone putting a perpetual "for sale" sign in front of their house because, what the heck... if someone offers them a million dollars they'd sell.

Worst... price discovery frame-work... ever.

The stated justification for subsidizing private parties to play while the government puts up 90% of the money--versus the government just buying directly--is that private investors are smarter and less likely to over-pay and will develop a "real" market. And if assets were forced onto the market and then sold at an auction that would make sense. But since the banks control both ends of the process (deciding what to "auction" and then deciding whether to honor the auction price) then the private involvement makes less and less sense... take away the cardbord scenery and the plan is that banks sell these assets for whatever price they want, or they don't sell.

As I have often stated, I am not an enemy of the Geithner plan in the abstract. I do not think it is more fiscally harmful than the alternatives. It does, however, consume political capital. (As does any expenditure at this point.) So what's the point? It is potentially costly and not clearly efficacious.

There is, however, a ray of light: My best guess as to the actual, like "for real" reason for the Geithner asset plan is not to do the best thing, but to turn the FDIC's power to loan money into a de facto congressional TARP appropriation. The TARP fund is down to about 135 billion with no more money in sight so the plan is to subsidize "private" sales with the FDIC, doing them as loans so losses don't appear right away. If the FDIC loaned a trillion dollars to the Treasury Department to buy bad assets outright it would be a little too obvious.

The private investor is the "beard"... a public cover for the fact that the FDIC and the banks are sleeping together. It is a clever arrangement... at least until the wife finds out.

We will be paying whatever the bank wants for these things as a means to shovel money into the banks, but by having a private party front the deal we can finance it as loans to a private party (that don't have to be repaid if the assets go bad) instead of purchases. No appropriated money up front. Then down-the-road congress will have no choice but to cover the losses (if any) because the alternative would be letting the FDIC fail.

I am all for getting money into the system, so that's cool... sort of.

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Gaming the Legacy Loan Auctions

I finally got a chance to read through the PPIP plan in detail. I noticed one curious point: under the program as announced, auctions for the legacy loans do not appear to be binding on the contributing entity.

The Process for Purchasing Assets Through The Legacy Loans Program: Purchasing assets in the Legacy Loans Program will occur through the following process:

Pools Are Auctioned Off to the Highest Bidder: The FDIC will conduct an auction for these pools of loans. The highest bidder will have access to the Public-Private Investment Program to fund 50 percent of the equity requirement of their purchase.

Financing Is Provided Through FDIC Guarantee: If the seller accepts the purchase price, the buyer would receive financing by issuing debt guaranteed by the FDIC. The FDIC-guaranteed debt would be collateralized by the purchased assets and the FDIC would receive a fee in return for its guarantee.

This is quite odd, since, if I read it correctly, it turns the entirety of the program into a put option for participating banks. That is, they could identify certain assets, put them up for auction seemingly risk-free, check the result, and reject anything below their internal valuation without any further capital contribution.

The structure, which seems to be confirmed by the term sheet (”Once a bid(s) is selected, the Participant Bank will have the option of accepting or rejecting the bid within a pre-established timeframe”), amplifies the lemons problem that Simon and James mention in their LA Times op-ed. If the plan revolved around binding auctions, a temporary market for the toxic assets could develop while investors make government-guaranteed “probing” bets on the precise toxicity of the assets for sale. If banks wanted the auctions to recur instead of being a one-time event (perhaps to sell a larger or more diverse set of loans), they might mix in some good assets with the bad ones. This move would assuage concerned investors and probably make it easier for the banks to get approval from their regulators for the particular sale. Investors who were smart/lucky enough to win the good assets with bids below their “worth” to the bank on a medium-term basis would then get to profit from their decision. Other buyers would want to follow suit, at least until the point in time when they would expect a bank to cash out on any previously established confidence with a large offer of only toxic securities that would earn a lot of money even in the absence of future auctions.

By contrast, if banks can selectively reject bids, they could offer an enticing mix of good and bad assets (say, 50/50) and then accept only the ones that grossly overpay for the bad ones. That is, they would get full power to exclude intelligent, accurate price setters from the auction process, undermining the efficacy of the program to an even greater extent than adverse selection would in a committed-sale context. Of course, it is not clear whether the current setup is objectively worse than the repeated-game lure-and-hook scenario, but the question is worth considering.

http://baselinescenario.com/2009/03/29/gaming-the-legacy-loan-auction

[Kurt_and_Hunter]

1. ...

[slipslidingaway]

2. K&R before it gets lost. n/t

[Zodiak]

3. Thanks, I read it in detail.

I am not an economist, so expressing a concrete opinion is probably a minefield at this point.

But what I see here is not good. There still is no oversight and the banks have way too much power to drive everything. I have no faith in the banks doing the right thing by the American people, and I cannot understand why we would write policy that is based on such faith.

[Kurt_and_Hunter]

4. I don't think anyone expects the banks to do the right thing

The plan makes more sense only if one accepts that its purpose is to pay too much for lame assets. It is an intentional subsidy to the banks themselves.

That sounds like a rip-off, but it is actually the whole point. One way or another we are going to move a boat-load of money into these banks.

I would prefer that we pull the band-aid quickly and find myself being pro-nationalization of the top money-center banks, but not fanatically so because it's an ungodly complicated topic.

[Political Heretic]

8. This only works if we can get the prices high enough, which is doubtful at best.

Banks want 100.

Investors only want to pay 10.

After huge, massive taxpayer banking, investors pay 10 plus 50 from the American people for 60.

Banks won't sell - want 100.

We come back to the drawing board.

[Usrename]

5. Aren't there hundreds of trillions of this stuff?

Or is it just tens of trillions masquerading as hundreds of trillions? Or is that the question these auctions are supposed to answer?

[tkmorris]

6. Thank you for the "meat" in this post

There hasn't been near enough actual analysis around here lately, just a lot of popping off at the latest rumor.

This seems to be an extremely convoluted method for getting the government (i.e., you and I) to pay way too much money for assets the bank doesn't want. These bankers aren't stupid, no one is going to get a bargain on anything here. It seems this plan does 2 things: A) It allows the banks to identify which assets they want rid of, and B) Name just about whatever price they want to for them, no matter how inflated. All paid for by the American taxpayer. I don't need to point out that this is a sucker deal for us, that's obvious, but what is the point of all the theatrics to accomplish it? Is the idea to make it so complicated that most people don't understand it anyway, so they won't bitch too much about it?

[Kurt_and_Hunter]

9. Yes, I think the convoluted method is creative (politically disguised) financing

The question boils down to whether it is desirable to move a big chunk of money into the banks.

If that is your goal then it makes no sense to pay 'fair' prices for bank assets... over-paying gets more money into the banks, which is the point.

If it is desirable to move a big chunk of money into the banks then this is a very shrewd way to do so.

If it is not desirable to move a big chunk of money into the banks then this is a bad move wrapped in a scam.

I generally agree with the need to shovel money into the banks but this current method is so fishy it tends to move me toward favoring accomplishing the same thing via forced receivership. (If we are going to shovel $trillions into the banks I would prefer we control the process.)

[Raineyb]

10. In other words, the plan is to allow the banks to overinflate what they're worth

by buying assets that are worth nothing at the inflated price at which the banks have these items on their books thereby making sure we continue to pump up the bubble.

I can't say anything good about a scheme it's blatant robbery.

Regards

[Political Heretic]

7. I was trying to point this out from the damn beginning.

What many are afraid is going to happen is that banks WONT SELL because they are waiting for prices that investors WONT PAY and we'll all be back at the drawing board again in three months only with 600,000 MORE jobs lost.