Geithner Plan 2.5 More exotic ways that a bank could buy transfer exposure to the taxpayer.
Geithner Plan 2.5
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- In the second Geithner video, I lay out a scenario where a
- bank could-- let me draw its balance sheet.
- Let's say-- oh, that's not how I wanted to do it.
- Let's say this is a bank.
- It's holding-- let me draw its assets and liabilities.
- So it's holding some toxic asset A right here.
- And that could be the bank's equity, that's its
- liabilities, And this is the other assets for the bank.
- So it could hold some toxic asset A, and we lay out a
- scenario where, what the bank could do, right now it has
- 100% exposure to A.
- What it could do is it could take a little bit of cash,
- lend it to another party.
- Let's say it could lend it to a hedge fund, so this becomes
- a loan to the hedge fund.
- So now the hedge fund owes this money to our bank and it
- now has the cash on its balance sheet.
- So this would now, instead of being cash, it'll be called
- loan to hedge fund.
- Now this is the hedge fund's balance sheet.
- Its liability is loan from bank.
- And now it has this cash, and then it could use this cash to
- invest in essentially the Legacy Loans Program, the
- public-private investor Legacy Loans Program that Geithner
- talks about.
- And if they did this, they could take this-- let's say
- this was $7.
- They could take this $7, contribute it to the equity in
- the program.
- The Treasury would contribute another $7.
- The Fed would contribute $84, and then they would have $100,
- and I know this is kind of messy, but they would have
- $100 that they can then use to go buy these assets.
- And the net effect of this is that this bank went from
- having 100% exposure to this toxic asset to having only $7
- exposure through this loan to this hedge fund, or this
- special-purpose entity, or whatever you want to call it.
- And I got a couple of emails, even from some colleagues, to
- say, well, can this really be done?
- And my kind of knee-jerk reaction was, well, if this
- can't be done, they'll figure out a way to do it, because
- there's billions of dollars at stake, and really, the
- incentive here is structured to do it.
- And frankly, the Government probably wants them to do it,
- because on some level, even though this would be a massive
- transfer of exposure and wealth from the taxpayers to
- the banks, it would on some level solve the problem.
- And if people really aren't aware of it, everyone will be
- happy about it, because all of these banks, Citibank and Bank
- of America, will just survive, and they can just kind of say
- that all's well.
- So what I wanted to do, just to answer those questions, is
- get a little bit particular about the wording.
- And I got an email.
- Leigh Logan actually emailed me, and she highlighted one
- clause in the Legacy Loans term sheet that seems to
- address what I talk about in that second video there.
- And this is from the Legacy Loans terms sheet.
- It says: "Private investors may not participate in any
- PPIF"-- so this is that Private-Public Investment
- Fund-- "that purchases assets from sellers that are
- affiliates of such investors or that represent 10% or more
- of the aggregate private capital in the PPIF."
- So the question is what's an affiliate?
- And I looked it up in the Securities Exchange Act of
- 1934, and there are multiple definitions.
- But this is probably the best one.
- It says: "The term affiliate means any company that
- controls, is controlled by, or is under common control with
- another company." And that's an area that I just outlined.
- This bank really doesn't control
- this hedge fund, right?
- They just essentially gave them a loan with very little
- stipulations on it, and then the hedge fund can go do it.
- But, you could say, oh, well, you know, there's nothing that
- this bank could do to force this hedge fund to buy these
- assets, so maybe this plan won't work.
- And another thing is what's the definition
- of the private capital?
- You also can't represent 10% more of the
- aggregate private capital.
- Frankly, when I think of private capital, I think more
- in terms of equity investments, but maybe the
- definition of private capital also includes debt
- investments, although, I doubt it.
- So in this video I want to lay out a scenario that,
- essentially, it can do the same thing economically, and
- in fact, the exact behavior that they want in other
- parties without being in any way an affiliate of the
- counterparty and in no way giving
- capital directly to them.
- So what Bank A could do instead-- let me redraw it.
- Actually, not Bank A.
- The bank that's holding toxic asset A.
- And this is what I thought of after kind of thinking about
- it for about five or ten minutes.
- You could imagine what the banks will come up with when
- they have billions of dollars and careers on the line.
- So if you have a scenario where you have this toxic
- asset A, and you economically want to do what I describe,
- but you don't want to be an affiliate and you don't want
- to give the appearance of self-dealing, what you do is
- you sell credit defaults on A that become supercheap, so you
- have essentially $7 exposure of credit defaults.
- Let me do it this way.
- So what you do is you sell credit default swaps.
- So let's say you sell $7 of exposure.
- So your liability right here, is a seven-dollar CDS
- exposure, and I'll go over the economics of how
- this works in a second.
- And you actually get some of the income stream.
- It wouldn't even be accounted this way.
- You normally just have to-- if you're insuring $7 worth of
- credit default swaps, your liability isn't $7.
- You do the probability of default and all that, so your
- liability will probably be-- I don't know, $1.00, whatever it
- is, and you get some income stream for it.
- But the general notion is that you sell credit default swaps
- on this toxic asset, on A, for really cheap.
- And just so you know what a credit default swap is, I've
- made a couple of videos on it, it is essentially an insurance
- policy on a loan or on a company, and if that company
- or this loan defaults, you say that you are going to pay up
- essentially the insurance amount.
- So what you do is you sell $7 of credit defaults swaps on A.
- And just so you know, most of these toxic assets that these
- banks hold, these are assets that they were the originators
- for, and so, they're very particular to
- the individual banks.
- So a bank can definitely say I'm selling a credit default
- swap on A, and they know that, in the end, when I kind of
- outline this whole thing, they'll be the main
- beneficiary of it.
- So if you sell $7 of credit defaults swaps on A, what
- would I do?
- Well, I'm a hedge fund.
- What I do is I buy those credit
- defaults for really cheap.
- And then I invest in the TALF, right?
- So let's say I'm a hedge fund, and I have two things.
- I have a $7 investment in the TALF-- sorry, in this Geithner
- Plan, and then I also have this credit default swap, this
- insurance contract.
- And just so you know, depending on the price, you
- pay a certain amount every year.
- But the key here is that this bank could sell it, if they
- wanted to, for almost free.
- They could essentially give away these
- credit default swaps.
- So if that bank did it, then the hedge fund's assets would
- have the $7 investment in this Geithner program, and then
- it'll have $7 of credit default swap protection.
- Now what happens to this hedge fund?
- In the world where asset A is worth a lot, they get all of
- the upside through their investment in
- the Geithner Plan.
- That $7 investment gets levered to $100.
- Let me actually draw that again.
- So that $7 investment is here, $7
- capital, $7 from the Treasury.
- You have $86 from the Fed, and they use this to give the cash
- here, and then that goes back here, and you're
- holding toxic asset A.
- Now if toxic asset A ends up being worth a lot of money,
- then this is worth a lot, and this is worth nothing, And
- that's OK, because the hedge fund essentially paid nothing
- for it or paid next to nothing for it, in which case,
- everyone kind of works out well in that scenario.
- On the other hand, let's say that this thing is worth zero.
- Let's say that this thing defaults.
- If that thing defaults, then this investment is worth zero.
- But guess what?
- The hedge fund had an insurance policy, where this
- guy was a counterparty.
- So he says, hey, this thing here defaulted.
- I'm going to claim my insurance policy, so this
- guy's going to have to send him $7.
- So it's economically the exact same thing that I outlined in
- the Geithner Two video, but in this situation, these guys,
- it's almost an arms-length transaction.
- But this bank can make that behavior happen by essentially
- going into the market and selling credit default swaps
- for this exact asset for really, really cheap.
- And this is just the first way I thought about it.
- There's other ways you could do it.
- If you're just a separate hedge fund and you own enough
- of the shares in a bank, let's say you owned all of the
- shares of the bank or a good percentage of the shares of
- the bank, then you would also have an incentive to go out
- there and use the Geithner Plan and lever up and buy
- these assets.
- Another thing is-- I don't want to get too technical --if
- you kind of hold one of the fulcrum pieces of debt, the
- pieces of debt that are trading at a discount, because
- you're afraid that this bank is going to fail, if you hold
- a bunch of those assets, you still would want to
- participate in the Geithner Plan and funnel money and use
- the Government money to essentially buy this asset A.
- I mean, the general theme here is, if you have two people, if
- this is the private world and you have a scenario where
- person A, if a transaction can make $100 or he gets rid of
- $100 exposure, and person B essentially has a potential
- loss of minus $7 of exposure, there's a net transfer of
- wealth here.
- You went from $100 of exposure to $7 exposure for this guy.
- So someone is offloading the $93 of exposure to this stuff,
- and that's the Government.
- The Government's only taking the down side.
- So this is a huge subsidy of exposure, and it depends what
- these are really worth, if this thing is really worth $30
- and it's a $63 exposure, but any time you have this, the
- private sector is going to figure out a way to make this
- subsidy happen.
- And everything I've outlined so far is if A is the bank
- that has 100% exposure, all they have to do is, through
- whatever back-door scheme or financial product or insurance
- or whatever they want to do, or loans that have very little
- stipulations on it, they just have to give this guy
- essentially $7 of compensation somehow that gets around the
- Government rules, and then this transaction will occur.
- And I hope it doesn't occur, and it's very possible it
- won't, because maybe I'm missing something here, but
- I'm just saying that everything I understand about
- the Geithner Plan is that there's a huge incentive for
- this to occur, and this is frankly the only reason why
- the plan would work.
- Because, as I outlined in the other videos, for a private
- investor who's not incentivized in this way, the
- put option that the Government is giving them still is not
- enough of a rationale to go from paying $30 for an asset
- to going to pay $60 an asset.
- So it won't work if this behavior doesn't occur.
- The only way that the plan quote unquote will work and
- people will overpay for the assets is if you have this
- type of action going on.
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