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Geithner plan 6: A better solution

A better way to solve the "liquidity" and "price discovery" problem. Created by Sal Khan.

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  • blobby green style avatar for user william.c.adair
    Is it possible (probable) that the transparency you advocate would expose corruption of a sort that would make potential buyers even less interested in these assets? Is the federal government covering up significant corruption to protect friends and even the reputation of the American economy?
    (13 votes)
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  • blobby green style avatar for user Dave Sasscer

    This sounds like an excellent solution. Since it hasn't been implemented, there must be some resistance. What are the arguments agains it?
    (4 votes)
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    • blobby green style avatar for user dlaskew
      I think some of the resistance would be time frame it would take to organize such a federal operation. It doesn't necessarily give the banks the selling price (i.e .60 cents on the dollar) they require to be solvent. It would probably yield them a lesser amount. Thus, it doesn't halt the domino effect of bankruptcy within banking system but instead only shrink the financial industry. This action plan leaves the tax pay off the hook,however, would still create havoc just on a smaller prolong scale. The Economy would also recover slower since the banks capital wouldn't be free up as it would have been in the previous plans.
      (2 votes)
  • blobby green style avatar for user PatvanN
    How could the value of these CDOs be so obscured? If I am understanding the structure correctly, the CDOs were continually garnering interest depending on the default rates. If default rates reached a certain point, the entire CDO would become worthless and stop producing interest. Couldn't one just look at the interest coming in from the CDOs to determine their value? Or was this whole discussion in anticipation of future defaults (i.e. for the time being the CDOs were still behaving normally)?
    (1 vote)
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  • duskpin ultimate style avatar for user tuannb1997
    I do agree with you about letting the banks go bankrupt - they deserve it after all ! ! ! But I've got a question: if, instead of taking subsidies from the government, the bank decides to throw it's toxic asset to the market to let investors decide how much the asset is worth, would anyone bother, or consider, valuing it ? Due to Asymmetric Information - investors aren't fully aware of what's inside those CDOs - they would be reluctant to invest in such assets, therefore I think the solution is just like dumping waste into the river, which does only evil - poisoning the whole market and triggering a financial catastrophe.
    (1 vote)
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  • blobby green style avatar for user Louise Des Bois
    Sal, i'ts not a US concern only, those CDO were well coted by agencies, many nations bouth those toxics papers.
    How can we protect our self ??? Buy gold ???
    (1 vote)
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  • male robot donald style avatar for user Eric
    Comment: Brilliant. What you are really suggesting at and just before when you state that what the government should really do is make the "toxic" securities transparent - what you are really doing is calling their bluff. Well done!
    Eric Davis
    (1 vote)
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  • leaf green style avatar for user Derek Chia
    well if they would have let those banks be bankrupt, then the gov wouldnt need to have QE1, QE2 and so forth..
    (1 vote)
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Video transcript

In the last couple of videos, I've been dumping on the Geithner Plan. Arguably showing that if right now the market is willing to rationally pay $30 for a security, even with the free put option that the government's willing to give, at most a rational investor who was willing to pay $30 is now maybe willing to pay $40 to $50. And that still won't meet the hurdle that the banks need in order to clear these assets off their books. Because, we've done it in a bunch of videos even when I did the videos on the first bailout, the TARP plan, that if they sell them for less than $60, that's the number you hear in a lot of the popular press, that the banks will essentially be insolvent. So they're not even willing to sell for less than $60. So if this is the case then the plan won't work. Right. It just won't work. It won't work. Now, there's the other scenario where, let's say we do see a bunch of trades where they are going for $60, $70, $80. And based on some of the arguments I've given in the previous video, I'd say well, the only rational person willing to pay $60-plus would be the banks themselves by creating some type of off balance sheet investor. There's tons of ways they've done this. I've gotten some letters where people said how can a bank sell to themselves? Well, you can give a non-recourse loan to a hedge fund that you just created and that hedge fund then invests in them. And to somehow have an audit trail, almost every hedge fund in the world has some relationship with one of these major banks. So it would be almost impossible to disassociate the private investors from the major banks that are trying to offload these assets. So I would argue that this probably is the case. But in this video I like to give Geithner and maybe even the plan a bit of a break, and give some credence to one of the arguments that they make. Right now, because of all of these assets going sour all at once, you have all of these forced sellers, right? You have all of these banks and they're all facing these liquidity issues. So you have this huge amount of supply of these securities. And right now since all of the natural buyers are distressed, all of these banks are forcing to sell, all the hedge funds who used to own these things, they're all going bust. And they're facing redemptions. And their investors want their money back. So the actual demand for these securities, the actual pool of money going after is very small. So the demand is very small. And they're saying this is the reason why you have this market disconnect. This is the reason why people are only willing to pay $30, because you have this illiquidity. You have all of these forced sellers and you have very few buyers left in the market. And the few buyers that are left in the market are able to get things at fire sale prices. That's the argument that we've heard time and time again about how $30 isn't the real price. That anyone who actually looked at what's in these, what have unfortunately been called toxic securities, probably because that's what they are. But anyone who looks at one of these securities and really looks inside of them will realize that these are worth way more than $30. That they're yielding a lot. That there will be some defaults but maybe they're really only worth $80 or $70 or $0.70 on the dollar. My argument, if is really the case, what the government should do instead of giving free put options to hedge funds to essentially subsidize the assets from banks. Or, even worse, allowing the banks to do kind of that scheme that I talk about in the second video where they can buy things from themselves and offload things on the taxpayer. What the government should do is really increase the transparency on these securities so that this pool of buyers becomes larger. Right now these securities, these are either collateralized debt obligations or mortgage backed securities. They're bonds of some kind. And the pool of people who can buy bonds is not a large one. It's essentially a bunch of professional investors, most of whom have blown up in this credit debacle. Let me draw a little balance sheet. You take those toxic assets, let's say this is a random bank's balance sheet. That's its assets, liabilities, equity. And it has one of these toxic assets sitting on it. Right. This is a toxic asset. What you do is you take the toxic assets, stick them in a company-- this is some corporation-- so then the toxic assets go there. That's the assets. And the corporation will just have a bunch of shares. If all the toxic assets came from this bank, give these shares back to the bank. And notice this isn't any sketchy accounting. The banks still have the assets on their balance sheet, but instead of having the assets directly they have the shares in this company. And the whole reason I'm doing this is and you can then take this company and float it on a traditional exchange. I mean we're talking about the government, The U.S. Treasury. They could force this thing to be listed on the New York Stock Exchange. So just by doing that, that significantly increases the pool of investors who could invest in it, right? Right now the only people who could invest in it are people who are essentially bond investors. And it's not a trivial matter to start investing in bonds. You have to invest in $1,000 increments at minimum. Usually it's much larger block sizes. And some of these are collateralized debt obligations. They're just hard to invest in even if you wanted to. Now, the second problem. That would solve just the pool of people who could invest. So that'll make it a little larger. But the second problem, this is frankly the bigger problem with these assets, is that there's no transparency. No-one knows what's in these toxic assets. Right? The problem that happened over this last real estate boom is, not only did they give loans to people that they shouldn't have given loans to, but they sliced and diced them. And I've done this in a bunch of the videos in the past. They'll take a bunch of mortgages, they'll take millions of mortgages, put them in a corporate structure. And then they slice and dice them into different tranches. And I explained this in the collateralized debt obligations. Where this tranche gets paid off first, this tranche gets paid off second, and this tranche gets paid off last. So any losses on this, this group takes it first. And for the most part these are the toxic securities. But some of these have also gone toxic. The problem with these things is that the way that they sold them is that they went to Moody's or S&P and they said, hey, Moody's, give us a rating on these securities right here. And Moody's would say oh that's a AAA-- and, well they wouldn't call that AAA, but they would say that's a B security. And we just took Moody's word for it that that's a B security. Or that this right here is a AAA security. And everyone now knows that the only reason why Moody's gave the rubber stamp on it is because the same people who were structuring these things and making all the money off of these things were the same people who were paying Moody's. So what we need to do is disintermediate the rating agencies. So the government, not only should it create these corporations so that you could essentially buy these assets without being a bond trader, you can just buy them on any exchange, what the government should do is hire a big team. And we're talking about billions or trillions of dollars here, so to hire a team that essentially puts up a website and lets us know what's in each of these securities. So let's say that this company that I just created, its sticker symbol is ABCD. So what we can do is we can go to a website, type in ABCD, and it'll tell me exactly what is in that toxic security. I know a lot of people who are professional investors who are in a position, if they wanted to, to pull the trigger and even buy them in their current form. And they're afraid to because they don't know what's in these toxic securities. They don't know whether they're completely fraudulent, only somewhat fraudulent. To some degree it's even hard to tell where a lot of the assets are sitting, in which of the tranches. So what the government should do is just make these as transparent as possible. They should have a map of the United States and they should say this security is for houses that are in upstate New York and in Florida, and its 30% upstate New York and X% Florida. It should have charts that tell me what percentage is defaulting. So I as an investor maybe I can extrapolate things, I can do models. But the crux of the issue here is that instead of having some opaque 800-page document that only a few people have access to and once they decide to parse through that thing they have to go to their local bond trader and invest in it that way, what you do is you put it into a company, list that company on the NYSE, and then make it completely transparent what's in that toxic security so that anybody watching this video can say, you know what, I think this thing is actually worth $0.40 on the dollar, not $0.30 on the dollar. And you won't have to commit millions of dollars. You could just go buy 1,000 shares for $400. It wouldn't be a major up-front investment. And if they did this, this would solve the liquidity problem. This would solve the liquidity problem. This pool of buyers would then become much, much larger. And then the government wouldn't be able to make this argument, and the banks wouldn't be able to make this argument that somehow that these are distressed sales. That these $30 sales are way below the actual value. Because you would have a lot of people with real information, with real access to actually trading them, being able to price these securities. And then when you're forced to do a mark to market -- First of all since each of these shares in this security will be trading on the New York Stock Exchange, you'll much more volume of the transactions. You'll have continuous trading. And then the mark to market that you'll be forced to do on these, essentially shares now, but it's the same thing right? It's shares in your toxic asset. But the mark to market on those will be much more accurate because you'll have much more volumne. You'll have much better market information as far as what they're worth. And then frankly if it turns out that these things really are worth $30, then we can let the banks fail and move on with our lives. And I've argued you could arguably start new banks or do something else. But we won't be kind of playing this charade of what are these assets worth? Wait, maybe we should subsidize the banks. Maybe we should be writing free put options to hedge funds and making it all opaque. The solution is just expose everything to sunshine. And then let the market price really reflect a true reality. And if that reality is that these banks are bankrupt, well then, you let them go bankrupt.