Triage For Troubled Assets

The Obama administration, led by Geithner, is proposing a triage of bad ideas for troubled assets. The Washington Post has the story in Bank Rescue Would Entail Triage for Troubled Assets.

The Obama administration's emerging rescue plan for the banking system would amount to financial triage, with the Treasury Department playing the delicate role of deciding which of the trillions of dollars in troubled assets plaguing the economy to buy, guarantee or leave in the hands of banks, sources said.

The high-stakes approach would dramatically increase the investment of taxpayer money in the financial industry, and the potential losses.

The basic problem confronting the government is that banks hold large quantities of assets that they value on their books for much more than investors are willing to pay. Banks cannot sell these assets without recording massive losses. But holding the assets is tying up vast amounts of money, choking the financial system.

My Comment: That is admittedly what Obama, and Geithner thinks is the basic problem, but the reality is different. The basic problem is the Fed together with Congress micromanaged the economy into a black hole from which there is no escape. If that sounds grim it is because it is grim.

The enabling force is fractional reserve lending and Congressional spending gone rampant. The only real solution involves time (more of it), price (falling), bankruptcies (more), and an increase in savings. Of course that is a short term solution. The long term solution to prevent this from happening again is to abolish the Fed and eliminate fractional reserve lending.

Since the early days of the financial crisis, officials have struggled to unwind that knot. If the government buys the assets at prices that banks consider fair, the Treasury would take a huge loss when it ultimately sells the assets for much less. If, instead, the government insists on paying market prices, the banks may not survive their losses.

My Comment: There is no knot except in Geithner's head. It is all imaginary. The only fair price is the market price. The sooner the insolvent banks go under, the quicker the recovery.

Instead of taking a single approach, the Obama administration plans to divide assets and other loans into three categories, each with its own solution, according to sources familiar with the discussions, speaking on condition of anonymity because the details are not finalized.

The government would buy and hold on to those assets whose falling prices are putting banks under the most pressure. Officials want to limit these purchases because of the vast expense.

The centerpiece of the plan would be a guarantee to limit losses on a second group of troubled assets that can be kept by the banks because they have more stable prices.

And it would allow banks to retain and profit from their healthiest assets.

My Comment: The centerpiece is insanity. The Government has already guaranteed $400 billion in bad debts of Citigroup and Bank of America. Now Geithner wants more. Note that the market cap of Citigroup (C) is roughly $19 billion and Bank of America (BAC) is roughly $27 billion. The treasury is guaranteeing $400 billion of debt on companies that would be worthless without those guarantees. Does this make sense?

Beyond these initiatives, the government also is likely to inject more capital into troubled institutions.

My Comment: Hells bells, Geithner is likely to do anything. He is in the very late stages of FIV, the dreaded Fiscal Insanity Virus.

The triage approach is a response to accounting rules.

When banks buy assets such as loans, they must specify for accounting purposes whether they plan to hold the asset until it is repaid in full or whether they might sell the asset earlier. If the price of similar assets begins to fall, banks may be required to record a loss in value. Those rules apply much more strictly to assets that a bank has said it may sell.

The government plans to focus on buying assets "available for sale" -- those assets whose values banks have already written down substantially, sources said. Such assets are causing immediate problems for banks because they must set aside substantial amounts of capital to compensate for the losses recorded on their books.

My Comment: Here's the deal. The government will buy the worst assets, dramatically overpay for them, stick taxpayers will the losses, and only reduce bonus pools of the banks by 40%. It's a great deal for those in the bonus pools. It's a horrid deal for everyone else.

Assets "held to maturity" would remain with the companies, but the government would guarantee to limit any losses.

My Comment: Preventing losses will keep that bonus pool humming.

Allowing institutions to hold those assets rather than selling them to the government would avoid a moment of reckoning because the banks will also be able to avoid acknowledging on their books the sharp declines in market prices. Government officials argue the approach is better for banks and taxpayers because the price of many assets will eventually recover after the financial crisis passes, so there is no value in forcing the banks to record losses.

My Comment: The whole scheme is nothing but a shell game. In fact, it is the Super SIV Bailout Plan revived once again.

Don't Ask - Don't Sell

• The plan boils down to this: Don't Ask - Don't Sell.
• Don't Ask what the asset is worth.
• Don't Sell or you will find out and not like the result.

The idea that asset prices are going to come back is sheer nonsense. And this carp about "better for taxpayers" is preposterous. What's better for taxpayers, the country, and in fact everyone in the world who is not in the bonus pool, is for the banks to go under.

Joshua Rosner, a financial analyst at Graham Fisher, said in a recent research note that it makes no sense to accept the prices banks have assigned to assets as more accurate than the prices assigned by investors in the marketplace.

"I would argue that it is a thinly veiled attempt to prevent losses from being recognized and which will result in larger levels of ultimate losses," he wrote.

My Comment: This is a rarity. Someone is making sense. Ring the bell and give Joshua Rosner a well deserved cigar.

In November, the government agreed to limit Citigroup's losses on a portfolio of $301 billion of troubled assets. Last month, the government issued a similar guarantee to Bank of America covering $118 billion in troubled assets. In both cases, the companies agreed to absorb an initial increment of losses -- about $30 billion for Citigroup and $10 billion for Bank of America -- with the government absorbing 90 percent of any subsequent losses.

To address public anger over the bailout, White House officials are set to detail today the restrictions that would be imposed on financial firms receiving what the government deems to be "exceptional" assistance. A minority of recipients would fall into this category.

Such companies would be required to cap their executives' pay at $500,000, a source said.

Instead of being fired for incompetence, executive salaries will be capped at $500,000.

For the record, I am not in favor of salary caps, especially caps imposed by the government. I am in favor of letting the free market work. What would happen under a free market approach is these executives would be out on their ass and their companies bankrupt and sold off in pieces.

Geithner's plan is a triad of stupidity. The reason Geithner is struggling with these ideas is none of them are worth a plug nickel. His solution is straight out of the "Official Bureaucrat's Handbook": take the worst of three bad ideas, merge them into one plan, and expect it to work.

I know I am going to get questions on this. Here is my reply in advance. No, this does not mean massive inflation is coming. What it means is the recovery is going to be slow in coming, weak in strength, and create few jobs, a veritable triad of bad news.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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