Wednesday, October 7, 2009

Cash for Trash: Better Never than Late

Posted on the Baseline Scenario by Linus Wilson:

The U.S. government does few thing better than create debt. After a year of talking about it, the government is going to have the chance to throw their good debt, Treasury bills notes and bonds, after bad, non-performing toxic loans and securities. The Federal Deposit Insurance Corporation (FDIC) and the U.S. Treasury are going their separate ways on their cash for trash schemes at this point. Accountants and investors should be wary of the big prices they see coming from the FDIC’s auctions, but taxpayers should be afraid of the U.S. Treasury’s efforts to re-inflate the securitization bubble.

The FDIC is nearing the century mark of bank failures this year and it has a lot of bad assets to unload. On Tuesday, October 6, 2009, it announced that it sold a $4.5 billion, festering pool of condo loans from the failed lender Corus Bank. The last 10-Q for the failed Chicago lender said that it had $3.3 billion in non-performing loans with heavy concentrations in busted condo markets of Miami and Los Angeles. Yet, zero-coupon, FDIC-guaranteed debt and a billion dollar line of credit led to the price of $2.8 billion. That price of about 60 percent of par seems rich when almost 70 percent of the loans are non-performing. A few weeks earlier the FDIC did its first Legacy Loans Program auction. My paper “Slicing the Toxic Pizza: An Analysis of FDIC’s Legacy Loan Program for Receivership Assets” found that the nearly 6-to-1 government subsidized leverage in the first Legacy Loans Program sale boosted prices by over 20 percent. Yet, the irony is that these subsidies don’t help the FDIC and ultimately taxpayers because the FDIC is offering cheap financing to sell assets it already owns. Any higher prices just offset the subsidized financing if the auctions are competitive. Yet, any marks obtained from these auctions are certainly inflated.

The Legacy Securities Program run by the U.S. Treasury with an initial taxpayer outlay of $30 billion is set to launch soon. More asset managers are closing their investment funds every week. The problem with the Legacy Securities Program is that the government will probably use cheap leverage to finance the sale of trash assets that it does not already own. That means that the taxpayer subsidies are enjoyed by the banks selling the assets. My research shows that the most troubled banks will be reluctant to part with their toxic securities. Yet, the healthy banks will be all too eager to unload those assets at inflated prices. Come Halloween the U.S. Treasury will be handing out the goodies. Unfortunately, taxpayers will be getting none of the treats but all of the cavities.

No comments: