Rolling Out TARP II

Creating an unnecessarily subsidized market in toxic assets

The Treasury Department has created a bit of a conundrum for libertarians when it comes to the newly announced Jekyll and Hyde-like TARP II. On the one hand, the government is finally reaching out to the private sector through this initiative, recognizing the power of markets and price discovery as means to end the economic crisis. But on the other hand, the taxpayers are still taking up to 93 percent of the risk in this new venture. That’s hardly an equitable solution and it could end up costing incalculable billions.

Since the Troubled Asset Relief Program (TARP) bailout was passed last September the money has been used for a host of recovery initiatives. The first half was used largely to recapitalize the banks by buying up equity shares. The second half, TARP II, will be focused on the initial goal of the bailout: to get the deadly mortgage-backed securities and toxic assets off bank balance sheets.

These real estate loans and securities have been rebranded as “Legacy Assets.” They are essentially mortgages, subprime and other, abandoned or in foreclosure, leaving the bank holding the debt in the weak housing market. Because balance sheets are cluttered with unpaid loans, banks have limited the amount of credit they are willing to extend, part of the cause of the economic slow down.

TARP II will use $100 billion of the Congressionally approved money to create the Public-Private Investment Program (PPIP) , a plan to unite private capital with taxpayer dollars to buy up to $1 trillion of the Legacy Assets from banks, easing their debt levels, allowing credit to flow more freely.

Treasury Secretary Tim Geithner argues that creating a program like this will leverage the price discovery process of the free market to help find the right price to buy the Legacy Assets from banks, and is better than the government trying to value the toxic debt on their own. On this point, Geithner is absolutely right. On its own, the government would almost certainly overpay for the assets.

Another positive of the plan is that banks, who have been holding out on selling their assets at a loss because bailouts have been keeping them alive, will be forced to either clean their books or stop asking for taxpayer money. However, these positives are counted by the fact that through this new plan the American taxpayer winds up on the hook for most of the risk.

Here’s how the public-private TARP II will work. First, banks will determine what Legacy Assets they want to sell and put them up on an auction block. Assets will probably be grouped together and sold in “pools.” Second, the government will decide how much it thinks the assets are worth and announce what percentage of a sale it will cover. Private market actors will then bid for the assets. Bidders could be pension funds, mutual funds, private equity firms, or even individual investors with enough capital. The assets will be sold to the highest bidder.

Finally, the FDIC and Treasury Department will provide financing to the private investor, and together they will assume joint ownership of the asset. Private fund firms will be hired to manage the asset until prices rise to the point that the asset can be sold and both investors and taxpayers get a return on their investment.

At least that is how the program is supposed to work.

The very real possibility exists that Legacy Assets will never regain their value, which means a loss to whoever owns them. This is where the first major flaw in the Public-Private Investment Program becomes apparent: if an asset matures in value then everyone wins big, but if an asset suffers a loss it will be the taxpayer who takes the biggest hit.

When you do the math, after FDIC financing and Treasury funds, private investors may only have to put up 7 percent of the money in buying a pool of assets, leaving the government to take a 93 percent loss if necessary. Such a low private market share defeats the purpose of a public-private partnership in the first place.

A key advantage of public-private partnerships, whether through this investment program or by creating a toll road, is to transfer financial risk from the taxpayers to the private sector. But with financing structure as it is, investors have big upsides with little skin in the game, while the government is likely to take big losses .

And that kind of investment is how we got into this mess in the first place. The government cannot continue to socialize losses.

Of course the problem of troubled Legacy Assets won’t go away over night. Some are arguing that the Private-Public Investment Program is a better option than nationalization or having the government buy up assets on their own. While that may be true, it doesn’t mean PPIP is the best choice.

We have no idea how much PPIP may wind up costing the taxpayer. The FDIC will be guaranteeing loans to purchase assets, but that money won’t come from the $100 billion TARP II money, it just appears out of thin air (the government’s favorite magic trick). Depending on how much financing is needed and what kind of losses Legacy Assets yield long term, this program could cost nearly $1 trillion in taxpayer, inflated currency.

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  • Reinmoose||

    Toxic Avenger what?

  • ||

    Geithner + Toxic Assets = This

    And then Leland hits him with a van while singing "Mairzy Doats."

  • ||

    I don't see the conundrum. This is a shell game. The government puts up most of the cash, the "private" sector puts relatively little at risk and stands to get disproportionate gains.

    The "price discovery" is a joke, hopelessly polluted by skewed risk and incentives on both sides of the sale.

    This is a smokescreen, designed to hide yet another massive transfer of wealth to fill the quadrillion dollar hole blown in the global economy by OTC derivatives.

  • alan||

    Bill Bonner has a money quote on TARP II.

    the
    big fellow who has just entered the game is every poker player's dream.
    He is almost infinitely rich and infinitely stupid. Before the night is
    over, investors are going to clean him out.

  • ||

    I sat in on the FDIC conference call yesterday. They have no idea how they want to run the auction, there are still a lot of details to work out. The FDIC is soliciting public comment up on their site FDIC.gov. Even the article, the game is undone, if the FDIC underwriters can decide how much they are going to lend and at what price against the asset pool to make a safe and sound loan, then they de facto know the value of the underlying asset (within a range) which would seem to make the whole auction process a waste of time. They could go through this whole show and end up right back with the assets in FDIC hands again. They could lose twice on the same asset. It is crazy town.

  • ||

    Condundrum? What part of libertarianism does Randazzo not understand?

  • ||

    These assets can be bought and sold now, in the current market. The catch is that the banks don't want to because they don't like the prices they are being offered, and bailouts have allowed them to hang on for a better deal. The best option is simply to let the banks that do not want to sell fail, and then divest the assets after going into bankruptcy.

    The prices on offer would force some of them into bankruptcy - perfectly rational to hold out as long as possible. Marked to market rules needless cause this foolish situation, since most banks are otherwise well capitalized.

  • ||

    scott clark - were they talking about reverse auctions at all? There is a lot of money on the sidelines, but guys like Ray Dalio (from bridgewater associates, who has a lot of it) have publicly said they distrust the government will play fairly.

  • ||

    Couple of comments:
    :The best option is simply to let the banks that do not want to sell fail, and then divest the assets after going into bankruptcy.

    It's 2009, gee maybe we could have taken our medicine back in early 2008. Foolishly thought that Bush set a precedent with Enron regarding bailouts. However, his political capital was spent and eventually was talked into seeking a bailout by the Treasury and GS (sorry, I mean the NY Fed). JPMorgan learned their lesson and did WAMU asset purchases the right way.

    :This is a smokescreen, designed to hide yet another massive transfer of wealth to fill the quadrillion dollar hole blown in the global economy by OTC derivatives.

    Love it. These are contracts between two willing parties that represented the best and the brightest of Wall Street, hedge funds, pension funds and everybody else with a Bloomberg machine. Too many firms played the role of Jack Lemmon in Glen Gary Ross... did you see how they were living? They are insane, certifiable. The contracts are worthless. (not word for word, but you get the jist). Too many folks were busy high-fiving one another over "printing money" that they didn't realize that they were all in the money against the same players and those players (who were high-fiving one another about 2 years earlier) were broke. And all of the players had levered up to continue playing. This was essentially a non-clearing market and things like this will happen... lo and behold as things started to get bad, everyone and their brother started demanding collateral to make sure that they would get actually get cash for their winning "bets". This is the reason we are in deep trouble. Deleveraging means putting up cash to clear trades/bets. You either have it or you don't. Bear didn't have it, Lehman didn't, AIG didn't... and it will continue to unravel. The best thing is, the guys who came to the game with the MOST credit of anyone are Fannie and Freddie and they are still in business. The only way to prevent this again (not a bubble, but just a steroid induced one) is having these instruments on exchanges where cash is settled constantly. Of course, that would mean price/volume transparency and THAT would mean real loss of revenue to the Street (how are those equity market makers doing these days...). Anyway, its my 2 cents.

    :the
    big fellow who has just entered the game is every poker player's dream.
    He is almost infinitely rich and infinitely stupid. Before the night is
    over, investors are going to clean him out.

    Just make sure the money is on the table and not in IOUs... (the Dumb and Dumber briefcase scene comes to mind), the govt has shown that they are more than happy to change the rules of the game when political winds shift. Rule of law, my a$$.

    Conundrum?? Absolutely none. Its a bad idea all around. The market is not broken, there are just people who don't like the prices they are seeing. Love how leverage and risk insurance are considered incentives rather than bribes. If the loans were recourse, maybe you could call it incentive.


    Much better. Happy Friday.

  • Jay S||

    I wish I knew something about finance right now. There is surely lots of money to be made by some shrewd bankers during the acquisition of these toxic assets. Naturally, this money would not be able to be made if the government didn't step in here. Plus, you wouldn't be railed on by the media since you made money on 'fixing' the problem, not creating it.

  • Craig||

    The Treasury Department has created a bit of a conundrum for libertarians when it comes to the newly announced Jekyll and Hyde-like TARP II.

    What conundrum would that be? Libertarians should oppose TARP II in its entirety, just as we opposed TARP I.

    If the assets aren't worthless, they can already be sold for some fraction of face value to risk-seeking entrepreneurs. The fact that they aren't selling simply means that the holders either under-estimate the risk, or are unwilling to admit how low the market value of the assets has actually fallen. Rather than blaming mark-to-market rules, I would question whether the current "mark" isn't indeed a bit too optimistic.

    Congress is running around in a circle, trying to figure out how to regulate the financial sector further so that this doesn't happen again, yet the simplest way to discourage a recurrence would be to simply let those companies that took on stupid levels of risk face the full consequences of their actions. Bailing out those who took on excessive risk only encourages more of the same in the future.

  • Paul||

    On the one hand, the government is finally reaching out to the private sector through this initiative, recognizing the power of markets and price discovery as means to end the economic crisis.

    Is this a glimmer of light in a total governmental hurricane? The fact that a Democratic administration actually acknowledges the fact that only open markets can properly discover prices?

  • Paul||

    If the assets aren't worthless, they can already be sold for some fraction of face value to risk-seeking entrepreneurs. The fact that they aren't selling simply means that the holders either under-estimate the risk, or are unwilling to admit how low the market value of the assets has actually fallen.

    Not entirely. It's also just as possible and very likely that these toxic assets aren't selling because the entire market for them is sidelined while it waits to see what the government is going to do.

    Why would you sell an asset for pennies on the dollar when the government might give you dollars on the penny?

  • Scarpe Nike||

    is good

  • HECM Calculator||

    Continued education on reverse mortgages is vital to help seniors completely understand the program. Also, it's important to have questions answered by top reverse mortgage professionals. Learn more about the program.
    http://www.reversemortgagelend.....gage-loan/
    http://www.reversemortgagelend.....formation/

GET REASON MAGAZINE

Get Reason's print or digital edition before it’s posted online

  • Progressive Puritans: From e-cigs to sex classifieds, the once transgressive left wants to criminalize fun.
  • Port Authoritarians: Chris Christie’s Bridgegate scandal
  • The Menace of Secret Government: Obama’s proposed intelligence reforms don’t safeguard civil liberties

SUBSCRIBE

advertisement