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After lambasting past announcements for being too broad brush, it is churlish to accuse Tim Geithner, US Treasury secretary, of obscuring his latest taxpayer-funded giveaway with excessive detail. In fact, the latest plan to cleanse the system of bad assets is appropriately nuanced. It is better crafted, using private involvement to lessen taxpayer risk. And there is the odd nice touch, like using a portion of fees to bolster deposit insurance funds.
There are two main components to the latest plan, one targeting loans, the other securities. In the first, banks put loans up for sale to competing private sector bidders. The Federal Deposit Insurance Corporation guarantees debt of up to six times the equity in the winning fund. The Treasury takes up to 50 per cent of the equity, or about 7 per cent, of the fund.
In the second part of the plan, the Treasury selects managers to run funds to buy real estate-backed securities, matching private investors dollar for dollar. Managers can top up with limited Treasury loans. The term asset-backed securities loan facility will also be expanded to finance purchases of legacy securities.
Equity stakes give bidders an incentive not to overpay while competition between private funds should deter low-balling. But it is unclear that cheap leverage can close the gap between the prices at which banks will sell and investors will buy. The former depends on where banks’ assets are marked (and if they can sell without rendering themselves demonstrably insolvent.) But only one fifth of all assets are marked to market, says Credit Suisse, with ailing fundamentals yet to be recognised.
The dross inevitably will be first on the block. After all, in the loan programme banks can choose what to sell and reject the result of the auction. This suggests price discovery only to the extent that prices are above banks’ marks.
A tougher regulatory stick is needed to force banks to face reality. Instead, generous terms may help bridge the pricing gulf – further reason for investors fearful of a political backlash to stay clear.
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