Monday, March 23, 2009

The Geitner Plan---Great Work If You Can Get It, Part II

Here is an update to calculations made in my earlier post today (below), now that I have seen the details of the Treasury's Public Private Investment Program for Legacy Assets. This is a 2 part plan (not 3 as weekend leaks had indicated) to purchase up to $1 trillion of Legacy (formerly known as Toxic) Assets: 1) a Public Private Investment Program (PPIP) for Legacy Loans and 2) a PPIP for Legacy Securities each expected to get roughly equal amounts of up to $100 billion in TARP money. FDIC leverage (debt to equity) for both programs will be equal to a max of 6:1 and Treasury (TARP) money will participate with private equity capital on a 1:1 basis in both programs, with one difference: in the Legacy Securities program Treasury can add 100% leverage to the combined equity. So that means that private capital will represent 7% for the Loan program but potentially as little as half that for the Securities program. Put another way, tax payers are on the hook for 93% of the investment in the Loan program and almost 97% for the Securities program. Another big difference, the Loan program will be open to a number of "qualified" investment managers but the Securities program will pick just five investment managers. The investment firms will have management discretion subject to certain government restrictions but will be free to set fees and maturity up to a max of 10 years. While the government keeps stressing that they will be participating in the equity capital pari passu with private investors, it does not appear that Treasury will have any participation in the management fees charged equity investors (including Treasury) other than receiving warrants whose terms aren't specified. The TARP money is expected to be allocated in equal amounts to each side of the program. On the Loan side of the program the annual management fees (the 2% on an assumed "2 and 20" structure) would pencil out at $2 billion a year, or $20 billion over 10 years. It would take roughly a 15% increase in the value of the pools purchased under this program to generate a 100% gross increase in the equity investors capital. On that basis, the investment manager would earn additional incentive profits of $20 billion. On the other hand, it would take only a 15% loss to wipe out all the equity in the pool. In the event that the investment manager made no money for the equity investors (ie broke even) or lost all the equity, they would still earn the management fees of $20 billion over 10 years in our example. The numbers in the Securities program are actually smaller given the potential additional leverage from Treasury, meaning less equity on which to earn fees. The cumulative 2% management fees would total ~$7 billion but it would take only a 7 % increase/decrease in the total value of the pools to generate a double in gross value/total loss for the equity investors. Big numbers for the lucky managers

In conclusion, while the government keeps stressing that they are participating pari passu with private capital on the upside, they really aren't since the fund management firms are reaping windfall profits in the event of either success or failure. And whether or not this will ultimately work as planned and entice enough buyers and sellers to reach a clearing price to trade these Legacy (aka Toxic) Assets remains to be scene. And if that does happen, whether that will be enough to cure the Toxic (ie potentially insolvent on a mark to market basis) Bank problem is doubtful. This will certainly NOT cure all banks (some of them very big) and significant recapitalization (from private and potentially public) sources will still be required to ultimately finish the job. The market's extreme positive reaction today, I believe, was not an indication that this is a great plan that will work but rather a big sigh of relief that after so many months and flubbed attempts (starting with the Paulson Treasury) the details of a somewhat comprehensible plan were finally put forth. And as I concluded in the earlier version of this post, there appear to be other potentially more palatable variants of this program. They seem to do this all the work in a bit of a vacuum without fully understanding market implications. Oh well, stay tuned---we're living through historic moments as if we didnt know that already.

1 comment:

  1. Krugman was brutally critical in Monday's Times. Seems to me (the total amateur) that's what happening here basically is that Krugman wants to nationalize the banks and wipe the toxic assets off the book, but if I'm correct, that would wipe out all the common shareholders, and Obama/Geithner/Emanuel ain't gonna do that, because Wall Street wouldn't like it. The fact that the Republicans like the plan is enough to make me suspicious. Geithner's plan (if it IS his plan, not Paulson's revamped) seems too complex and I have a feeling it will simply divert the funds.