Why Geithner's Plan Is Nearly Guaranteed To Fail And Possibly Destabilize The FDIC In The Process
First off, I would encourage you to pass this post along or freely use any of its content to write of the Treasury plan yourself if you believe this warrants additional exposure. We the people need to start getting some alternative views into public policy. The more we can educate society, the better our chances are of dealing with these crises.
I decided to do a complete breakdown of the Treasury plan after listening to the comments by Secretary Geithner shown in the Congressional testimony below. Geithner is simply pushing another Treasury ramrod job that had not been subjected to any reasoned critical analysis. For Geithner to state unequivocally that this plan will work when no Treasury plan to date has worked is without logic, reason or truth. Sure, throwing money at the banking system has temporarily stabilized it, but the economic environment is not improving even with trillions thrown at mega banks.
That a substantial number of talking heads in the mainstream economics and investment community have lined up behind the plan is irrelevant. I have not seen a single reasoned analysis of the prospective risks or dangers associated with the plan by any supportive voices. So, without any such analysis we, the sovereign, should view these ad hominem arguments for this plan as self-serving. Why should we conclude this? Because even the founder of capitalism identifies the self-serving nature of market participants as the key driver of economics. In other words, there is a general desire by these communities to save the current financial system rather than transform it into something that serves all of society. Concentrated wealth will obviously support policies benefiting concentrated wealth. Let's be frank. If you aren't part of the club there is no one in this process looking out for your best interests. It is up to you to speak through your elected public servants to look out for your best interests. And you must be persistent because your voice is fighting billions of dollars in lobbying money. In other words, your ace is the ability to revoke your elected official's membership in the club. That is the most powerful card in the deck if used properly.
While I am sure Geithner genuinely believes in what he is doing, as the titled post of a few days ago states, the road to hell is often paved with good intentions. Geithner's surety of a plan that involves incredible risk is a sign he is playing the primary role in the Confidence Trick. This is a trademark attempt by power players to ramrod decisions rather than embracing public discourse to find superior solutions. Remember, power always seeks to consolidate its base in times of crisis. At these very moments it is important that the sovereign make their voices heard. This compels me to give a reasoned and logical analysis of this failed plan and its potentially dire implications.
To start, I want to discuss a few surrounding details of the Treasury's plan which I believe have substantial relevance. Not to its success but to other substantial issues facing society.
It was reported a few days ago that Geithner has been ginning up support for his plan on Wall Street in advance of its announcement. This week's Congressional testimony presented Geithner with a question of whether Wall Street's advance knowledge of this plan gave them any advantage. Geithner's response was a categorical no. Here's reality. Want to bet it's easy to figure out what day this plan was shared with Wall Street? How about within days of this rally. Why have I mentioned this over and over? Well, besides that I'm insane? It is representative of the insider information and lack of transparency that makes it so difficult for an average American to effectively invest in our financial markets. On many levels the game is rigged. In this case, Wall Street knows more about what is going on in our government than we do. Not a new development but most likely relevant to a society now realizing this fact for the first time.
So does this mean this rally is contrived by Wall Street? Front running the announcement as we wrote last week? Orwellian manipulation of the public? Our 401Ks are going up so we should be happy with the Treasury plan? It is classical Wall Street whether this is true or not. And, there is ample evidence it is. It's hardly a surprise that we had a rally. The Transports nailed our downside target within a few percentage points and the S&P hit our downside target zone. But it appears to me that something stinks beyond the normal stench. Citi going from 99 cents to close to $4 seems more than a little contrived or pointing to insider information. So are similar moves at other mega banks - the sole benefactors to this bailout scheme. Why else would mega banks rally so disproportionately? There is no logical reason.
Anyway, let's look at the Treasury plan. First, here's a very simple fundamental reason why it won't work - we are just pushing around paper. That's it. Okay, a little more detail is warranted so let's break the plan down into a very simple analysis because it really is simple.
If you own a toxic asset or I own a toxic asset or Elmer Fudd owns a toxic asset, it equally impacts capital in the economy. It simply doesn't matter who owns the asset given a finite amount of money. In other words, if there are ten people in a small closet and someone sets off a stick of dynamite, does it really matter who is actually in possession of it? If banks own a toxic asset, a ridiculous theory put forth by Treasury is that it keeps the bank from lending to the private economy. A private economy that supposedly has capital it wants to use to initiate loans with said banks. Yet banks are unwilling to lend because they are holding toxic assets? This is a cockamamie theory. Remember there are 20,000 banks and credit unions that can supply loans in the economy. Most are reasonably healthy. The Treasury's plan is focused on less than two dozen. Private capital can already initiate loans in the other 19,980 institutions without Geithner's plan if they so desire or if they are credit worthy. Anyway, for argument's sake, let's assume Geithner's notion is true to continue with our analysis.
If a bank transfers a toxic asset to private hands under Geithner's plan, they can do so in one of four possible transactions:
1) They can do so at par value. In that case, there is no incentive for the private investor to buy the asset. There are substantially too many risks for this transaction to be appealing to private investors. Especially in today's environment.
2) They can transfer the asset at a loss which further erodes the banks capital and puts them in a worse position than before the toxic asset sale.
3) They can transfer the asset to their own economic benefit, ie above par, at which point the private investor has no incentive to acquire the toxic asset.
4) A middle man or third party can be inserted into the transaction to take on substantial loss or risk of loss in the transaction so that both banks & private investors or one of the two have sufficient risk/reward ratios to participate. That third party would be the American citizens and the FDIC under Geithner's plan. In this scenario the transaction is effectively rigged and the middle man is left holding the bag. As economics tells us, in a rigged transaction or a asset transfer transacted outside of free markets, there can be no true price discovery. Thus using private investors to acquire toxic assets while utilizing a third party to absorb risk as the Treasury plan attempts to do, creates a fundamental mistruth in any attempt at price discovery. In other words, an attempt to use free markets in this scheme is a gross mischaracterization and dishonest at worst.
So, only two of four scenarios will clear the toxic assets off of bank books. These two scenarios are either ridiculously inept decisions for the banks or for American citizens. If the first is true, banks are exposed to greater losses. If the second is true, well......you get the idea. Care to guess which outcome has a near certain probability of coming to pass?
So, let's continue and assume we live in a world of dunces and banks actually do transfer toxic assets to private investors in one of the scenarios above. Now what? Do you remember our many posts about The Game? (I reposted it below if you weren't a reader at that time. In a nutshell, in The Game there are macro circumstances today which lead to continual deterioration of asset quality which ultimately fuels recursive losses and asset unwindings until The Game is over.) You can read the repost below if you want more details.
Let's apply The Game to the outcome of asset transfers under the Treasury's plan. Let's assume we have now exercised the plan and private investors own the bank's toxic assets. First, if banks have sold assets below par the banks either now need additional capital or they are going to be hampered in lending new money. In other words, paper losses at banks have become realized losses and the banks will need even more capital injections. That's the first problem. Forget about the FDIC and citizen involvement in the transaction for a moment and let's look at the private investors acquiring the assets. Over time, we can expect these assets to erode in value because of current fundamentals as we wrote in The Game. How do I know this? Today, we are making an assumption The Game is not over. Soon, I will share a post that provides data confirming The Game is not over.
Banks have now rid themselves of toxic assets so they could theoretically start lending again. (Geithner's premise for this plan.) But, because of The Game continued erosion of the toxic assets in the hands of private investors actually has the effect of reducing capital in the private economy and, hence a reduced desire for the private economy to borrow. Remember, there is a finite pool of capital in the economy and regardless of who is taking the loss, the consequences have an effect of reducing that pool. This is regardless of whether private investors take future losses or whether taxpayers or the FDIC takes the hit through their burden of risk in the transaction.
So, effectively what Treasury's plan has done is exactly the opposite of its intent. It has made the crisis worse - the law of unintended consequences. It has actually reduced the ability of the private sector to borrow by reducing capital in the economy. It also has the impact of reducing the capital in the private economy needed to conduct existing nonfinancial business. That means the newly refreshed banks will ultimately see an even further erosion of their balance sheets as less private capital is available to pay other existing bank debts assumed to be "good" assets before the execution of Treasury's plan. Or even new bank loans that will be initiated after the execution of the Treasury plan. Geithner's plan ultimately leads to further destruction of bank capital, further destruction of private capital and a larger crisis.
Given the FDIC has been pulled into this plan to backstop risk, failure of this exposes the FDIC to substantial loss. Now, what impact would this have on the FDIC's role of protecting citizen's bank deposits? Remember the FDIC's intent is to protect our deposits. To protect us from mismanaged banks. Not to be exposed to risky schemes that threaten confidence in the FDIC. Or to prop up failed management and insolvent banks.
This plan transfers even more wealth from those least able to bear the burden, the American people, to a chosen few. First Paulson then Geithner and now a future bureaucrat will be tin-cupping for another bailout. When will this end? When The Game ends. That is, when we have bankrupted society or when we have printed a mountain of money thus further destroying private wealth or when toxic assets reach an equilibrium or when these actions have created an environment of social unrest or some combination of the above.
Did anyone in government ever take a math class? Hey Washington, Free Lunch economic theory doesn't work.
How many bailouts have we had now? Remember Paulson confidently told us $700 billion was enough. By the way, that was after he repeatedly told us how great the economy was. Geithner is the new leader in the same Confidence Trick. $10 trillion later the same hacks are still playing games with our future.
One point I find most troublesome is that there are six billion people on this planet and we can't seem to get beyond the ideas of a handful of people with substantial conflicts of interest, bias and little knowledge of how to solve this crisis using sound reason and logic. This very fact is contributing to the negative consequences and raising the long term risks for everyone. This is indicative of an elitist culture that eschews the intellectual capital of society. Of public discourse, of peer review, of the inherent problem solving ability of a free society. In other words, placing the economic decisions for hundreds of millions of people in the hands of a few back room decision makers is exactly the economic model embraced by the Soviet Union. It will result in miserable policy failures and terrible economics.
Are politicians really that foolish or simply that beholden to Wall Street? This crisis is far from over.
=====================================================
Remember, I posted this before this crisis developed. So, it is in future tense. Keep that in mind given we have already seen The Game develop. In fact, The Game is exactly what has collapsed our financial system and the global economy and what will contribute to the Treasury plan's failure.
Repost of The Game.
Question: What if an environment existed where there was significant leverage in many assets and very large bets across all assets. And, let's say some of those assets are more liquid than others. And, that some assets are actually quite illiquid. By that I mean there is not a clearinghouse or large auction market with substantial players to trade that asset. A piece of art may be an example of an illiquid asset. And, let's say any one of those bets turns against one of the players or many players. And, let's say one day players have to recognize that bad bet(s). In doing so, the players have to recover a stable financial position. In other words, they need to raise capital to remain liquid and stay in the game. Or, in a bank's case, remain solvent. And, let's say it has become impossible to raise that capital through the sale of semi-liquid or illiquid assets. And, in a worst case scenario, let's say the illiquid assets are the ones that have turned against those players. What are the players forced to do? And what are the consequences for the players and for the asset markets they've invested in? Both short term and long term?
Answer: There are many outcomes. One is forced selling. Even many deeper angles on the selling. One of them is that players are left with continually deteriorating BAD bets while they sell their good bets to remain in the game. That has a self-reinforcing or recursive effect of selling more and more good bets while more and more bad bets draw down their capital positions over time and thus continually erode their capital positions until either bankruptcy, capital injection or bad bets stabilize. Selling of good bets are not just paper assets or traded assets but could be other parts of the company, people, their trading businesses, etc. And, what might that mean for hedge funds that rely on them to stay in business? And, what does that imply for intrinsic value of these players? That said, there are still so many other angles.. .....But, we'll all watch as it unfolds.
I decided to do a complete breakdown of the Treasury plan after listening to the comments by Secretary Geithner shown in the Congressional testimony below. Geithner is simply pushing another Treasury ramrod job that had not been subjected to any reasoned critical analysis. For Geithner to state unequivocally that this plan will work when no Treasury plan to date has worked is without logic, reason or truth. Sure, throwing money at the banking system has temporarily stabilized it, but the economic environment is not improving even with trillions thrown at mega banks.
That a substantial number of talking heads in the mainstream economics and investment community have lined up behind the plan is irrelevant. I have not seen a single reasoned analysis of the prospective risks or dangers associated with the plan by any supportive voices. So, without any such analysis we, the sovereign, should view these ad hominem arguments for this plan as self-serving. Why should we conclude this? Because even the founder of capitalism identifies the self-serving nature of market participants as the key driver of economics. In other words, there is a general desire by these communities to save the current financial system rather than transform it into something that serves all of society. Concentrated wealth will obviously support policies benefiting concentrated wealth. Let's be frank. If you aren't part of the club there is no one in this process looking out for your best interests. It is up to you to speak through your elected public servants to look out for your best interests. And you must be persistent because your voice is fighting billions of dollars in lobbying money. In other words, your ace is the ability to revoke your elected official's membership in the club. That is the most powerful card in the deck if used properly.
While I am sure Geithner genuinely believes in what he is doing, as the titled post of a few days ago states, the road to hell is often paved with good intentions. Geithner's surety of a plan that involves incredible risk is a sign he is playing the primary role in the Confidence Trick. This is a trademark attempt by power players to ramrod decisions rather than embracing public discourse to find superior solutions. Remember, power always seeks to consolidate its base in times of crisis. At these very moments it is important that the sovereign make their voices heard. This compels me to give a reasoned and logical analysis of this failed plan and its potentially dire implications.
To start, I want to discuss a few surrounding details of the Treasury's plan which I believe have substantial relevance. Not to its success but to other substantial issues facing society.
It was reported a few days ago that Geithner has been ginning up support for his plan on Wall Street in advance of its announcement. This week's Congressional testimony presented Geithner with a question of whether Wall Street's advance knowledge of this plan gave them any advantage. Geithner's response was a categorical no. Here's reality. Want to bet it's easy to figure out what day this plan was shared with Wall Street? How about within days of this rally. Why have I mentioned this over and over? Well, besides that I'm insane? It is representative of the insider information and lack of transparency that makes it so difficult for an average American to effectively invest in our financial markets. On many levels the game is rigged. In this case, Wall Street knows more about what is going on in our government than we do. Not a new development but most likely relevant to a society now realizing this fact for the first time.
So does this mean this rally is contrived by Wall Street? Front running the announcement as we wrote last week? Orwellian manipulation of the public? Our 401Ks are going up so we should be happy with the Treasury plan? It is classical Wall Street whether this is true or not. And, there is ample evidence it is. It's hardly a surprise that we had a rally. The Transports nailed our downside target within a few percentage points and the S&P hit our downside target zone. But it appears to me that something stinks beyond the normal stench. Citi going from 99 cents to close to $4 seems more than a little contrived or pointing to insider information. So are similar moves at other mega banks - the sole benefactors to this bailout scheme. Why else would mega banks rally so disproportionately? There is no logical reason.
Anyway, let's look at the Treasury plan. First, here's a very simple fundamental reason why it won't work - we are just pushing around paper. That's it. Okay, a little more detail is warranted so let's break the plan down into a very simple analysis because it really is simple.
If you own a toxic asset or I own a toxic asset or Elmer Fudd owns a toxic asset, it equally impacts capital in the economy. It simply doesn't matter who owns the asset given a finite amount of money. In other words, if there are ten people in a small closet and someone sets off a stick of dynamite, does it really matter who is actually in possession of it? If banks own a toxic asset, a ridiculous theory put forth by Treasury is that it keeps the bank from lending to the private economy. A private economy that supposedly has capital it wants to use to initiate loans with said banks. Yet banks are unwilling to lend because they are holding toxic assets? This is a cockamamie theory. Remember there are 20,000 banks and credit unions that can supply loans in the economy. Most are reasonably healthy. The Treasury's plan is focused on less than two dozen. Private capital can already initiate loans in the other 19,980 institutions without Geithner's plan if they so desire or if they are credit worthy. Anyway, for argument's sake, let's assume Geithner's notion is true to continue with our analysis.
If a bank transfers a toxic asset to private hands under Geithner's plan, they can do so in one of four possible transactions:
1) They can do so at par value. In that case, there is no incentive for the private investor to buy the asset. There are substantially too many risks for this transaction to be appealing to private investors. Especially in today's environment.
2) They can transfer the asset at a loss which further erodes the banks capital and puts them in a worse position than before the toxic asset sale.
3) They can transfer the asset to their own economic benefit, ie above par, at which point the private investor has no incentive to acquire the toxic asset.
4) A middle man or third party can be inserted into the transaction to take on substantial loss or risk of loss in the transaction so that both banks & private investors or one of the two have sufficient risk/reward ratios to participate. That third party would be the American citizens and the FDIC under Geithner's plan. In this scenario the transaction is effectively rigged and the middle man is left holding the bag. As economics tells us, in a rigged transaction or a asset transfer transacted outside of free markets, there can be no true price discovery. Thus using private investors to acquire toxic assets while utilizing a third party to absorb risk as the Treasury plan attempts to do, creates a fundamental mistruth in any attempt at price discovery. In other words, an attempt to use free markets in this scheme is a gross mischaracterization and dishonest at worst.
So, only two of four scenarios will clear the toxic assets off of bank books. These two scenarios are either ridiculously inept decisions for the banks or for American citizens. If the first is true, banks are exposed to greater losses. If the second is true, well......you get the idea. Care to guess which outcome has a near certain probability of coming to pass?
So, let's continue and assume we live in a world of dunces and banks actually do transfer toxic assets to private investors in one of the scenarios above. Now what? Do you remember our many posts about The Game? (I reposted it below if you weren't a reader at that time. In a nutshell, in The Game there are macro circumstances today which lead to continual deterioration of asset quality which ultimately fuels recursive losses and asset unwindings until The Game is over.) You can read the repost below if you want more details.
Let's apply The Game to the outcome of asset transfers under the Treasury's plan. Let's assume we have now exercised the plan and private investors own the bank's toxic assets. First, if banks have sold assets below par the banks either now need additional capital or they are going to be hampered in lending new money. In other words, paper losses at banks have become realized losses and the banks will need even more capital injections. That's the first problem. Forget about the FDIC and citizen involvement in the transaction for a moment and let's look at the private investors acquiring the assets. Over time, we can expect these assets to erode in value because of current fundamentals as we wrote in The Game. How do I know this? Today, we are making an assumption The Game is not over. Soon, I will share a post that provides data confirming The Game is not over.
Banks have now rid themselves of toxic assets so they could theoretically start lending again. (Geithner's premise for this plan.) But, because of The Game continued erosion of the toxic assets in the hands of private investors actually has the effect of reducing capital in the private economy and, hence a reduced desire for the private economy to borrow. Remember, there is a finite pool of capital in the economy and regardless of who is taking the loss, the consequences have an effect of reducing that pool. This is regardless of whether private investors take future losses or whether taxpayers or the FDIC takes the hit through their burden of risk in the transaction.
So, effectively what Treasury's plan has done is exactly the opposite of its intent. It has made the crisis worse - the law of unintended consequences. It has actually reduced the ability of the private sector to borrow by reducing capital in the economy. It also has the impact of reducing the capital in the private economy needed to conduct existing nonfinancial business. That means the newly refreshed banks will ultimately see an even further erosion of their balance sheets as less private capital is available to pay other existing bank debts assumed to be "good" assets before the execution of Treasury's plan. Or even new bank loans that will be initiated after the execution of the Treasury plan. Geithner's plan ultimately leads to further destruction of bank capital, further destruction of private capital and a larger crisis.
Given the FDIC has been pulled into this plan to backstop risk, failure of this exposes the FDIC to substantial loss. Now, what impact would this have on the FDIC's role of protecting citizen's bank deposits? Remember the FDIC's intent is to protect our deposits. To protect us from mismanaged banks. Not to be exposed to risky schemes that threaten confidence in the FDIC. Or to prop up failed management and insolvent banks.
This plan transfers even more wealth from those least able to bear the burden, the American people, to a chosen few. First Paulson then Geithner and now a future bureaucrat will be tin-cupping for another bailout. When will this end? When The Game ends. That is, when we have bankrupted society or when we have printed a mountain of money thus further destroying private wealth or when toxic assets reach an equilibrium or when these actions have created an environment of social unrest or some combination of the above.
Did anyone in government ever take a math class? Hey Washington, Free Lunch economic theory doesn't work.
How many bailouts have we had now? Remember Paulson confidently told us $700 billion was enough. By the way, that was after he repeatedly told us how great the economy was. Geithner is the new leader in the same Confidence Trick. $10 trillion later the same hacks are still playing games with our future.
One point I find most troublesome is that there are six billion people on this planet and we can't seem to get beyond the ideas of a handful of people with substantial conflicts of interest, bias and little knowledge of how to solve this crisis using sound reason and logic. This very fact is contributing to the negative consequences and raising the long term risks for everyone. This is indicative of an elitist culture that eschews the intellectual capital of society. Of public discourse, of peer review, of the inherent problem solving ability of a free society. In other words, placing the economic decisions for hundreds of millions of people in the hands of a few back room decision makers is exactly the economic model embraced by the Soviet Union. It will result in miserable policy failures and terrible economics.
Are politicians really that foolish or simply that beholden to Wall Street? This crisis is far from over.
=====================================================
Remember, I posted this before this crisis developed. So, it is in future tense. Keep that in mind given we have already seen The Game develop. In fact, The Game is exactly what has collapsed our financial system and the global economy and what will contribute to the Treasury plan's failure.
Repost of The Game.
Question: What if an environment existed where there was significant leverage in many assets and very large bets across all assets. And, let's say some of those assets are more liquid than others. And, that some assets are actually quite illiquid. By that I mean there is not a clearinghouse or large auction market with substantial players to trade that asset. A piece of art may be an example of an illiquid asset. And, let's say any one of those bets turns against one of the players or many players. And, let's say one day players have to recognize that bad bet(s). In doing so, the players have to recover a stable financial position. In other words, they need to raise capital to remain liquid and stay in the game. Or, in a bank's case, remain solvent. And, let's say it has become impossible to raise that capital through the sale of semi-liquid or illiquid assets. And, in a worst case scenario, let's say the illiquid assets are the ones that have turned against those players. What are the players forced to do? And what are the consequences for the players and for the asset markets they've invested in? Both short term and long term?
Answer: There are many outcomes. One is forced selling. Even many deeper angles on the selling. One of them is that players are left with continually deteriorating BAD bets while they sell their good bets to remain in the game. That has a self-reinforcing or recursive effect of selling more and more good bets while more and more bad bets draw down their capital positions over time and thus continually erode their capital positions until either bankruptcy, capital injection or bad bets stabilize. Selling of good bets are not just paper assets or traded assets but could be other parts of the company, people, their trading businesses, etc. And, what might that mean for hedge funds that rely on them to stay in business? And, what does that imply for intrinsic value of these players? That said, there are still so many other angles.. .....But, we'll all watch as it unfolds.
<< Home