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Larry Levin’s Nightly Newsletter & Trading Signals

Toxic asset plan – A C.R.A.P.

Tax-Cheatin’-Timmy of the US Treasury has finally unveiled his plan to save the banks, which is simply a retread of the Paulson Plan. In the plan, which I will discuss below, his brilliant idea is revealed: relieving banks of toxic assets and loading them onto the taxpayer. Thanks Tim. The new plan is called the Public-Private Investment Fund (PPIF). I believe, however, his plan should be renamed “Collateralized Rescue Asset Plan” so we could refer to it as the C.R.A.P. plan.

Whatever you call it, it’s just another euphemism for another BANK BAILOUT on the order of $1 trillion (more) dollars.

Because the housing market has collapsed, the securitized debt that the banks hold is underperforming, and in some cases non-performing (already foreclosed). However, portions of these securities are good but are tied to the bad debt and cannot be untangled. The tangled spider web of assets in these securities is so complex that Alan Greenspan has said he could not figure them out.

Since they cannot be “untangled” and since they have been priced by some measures at being only worth 30-cents on the dollar, they are straining the banks balance sheets. (In fact, Merrill Lynch sold a portion of its assets at only 20-cents on the dollar and provided the funding, making the cost closer to 10-cents on the dollar.) But the banks do not want to sell these securities now, because maybe they will be worth 100% some time in the future. In the meantime the banks have been forced to write down the value of these assets, which forces them to raise more capital, and that well has run dry. How low have they been marked down? From what I have read most banks have only written down these bad assets by about 15-cents on the dollar, so the banks still have them valued at around 85% of their original fairy-tale value.

In steps the Treasury again with the “solution” revolving around five steps.

1) A bank decides what pool of assets they would like to sell.

2) After determining that it would be willing to leverage the pool, the FDIC will conduct an auction. For instance, mortgages with $100 face value would be bought for $84.

3) Of the $84, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.

4) The Treasury would then provide 50% of the equity financing. In this example, Treasury would invest $6 and the private investor would contribute the other $6.

5) The private investor would manage the servicing of the asset pool using managers approved by the FDIC.

How did that sound? Is that a public-private investment plan or a public-taxpayer-bend-over-again-plan? Oh yeah, it’s the “Collateralized Rescue Asset Plan” – C.R.A.P.

As you can see, the Treasury is already assuming bidders will buy these assets for about their current value: 84/85-cents on the dollar. If the private buyer puts up $6 for an $84 asset, how much of his money is at risk? The answer is only 7%. Said another way, the taxpayer is on the hook for 93%, which is simply another bank bailout or C.R.A.P. if you like. And doing it this way means there is no need to go through Congress for funding, which is yet another end-around constitution.

The government guarantees are being made by the FDIC and are non-recourse loans, which simply mean if the investment goes sour; the government cannot go after anyone to get paid. Taxpayers get hosed again. Umm, when did the FDIC mission expand to speculative lending in the securities market? Doesn’t that place their core mission, to backstop the little guy’s savings in a crash, at risk? Is this the same FDIC that does not have enough money right now to finance 2009’s expected bank failures? Well thank the Lord money grows on trees now!

Now we know the true purpose of that $500 billion the FDIC asked for a few weeks ago. The intent never was to “rebuild its fund that insures consumers’ deposits.” The intent all along was to swindle taxpayers to the tune of at least $500 billion to possibly $1 trillion.

The guarantees are what are getting the market excited because this should make it easy to overpay for the bad assets. Who cares right? The taxpayer is taking 93% of the risk. But what if private funds don’t overpay? This scenario is why the Paulson plan wasn’t done; it didn’t contain the screw-the-taxpayer provision. If the funds bid only 30-cents on the dollar and don’t clear because the bid doesn’t reach the bank’s minimum price, then no one will any longer be able to perpetuate the fiction that America’s banks are solvent.

But here’s the real problem: couldn’t the banks set up an off-balance sheet entity and buy their own bad debt at face value using some of their TARP money? All of a sudden their non-performing assets will have an FDIC guarantee! And if the banks can’t buy their own bad debt, why provide such a sweetheart deal to the hedge fund crowd? Is the Federal Reserve working for the hedge funds now?

To be specific, wouldn’t it be hilarious if one of the major players in this activity was AIG? Picture this: AIG puts up $5 billion of TARP money and the Treasury puts up $5 billion of new TARP funds to buy $75 billion of toxic debt. This new public/private partnership buys a pool of their own (AIG’s) assets for 75-cents on the dollar, and the FDIC is a guarantee for the other $65 Billion. Now a year and a half later they sell the assets for 90-cents on the dollar and split the $15B profit 50/50 with the Treasury. AIG’s $7.5 billion share of the profits is a return of 150% over 18 months or 100% annualized internal rate of return (without allowance for compounding) on the $5 billion originally invested. They take 40% as a bonus and payout $3.0 billion. Then they take a group photo of all the AIG traders thumbing their noses at Congress and the taxpayer.

If this doesn’t work, maybe the banks will use the Fed’s TALF. Why wouldn’t a bank put an asset up for auction under TALF and if the bid isn’t high enough to its liking, the bank places a bid on the asset itself, offering a price high enough to the board’s liking. Since the bank will be buying the asset from itself it doesn’t cost the bank anything, instead the bank gets to immediately monetize 85% of the fictitious price of the “asset,” while transferring the risk for that 85% to the Fed/taxpayer.

But today in the media we didn’t hear of these possibilities. We only heard how great it was for the investors and the taxpayer – both are going to make so much money they all said. But I wondered, with all the supposed upside – why do the banks want to sell again?

Trade well and follow the trend, not the so-called experts.

Geithner’s Toxic Asset Plan – Bloomberg

Don’t Panic! Toxic Asset Plan?