Excellent post written by someone in Yahoo. Hope people here will like this:

You may recall back to last fall, when then Secretary of the Treasury Hank Paulsen got Congress to pass his $800 billion TARP (Troubled Asset Recovery Program) proposal, almost overnight. The idea was this: Banks have huge volumes of mortgage-backed securities in their portfolios. These securities are CDOs (collateralized debt obligations), CDOs-squared (CDOs of CDOs), CDSs (credit default swaps), and numerous other highly leveraged structured securities designed by brilliant financial engineers just a few years ago. These securities are now being called “toxic assets” or “toxic waste,” because they’re worth a lot less than thought. There’s no market for these securities any more, and when forced to sell via a “fire sale,” banks are getting 20 or 30 cents on the dollar. If banks are forced by “mark to market” rules to mark down the values of these assets to 20-30 cents on the dollar, then many banks immediately become essentially bankrupt, for all practical purposes. So the TARP program was supposed to purchase the toxic assets at something like 60-80 cents on the dollar, so that banks can get them off their balance sheets, and still survive. Paulsen got his $800 billion, but unfortunately he never got around to buying up all those toxic waste securities. For some strange reason, he just never got around to it. I guess he must have spending too much time working out at the gym, or something. Anyway, early in February, President Obama gave a press conference at which he announced that the shiny, brand new Secretary of the Treasury, Timothy Geithner, would announce the details for how the banks would be saved. The next day came and and Geithner gave his own press conference but, for some strange reason, he provided absolutely no details whatsoever. I guess he must have spending too much time celebrating the inauguration, or something. I’ve said repeatedly what the problem is. The problem is that there are many tens of trillions of dollars worth (nominal value) of this toxic waste, perhaps over a hundred trillion, and there isn’t enough money in the world the buy them all. That’s the ice water reality that keeps striking these government officials. People keep saying, “Why doesn’t the government just buy these things up?” Or, “Why doesn’t the government just nationalize the banks?” Or, “Why don’t we just let these banks fail, and the market will dispose of the toxic waste?” The problem is that none of these “solutions” has any chance of working. When you’re talking about many tens of trillions of dollars of toxic waste, there’s literally no way to deal with it, without massive and widespread homelessness, bankruptcies, poverty, and starvation. The dot-com, real estate, credit and stock market bubbles took almost 15 years to grow. By using leverage, and leverage on leverage, and leverage on leverage on leverage, there are now well over $1 quadrillion worth of structured securities in the world. All those bubbles have to deflate before things can return to normal. And it can’t be done overnight. If it took almost 15 years for the bubbles to expand, then it will take a similar period of time for the bubbles to deflate. This crisis has barely begun. So finally, Tim Geithner had to do SOMETHING. The investors were demanding it. The Congress was demanding it. The public was demanding it. The President was demanding it. So he came up with a “public-private partnership” that tries to use allow the market to dissolve the toxic waste. The Treasury won’t buy the toxic waste from banks, as it would have with the TARP plan. Instead, a bank can sell the toxic waste to certain third party investors, and the Treasury will put up 86% of the purchase price. The purchaser need put up only 14% of the purchase price, providing 6 to 1 leverage. But by another arrangement, the FDIC will put up half of the remaining price. So the investors only puts up 93% of the purchase price, providing 13 to 1 leverage. It wouldn’t be a straight sale. Instead, several of these investors would bid on the toxic waste at an auction. That way (it is hoped), a realistic market value for the toxic assets will be established. If the value of the toxic waste assets goes up, then the investors will make money. If the value goes down, then the investors lose less than they would have otherwise. This doesn’t solve the size problem in any way that I can see. There are still many tens of trillions of dollars worth of these things, and now the US government only has to pay 93% instead of 100%. That isn’t going to make any difference.

Related Posts:

• The CDO/ABS/CDS “market” was the biggest pump and dump scheme in history.
• Let’s do those stress tests again.
• The time to rein in the banks has come and gone.
• Better keep an eye on this potential back-door Tarp.
• Obama’s failure

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