No one knows the value of toxic assets because no one knows their value??

[EmilyAnne]

The major criticism of Geithner's plan is that nobody knows the worth of the toxic derivative assets.

To price them, Geithner wants private investors and the government to work together on finding their true value.

Krugman says this won't work because nobody knows what they are worth, but also says he is certain that they are worth much less than the bank books reflect.

So, the problem with pricing the assets is that nobody knows how to price the assets?
That seems very circular to me.

Another argument against Geithner's plan is that private investors will be putting up 15% of the cost of an asset. Since they will put in so little, they won't have an incentive to get the price really low. They have nothing to lose.
This doesn't make sense to me because it seems that they have 15% to lose along with the most motivating factor of all: profits.

Can anyone shine some light on this, because these particular criticisms don't make sense to me,

[underpants]

1. The accounting and record keeping are a mess

The record keeping-if you aren't familiar with the "Produce the Note" movement basically foreclosed homeowners file a free legal document at their local court of jurisdiction forcing the production of the actual note.... no one knows where they are. The foreclosed former homeowner gets moved to the back of the line (from what we have seen) and they foreclose on property more easily repossessed.

Accounting. Lots to write about here and there are serious discussions in the accounting world about this. Let me summarize with one point-- mark-to-market accounting. Amongst the features of this is the valuing of assets on your books at what is determined to be the "market value" of the asset. You also get to go ahead and record the gain on said asset as if you were selling it, this is (to me) directly in contrast to the regular accounting I was trained in (acctg. degree) you can't have an asset AND a gain at the same time..you have to pull the trigger on a sale to realize the gain and in doing so you lose the asset on the balance sheet. The problem really is that the "market value" of assets are impossible to determine right now because everything changed. They can't know what the "market value" is because the market has not determined what everything (real estate especially) is worth right now. To further confuse things you have to realize that some banks bought bits of mortgages so they have to figure out what that BIT is worth. Basically they took mortgage "paper" ripped it into pieces and sold the pieces THEN re-sold the pieces over and over amongst themselves. Not only would you have to determine what the entire piece of paper is worth but you also have to figure out what the WHOLE paper is worth and back out the bit here or bits that no longer make the paper whole.

[EmilyAnne]

3. So how would nationalizing a bank handle this?

And thanks for your explanation!

[KittyWampus]

6. Let's call it restructuring (not nationalization). The governent brings in auditors

who go through the books as a first step.

Again, that's my problem with this whole thing.

Wall Street is telling the Government, "No, you can't see our book" when we all know that their books will show they ultimately made unsound investments and KNEW they were unsound.

[EmilyAnne]

11. Aha! Ok! That is something new to me. They will be going into bid on the assets having no idea

about what reflected on the banks' books?

About the auditors, who would they be?
New hires, yes?

[KittyWampus]

13. Okay, I think that's something we'd need to investigate. In Reagan years the govt. did same to

Savings and Loans, remember?

I think if the government doesn't have enough qualified people, it'd hire out.

[KittyWampus]

23. Okay, here's more detailed info on what a bank going into recievership means-

That's hogwash, says University of Texas professor James Galbraith, author of The Predator State. Of course there's an alternative: FDIC receivership of insolvent banks.

Aside from being legally proscribed, the upside of FDIC receivership is the banks are restructured and reorganized for potential sale (either in whole or parts), Galbraith says. Such was the fate in 2008 of, most notably, Washington Mutual and IndyMac.

Crucially, FDIC receivership also means new management teams for insolvent banks; and Galbraith notes new leaders will have no incentive to cover up the fraudulent or predatory lending practices of their predecessors. Given the entire system was "massively corrupted by the subprime debacle," the professor believes criminal prosecutions on par with the aftermath of the S&L crisis - when hundreds of insiders went to jail - is a likely (and necessary) outcome of the current crisis.

But don't expect to see many "perp walks" if Geithner's current plan comes to fruition. That's one reason Galbraith called the plan "extremely dangerous" in part one of our interview.

So why isn't the Obama administration pushing for FDIC receivership? "Political influence of big banks," the economist says.

[underpants]

33. Great post

Some people here said that Geitner was waiting for the "stress tests" to be done and that is why there was no concrete plan yet ( I am not sure if even that last part is true) but *my* take on it was that they are the midst of negotiations with the banks and financial higher-ups. These people negotiate for a living so basically there is a side game going on that we aren't supposed to know about.

[Imperialism Inc.]

17. Depends on the plan.

With the good bank/bridge bank idea they would just side step the valuation process. They would split off (or sell off) the good assets that aren't in question. However much that is worth the old bank (holding the un-priceable junk) just gets that much equity (i.e. stock) in the new company holding the good stuff. Then their banking license is removed and they just "manage down" the junk until it is all resolved.

[underpants]

31. Like how the never-talked-about Savings and Loan crash was handled

good assets were managed and bad assets were either swallowed or revalued and then managed....very successfully

[DeepBlueC]

7. but if these things are going for sale at auction

won't that be an opportunity to set a value? The government is in the deal to sweeten the deal for private investors who will be there to exert market discipline i.e. trying to get them for as little as possible while outbidding others.

[KittyWampus]

9. yes, and since the government is 'sweetening the deal' its artificially keeping values inflated

It's like saying "okay, the emperor has no clothes but let's pretend he does for a little longer because if we say anything he'll have use beheaded".

The US Government is refusing to play hardball. They are allowing Wall Street to dictate terms.

[DeepBlueC]

28. it may encourage investors

but even if the government helps investors are still weighing the upside. By investing in the first place they are helping to establish that these still HAVE value. The investors still have an interest in getting it for the least and selling for the most. But the government is needed to jump start this at all. It really does the economy no good if these are disposed of at two cents on the dollar or as low as they can be driven. The perceived lack of value is the source of the current market malaise.

[Imperialism Inc.]

2. The market for these things is basically dead. The banks want to sell

them at 50 or 60 cents on the dollar and investors want to pay about 20 to 30 cents. In addition the economy is deteriorating, so no one is sure how many more foreclosures there will be. This introduces uncertainty in how much assets based on these, possibly failing, mortgages will be worth in the future.

Part of the plan is indeed to induce the private equity funds to pay more than the 20 to 30 cents they are willing to pay now. You are right that they still have incentives to get as low a price as possible, but since the banks wont sell at 20 to 30 they are going to have to come up some to even get a sale at all. The other incentive working the opposite way is the leverage and non-recourse part of the plan. 85% of the price will be paid by the government with a non-recourse loan. First, the private firms only have 7 1/2% to lose since the government is also splitting the 15% with them 50-50. The non-recourse loan means that if they walk away the government is just stuck with the asset and can't collect the rest of the loan. So, they have very little down side and a lot of upside. For 7 1/2% of the money they get 50% of the profits!

Imagine if you were asked to bet on the roll a die and every time a 1,2 or 3 comes up you double your money. But, if a 4,5, or6 comes up you lose your bet, but some else will pay for 75% of it for you. You are going to be willing to risk a lot of money. Sure you could hit a bad streak of rolls but your "partner" is paying for most of that!

[EmilyAnne]

5. But I assume that the government will be choosy about the assets that is purchases?

Not all toxic assets will be bought.

Of those bought, most will yield profits when they mature, yes/no?

I do understand your gambling analogy.

Another thing, will Obama's policies on preventing foreclosures stabilize the value of a lot of these assets?

[Imperialism Inc.]

12. That is certainly the hope. The FDIC will be reviewing each portfolio of

assets a bank puts up for auction. They will give a maximum they are willing to pay for it. At least that is my understanding. There is also hope that the private equity will at least be doing some due diligence on the assets too. It isn't all bad but basically the government is placing an enormous bet on the idea that the market is underpricing these assets. If they are wrong, the agency that insures everyone's bank deposits will take an enormous hit! I have to admit, that scares the crap out of me.

Obama's foreclosure stabilization plan should help some I think. To be honest though I'm not sure of all the details and how they mesh with the structure of these assets. Remember that it isn't actually individual mortgages. They have been sliced and diced and repackaged many times over.

[KittyWampus]

15. Is that true, though? Will the government audit each asset it puts up for auction and make findings

public?

Because if the real-world value is determined, why would the government have to "sweeten the pot" to such a huge extent?

[EmilyAnne]

26. Maybe to get investor confidence up? They will finally start spending?

[Imperialism Inc.]

27. That's what thay have said they are going to do. Like someone else said

it isn't just will they but can they? Any evaluation will be have to be based on guesses about the future and models based on that. Kind of like the banks were doing during the boom time! Scary!

[EmilyAnne]

16. So the "books" will actually be open to the FDIC?

If the assets are undervalued, won't they be held until they mature or the market gets stronger?
So, in the short term we would be taking on a debt that could be remedied in the future?

This is so overwhelming to me.
Thanks for your responses!

[KittyWampus]

20. that's a great question. I hope there's a definitive answer. Thanks for this thread

[Imperialism Inc.]

25. Well the regulators doing the "stress tests" currently are looking at the books.

Presumably they will share that with the FDIC. So the FDIC will be armed with that information plus they are going to look at each portfolio of loans put up for auction in more detail.

If the bet is right, that the market is currently under valuing the assets then there is a potential to make money. Some examples. I'll assume that we can see the in to future and know exactly what the asset really ends up being worth. Of course FDIC and investors can't really do that but it lets us look at scenarios.

Example 1:
They pay $100 total. $85 FDIC loan. $7.50 treasury. $7.50 private
Future value ends up being $120
FDIC gets back $85 plus very low interest (from the private investor)
Treasury gets $7.50 + $10.00
Private gets $7.50 + $10.00

Example 2:
They pay $100 total. $85 FDIC loan. $7.50 treasury. $7.50 private
Future value ends up being $100
FDIC gets back $85 plus very low interest (from the private investor)
Treasury gets $7.50
Private gets $7.50
That's if the private investor doesn't walk away. They might do so eventually in this case since they are paying interest and will realize they aren't going to make a profit.

Example 3:
They pay $100 total. $85 FDIC loan. $7.50 treasury. $7.50 private
Future value ends up being $70
FDIC gets back $70 plus very low interest (from the private investor). They lose $15 overall
Treasury gets $0
Private gets $0
Also, realize in this case that the investor will walk away early on in the process once they realize they are going to lose it all. No sense to pay interest on something that is going to lose money.

[alcibiades_mystery]

24. This is the basic assumption that divides people

I should say that the positions on both sides are being put forward in good faith.

One side believes that the FDIC can and will exercise due diligence and oversight with respect to the non-recourse loans.

The other side believes that the FDIC either can't or won't do so.

If you believe the first, then the "math" criticizing the plan is based on false assumptions.

If you believe the second, then you can easily construct scenarios under which the taxpayer is being fleeced.

It is really the nub of the question: can and will the FDIC make good judgments about the collateral?

[KittyWampus]

4. EmilyAnne, you've touched on my problem with Geithner's plan. He's just continuing the shell game

These assets are over-inflated.

It isn't just mortgage interest payments that've been bundled together, it's essentially bets on the bets on the bets on whether the mortgages will get paid.

And the only reason Geithner's plan is attractive to these huge investment firms is because the federal government is fronting so much money.

Now you and I both know, if you're in credit card debt the only way to get out from under is to be HONEST. Stop just shoving bills in the drawer, stop paying one bill at a time, stop opening up new interest-free accounts to pay off the old accounts.

[EmilyAnne]

8. I was under the impression that this is what Geithner wants to do. Assess the real value underneath

all of the shell game stuff.

Is the fear that this just isn't possible now? Or ever?
I know exactly what you are talking about in your last lines. I had an old roommate who would do this with all of the credit card offers we got in college. She would even get cash advances off of them.
She took on so much debt before she was 22, paying one card off with another, etc.

[KittyWampus]

10. His plan artificially keeps values inflated cause the government is fronting so much money

And my understanding is there is no auditing involved. It's just auctioning off as described above.

So the value is STILL not based on real-world assets and worth.

And that's part of how we got into this mess.

These funky investment vehicles were rated as sound and low-risk not because of what they actually are .... the rationale the investment firms used to have this crap rated highly was .... HEY, we're gambling so much on them so the MUST be worth this much.

[high density]

34. You're confusing mortgage backed securities with credit default swaps or something else

These are not bets on bets, these are people's mortgages backed by their homes. That's not a shell game. Most people are still paying their mortgages which means most of these assets are still performing. The problem is that the market for these types of securities has been decimated and the Treasury department thinks they can improve that by reducing the risk for the private investors.

[Romulox]

14. They are "worth" what a willing buyer will part with. Which means ZERO.

This is a very basic concept. Things are worth what a willing buyer will give for them, on one hand, and what a willing seller will part with, on the other.

[EmilyAnne]

19. So true. So, what is the ultimate goal with this plan? Why buy assets that are worth, essentially,

zero?
Even if you don't agree with anything about this plan, can you play devil's advocate about this?

[KittyWampus]

21. I don't think anyone is saying they're worth zero. Just a lot less. And since the government

is paying in such a huge amount, it becomes worthwhile.

[Romulox]

22. We are guaranteeing the reckless bets of the Ruling Class. It really is as simple as that. nt

[DeepBlueC]

29. they are worth zero because of lack of confidence in ability to sell them

people will pay mortgages though, some or most of them, so there is actual money value there.

[Romulox]

35. As always, the risk is built into the price.

The Geithner plan is to re-inflate the bubble by assigning 95% of the risk to the US taxpayer. Naturally I will be willing to "bet" trillions on the roulette table if the government pays out if I lose, but I get to collect if I win. :shrug:

[AngryAmish]

32. The point of the plan iss the value is different than the price

Market-heads think price always equal value.

So the government is coming up with a plan to raise the price/value of the assets.

How does one inflate the price/value? This plan of giving non-recourse loans to the hedge funds artifically inflates the price (since they do not have to put up the full value).

Thinking that this artifical raising of price is a bad thing is the gist of Krugman's critique. He thinks all of these assets are valueless because there is no market price.

[Romulox]

36. The "extra value" Geithner is discovering is TAXPAYER DOLLARS. Nothing more. nt

[HereSince1628]

18. No one knows fair value until the houses with falling prices start selling.

Part of the administration's plan is to get houses being purchased again. That will shore up prices. A consequence of shoring up prices is that the gov't will be jumping in when prices are higher than their real market value.

That's true. So Krugman is right on that. But within the argument for government incentives there rests the notion that it is desirable to halt the falling prices.

The government's insurance against loss seems to me to be vexed by the same thing as the derivative bets against foreclosure that contributed to the subprime mess. No one is willing to take an uninsured risk. If you have an insured risk, it isn't much of a risk. You can go ahead and accumulate more risk. This creates a false notion about the real risk of foreclosure and all the damage that does to borrowers, neighbors and communities. It is something akin to the idea that as a parent you don't need to have your kids wear helmits on a bunny hill because you have a health insurance policy. False notions about safety are never safe.

[ColesCountyDem]

30. Putting all the fancy theory aside, they're 'worth' exactly what a buyer is willing to pay for them.

It's Econ 101, essentially. Geithner's plan essentially envisions a receivership and orderly liquidation, much like what the FDIC and FSLIC do with failed banking and savings-and-loan institutions.