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Monday, March 23, 2009

My Name Is Bond - James "Bad" Bond

James Bond is back under another incarnation, brought to you by the next Treasury bad asset mitigation scheme. In today's episode of "All Our Financial Troubles", we meet our protagonist, James "Bad" Bond. Theme song here.

With that playing in the background, the credits give way to the opening scene. Setting, a Wall Street financial's headquarters. Ms BarelyAPenny is ushering in James "Bad" Bond to speak to a figure sitting in front of an untinted window. The light from the window streams dazzlingly past this figure, and neither the viewer nor our hero sees more than a shadowed figure nearly drowned by scintillating light. This shadowed figure speaks. Slowly, gravely, paternally.

"James, I've called you here because I've heard through the grapevine that you aren't pleased by our new "Bonuses if Congress doesn't want the Money" compensation plan, and that you are seeking another opportunity."

James "Bad" Bond, stirred but not shaken, replies with his best Clint Eastwood imitation. His acting talents are few, so he merely narrows his eyes and breathes a bit heavily. "I offloaded nearly 80% of that SIV with only 70% of the cost covered by a non-recourse loan. Your eventual losses will probably be cut by 40%. I was promised 2 percent, and a lousy million just doesn't cut it."

The shadowed figure swivels in his chair, causing his outline to shimmer in the light. James "Bad" Bond is not impressed. "Oh, don't be misled," the Shadowed One says gently. "We understand your position. Indeed, we sympathize. Our problem is with the auditors. They found the corporation that wound up with most of the bonds sitting in our Level 3 assets. It should have been enough to have the first fund pay back its no recourse loan from us, but no, now they are raising difficulties on the valuation of the company you formed to buy them. And after that little Bernie problem, it appears that no other auditing firm is prepared to work with us either to accept our current valuation of that firm. But none of that is your fault, James, and we have a high regard for you.

"In fact, we have a proposition and an opportunity for you."

James "Bad" Bond narrows his eyes, wondering if it is too late for acting school.

"London is calling, James. London. You have heard of the Treasury plan, haven't you?"

James nods, attempting to exude strong, silent displeasure.

"Think of the opportunities, man! They are willing to lend up to 100% of the capital, with no recourse loans, and they don't care who buys the stuff. Your mission, James (and if you don't accept it this interview will not end well) is to take 1 billion money in seed money from us, go to London, establish a fund there, and participate in the Treasury program. Success is guaranteed as long as you remember to pay yourself a high salary!"

James smiles. This is a mission he can handle. "The jet?" he asks.

"Buy yourself one, James! And make sure to get some nice offices over there. Word has it that financial space is opening up at very good prices. We look forward to doing business with you. Ms. BarelyAPenny has a list of realtors, London lawyers and other resources for you."

The Treasury plan's official terms can be found here (PPIP). The definition of "private sector financing" is hilarious. For the first segment:
If a bank has a pool of residential mortgages with $100 face value that they are seeking to divest,
the bank would approach the FDIC. The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio. The pool would then be auctioned by the FDIC, with several private buyers submitting bids. The highest bid from the private sector – in this example, $84 – would define the total price paid by the private investors and the Treasury for the mortgages. Of this $84 purchase price, the Treasury and the private investors would split the $12 equity portion. The new PPIF would issue debt for the remaining $72 of the price and the debt would be guaranteed by the FDIC. This guarantee would be secured by the purchased assets. The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis – using asset managers approved and subject to oversight by the FDIC. Through transactions like this, the Legacy Loans Program is designed to use private sector pricing to cleanse banks’ balance sheets of troubled assets and create a more healthy banking system.
It's a great way to privatize profits and nationalize losses!!! The loans are non-recourse because they are secured only by the assets purchased. Needless to say this constitutes a raid on FDIC resources. I suspect the healthy banks will end up paying for this guarantee.

The second part of the program uses the TALF to fund purchases:
However, any private investor, even those who do not partner with Treasury under the Public-Private Investment Program, will also be able to access the TALF to purchase legacy securities.
Through this expansion of the TALF, non-recourse loans will be made available to investors to fund purchases of legacy securitization assets. Eligible assets are expected to include certain non-agency residential mortgage-backed securities (“RMBS”) that were originally rated AAA, and outstanding and commercial mortgage-back securities (“CMBS”) and ABS that are rated AAA. Borrowers will need to meet certain eligibility criteria. Haircuts will be determined at a later date and will reflect the riskiness of the assets provided as collateral.
When I read that, I was thinking "This isn't serious. This is cover for something else." And here is the something else:
In conjunction with these efforts, the Treasury is also announcing a program to partner with private fund managers to support the market for legacy securities.
Under this program, private investment managers will have the opportunity to apply for qualification as a Fund Manager (“FM”). Applicants will be pre-qualified based upon criteria that are expected to include a demonstrable historical track record in the targeted asset classes, a minimum amount of assets under management in the targeted asset classes, and detailed structural proposals for the proposed Legacy Securities PPIF. Treasury expects to approve approximately 5 FMs and may consider adding more depending on the quality of applications received. Approved FMs will have a period of time to raise private capital to target the designated asset classes and will receive matching equity capital from Treasury. FMs will be required to submit a fundraising plan to include retail investors, if possible. Treasury equity capital will be invested on a fully side-by-side basis with these private investors in each PPIF.

Furthermore, FMs will have the ability, to the extent their fund structures meet certain guidelines, to subscribe to Treasury for senior debt for the PPIFs in the amount of up to 50% of a fund’s total equity capital, and Treasury will consider requests for senior debt for the PPIFs in the amount of up to 100% of a fund’s total equity capital subject to further restrictions on asset level leverage, redemption rights, disposition priorities, and other factors Treasury deems relevant. This senior debt will have the same duration as the underlying fund and will be repaid on a pro-rata basis as principal repayments or disposition proceeds are realized by the PPIF. These senior loans will be structurally subordinated to any financing extended by the Federal Reserve to these PPIFs via the TALF.
So this is a call to restart the SIVs.

Remember the SIVs? Those off-balance-sheet funds that held long term assets, guaranteed by the institutions or funded by no-recourse loans, which used these pools as security for money-market funds? Now they are back, but they are truly funded by Treasury, so they are actually off the balance sheets of the major financials.

The sky's the limit. Krugman is having a fit over this:
This is more than disappointing. In fact, it fills me with a sense of despair.
But the Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt. So this isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets.
But the real problem with this plan is that it won’t work. Yes, troubled assets may be somewhat undervalued. But the fact is that financial executives literally bet their banks on the belief that there was no housing bubble, and the related belief that unprecedented levels of household debt were no problem. They lost that bet. And no amount of financial hocus-pocus — for that is what the Geithner plan amounts to — will change that fact.
He's wrong. This plan will work, especially for James "Bad" Bond and the Shadowed One. It will put the taxpayer on the hook for all that bad debt, but it will bail the institutions out of their situation. Last year, the big financials were giving their own no-recourse loans to anybody who would take the stuff off their hands. This year, Treasury does it.

The auditors won't have a problem with this (for FDIC-insured institutions):
Consideration paid to Participant Banks in exchange for purchased Eligible Asset Pools will be in the form of cash or cash and debt issued by the PPIFs. PPIF debt will be guaranteed by the FDIC. Terms of the debt and debt guarantee will be as stipulated in the FDIC Guaranteed Secured Debt for PPIF Term Sheet.
So, the bank hands over the loans, doesn't have to pay any more into reserves, and gets guaranteed debt back. Some of them will show an immediate addition to capital because they had already set aside substantial ALLL on the loans, and now that gets recovered.

Because losses on loans come slowly, there will be short-term profit, and who the heck cares about long-term losses as soon as you recover your initial investment, which is very little. Given the first example, the private investor's capital at-risk is 6 billion out of the 84 billion theoretically valued pool which had an original value of 100 billion. You can make that off almost any loan pool; you only need to get back 12 cents on the original dollar to break even long term, and in the mean time you get a nice run of profits. It would be a pretty dumb bunny who couldn't make this pay even if you have to way overbid on the pools. But of course the deal has to be sweet. The entire point of it is to unload the stuff at a much higher price than the market will offer.

It's a great time to be in London, out of the reach of Congress Critters, but with US government-guaranteed profits. And this has been in the pipeline ever since, to my astonished guffaws, CIT Group was allowed to become a bank. The big financials dumped a lot of money into CIT so they could dump debt on it, and then the lousy FDIC wouldn't cooperate.

Let the Special Financial Olympics begin. Hope, change, cash for troubled bankers. It's paarrrty time on the Street.

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