Monday, March 23, 2009

U.S. Treasury Bailout

The Treasury's plan to isolate toxic assets appears to be thoughtful. Its strength is the reliance on private sector valuation of assets, the weakness may be having the private sector administer the assets under FDIC guarantee.

The document correctly identifies the lack of liquidity as the colonic blockage of the system and is on the right track in trying to arbitrage or bridge the time needed to find a more realistic balance between information and valuation. Inviting private investors is a good move to assure those with "skin in the game" are valuing these assets and not politicians! Nevertheless, only the details of the contracts will tell if terms sufficient to offset the risks inherent in the worst paper will attract speculators. There is not enough evidence that long term investors would be interested at this time because the banks are most likely to dump the worst quality paper into this program first and retain the better ones.

No bank wants to incur more massive write downs or have write downs already taken to be determined as having been insufficient. Already exhausted stockholders would muster another breathe to whip them anew in the marketplace.

While it will be in the best interest of the new equity owners of these assets to maximize their returns, with the 6 to 1 leverage, this may mean selling quickly or foreclosing rapidly to realize any value above the bid. This may not serve the public policy piece as the Administration may have hoped. Earlier foreclosures are a blessing and a curse. The blessing is the more direct resolution of poor loans, but the curse of exacerbating additional negative public sentiment does little to bolster consumer confidence.

On balance, getting bankers to lend again is an essential first step and providing greater clarity about their real capital levels is important. Nevertheless, it would have been nice to see some extra discipline implemented in the governance of the banks themselves when the opportunity is most ripe. Bank boards have not been held adequately responsible for their role in the financial "train wreck".

Perhaps we can look forward to additional measures in the future if this plan works. If it doesn't, I suppose no rules or discipline will matter very much at all.

Tuesday, March 17, 2009

AIG Bonus Issue

It looks bad, smells worse and feels slimy, but AIG executives have been asking for this day since they partied the night away to celebrate the first of many government injections of capital to keep the "too big to fail" organization alive.

What these "bozos" did is no worse than any of the Wall Street investment bankers have done in looking out for themselves first, their families second and their Porsche lease payments third. That the AIG transgressors speak with English accents (it was the London office that masterminded the fiasco) or with Connecticut clipped phrasing is not important. The disconnect from "Main Street" is laughably tragic.

The fact that the Government is least likely to succeed at managing a business of any kind is worrisome. They screwed up the management of the Mustang Ranch outside of Las Vegas when they assumed ownership after a tax issue. If they couldn't make a brothel that served booze make money, we all have to worry if they try to manage anything more complex than a lemonade stand in the desert.

The blame should be kept separate from the solution. The blame is Hank Paulson and the deregulating regulators. Andrew Cuomo as head of HUD under Clinton bears some responsibility also but Donaldson and Cox at an SEC that allowed for the abandonment of common sense need to be fingered for sure.

A solution is to arbitrage time. Taxpayers bridge the bad paper until it is worth something and be sure the bridge loans are properly valued and that the spread on the inevitable public offering that Goldman Sachs underwrites, reflects the fees paid to that organization to keep it alive. In fact the fees that GS makes on government offerings should be gratis even if Paulson coughs up his ill gotten $700 million that he picked up during the last few years at GS.

Wednesday, March 11, 2009

I can't take credit for this but it is pretty cute.

The Credit Crunch Explained

Heidi is the proprietor of a bar in Berlin. In order to increase sales, she decides to allow her loyal customers, most of whom are unemployed alcoholics, to drink now
but pay later. She keeps track of the drinks consumed on a ledger (thereby granting
the customers loans).

Word gets around and as a result increasing numbers of unemployed alcoholics
flood into Heidi's bar. Taking advantage of her customers' freedom from immediate payment constraints, Heidi increases her prices for wine and beer, the most popular drinks. Her sales volume increases massively.

A young and dynamic customer service consultant at the local bank recognizes these
customer debts as valuable future assets and increases Heidi's borrowing limit. He
sees no reason for undue concern since he has the debts of the alcoholics as

At the bank's corporate headquarters, expert bankers transform these customer
assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities are
then traded on markets worldwide. No one really understands what these
abbreviations mean and how the securities are guaranteed. Nevertheless, as their
prices continuously climb, the securities become top-selling items because (insert
here the name of your financial advisor) recommended them as a good investment.
One day, although the prices are still climbing, a risk manager of the bank,
(subsequently of course fired due to his negativity), decides that the time has come to demand payment of the debts incurred by the drinkers at Heidi's bar. But of course
they cannot pay back the debts.

Heidi cannot fulfill her loan obligations and claims bankruptcy.DRINKBOND and ALKBOND drop in price by 95 %. PUKEBOND performs better, stabilizing in price after dropping by 80 %. The suppliers of Heidi's bar, having granted her generous payment due dates, and having invested in the securities, are faced with a new situation.
Her wine supplier claims bankruptcy, her beer supplier is taken over by a

The bank is saved by the Government following dramatic round-the-clock consultations by leaders from the governing political parties. The funds required for this purpose are obtained by a tax levied on the non-drinkers.

Monday, March 2, 2009


From the Treasury statement:

Washington, DC The U.S. Treasury Department and the Federal Reserve Board today announced a restructuring of the government's assistance to AIG in order to stabilize this systemically important company in a manner that best protects the US taxpayer. Specifically, the government's restructuring is designed to enhance the company's capital and liquidity in order to facilitate the orderly completion of the company's global divestiture program.

The company continues to face significant challenges, driven by the rapid deterioration in certain financial markets in the last two months of the year and continued turbulence in the markets generally. The additional resources will help stabilize the company, and in doing so help to stabilize the financial system.

As significantly, the restructuring components of the government's assistance begin to separate the major non-core businesses of AIG, as well as strengthen the company's finances. The long-term solution for the company, its customers, the U.S. taxpayer, and the financial system is the orderly restructuring and refocusing of the firm. This will take time and possibly further government support, if markets do not stabilize and improve.

Given the systemic risk AIG continues to pose and the fragility of markets today, the potential cost to the economy and the taxpayer of government inaction would be extremely high. AIG provides insurance protection to more than 100,000 entities, including small businesses, municipalities, 401(k) plans, and Fortune 500 companies who together employ over 100 million Americans. AIG has over 30 million policyholders in the U.S. and is a major source of retirement insurance for, among others, teachers and non-profit organizations. The company also is a significant counterparty to a number of major financial institutions.

AIG operates in over 130 countries with over 400 regulators and the company and its regulated and unregulated subsidiaries are subject to very different resolution frameworks across their broad and diverse operations without an overarching resolution mechanism. Within the options available, the restructuring plan offers a multi-part approach which brings forward the ultimate resolution of the company, has received support from key stakeholders and the rating agencies, and provides the best possible protection for taxpayers in connection with this commitment of resources.

The steps announced today provide tangible evidence of the U.S. government's commitment to the orderly restructuring of AIG over time in the face of continuing market dislocations and economic deterioration. Orderly restructuring is essential to AIG's repayment of the support it has received from U.S. taxpayers and to preserving financial stability. The U.S. government is committed to continuing to work with AIG to maintain its a bility to meet its obligations as they come due.

Treasury has stated that public ownership of financial institutions is not a policy goal and, to the extent public ownership is an outcome of Treasury actions, as it has been with AIG, it will work to replace government resources with those from the private sector to create a more focused, restructured and viable economic entity as rapidly as possible. This restructuring is aimed at accelerating this process. Key steps of the restructuring plan include:

Preferred Equity : The U.S. Treasury will exchange its existing $40 billion cumulative perpetual preferred shares for new preferred shares with revised terms that more closely resemble common equity and thus improve the quality of AIG's equity and its financial leverage. The new terms will provide for non-cumulative dividends and limit AIG's ability to redeem the preferred stock except with the proceeds from the issuance of equity capital.

Equity Capital Commitment : The Treasury Department will create a new equity capital facility, which allows AIG to draw down up to $30 billion as needed over time in exchange for non-cumulative preferred stock to the U.S. Treasury. This facility will further strengthen AIG's capital levels and improve its leverage.

Federal Reserve Revolving Credit Facility : The Federal Reserve will take several actions relating to the $60 billion Revolving Credit Facility for AIG established by the Federal Reserve Bank of New York (New York Fed) in September, 2008, to further the goals described above.