I don’t have the energy to fully explain what a bonehead Jeffrey Sachs is, but I can show you a taste. Sachs is a professor of Economics at Columbia University, so you would think he might have some clue what he is talking about when he opines about the dangers of the Legacy Securities Public-Private Investment Funds proposal. But he has no clue. Sachs starts with alarming news.
Two weeks ago, I posted an article showing how the Geithner-Summers banking plan could potentially and unnecessarily transfer hundreds of billions of dollars of wealth from taxpayers to banks. The same basic arithmetic was later described by Joseph Stiglitz in the New York Times (April 1) and by Peyton Young in the Financial Times (April 1). In fact, the situation is even potentially more disastrous than we wrote. Insiders can easily game the system created by Geithner and Summers to cost up to a trillion dollars or more to the taxpayers.
Sounds terrifying, doesn’t it? How can ‘insiders’ accomplish this task? Sachs provides a scenario.
Here’s how. Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset. All of the previous articles consider the case of true outside bidders.
Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total.
Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank’s net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K.
First off, the Treasury Department has two programs: the Legacy Securities Public-Private Investment Funds and the Legacy Loans Program. The Securities program involves “securities backed by mortgages on residential and commercial properties”. The Loans program involves “troubled
and illiquid loans and other assets in substantially sized pools from insured banks and thrifts.” When you hear talk of the government providing non-recourse loans up to 85% of the selling price, they are talking about the Loans program. Here is the rule for the Securities program:
Each Fund Manager will have the option to obtain for each Fund secured non-recourse loans from Treasury (“Treasury Debt Financing”) in an aggregate amount of up to 50% of a Fund’s total equity capital; provided that Treasury Debt Financing will not be available to any Fund Manager in respect of a Fund in which the private investors have voluntary withdrawal rights.
When Sachs talks about a ‘toxic asset held by Citibank’ that has a face value of $1 million but potential sale value of zero, he can only be talking about securities because home mortgage loans can never fall to a value of zero (if nothing else, there are foreclosed homes to resell). So, Citibank’s shadow PPIF could not necessarily obtain 85% financing on a $1 million package of toxic securities. They can only borrow up to 50% of the money they raise for making investments.
That changes his calculations considerably. The new numbers? If the Citibank PPIF raised $1 million to invest, they could borrow up to $500,000 to buy securities.
For example:
The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow
$850K$500k from the FDIC, and get$75K$250K from the Treasury, to make the purchase! Citibank will only have to put in$75K$250K of the total.Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against
$850K$500K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank’s net profit on the transaction is$925K$750K (remember that the bank invested$75K$250K in the CPPIF) and the taxpayers lose$925K$500.
It still sounds pretty terrible. The taxpayers still lose a lot of money. But fortunately Sachs is making several more mistakes. For one, would Citibank really be able to set up a PPIF? What are the rules?
Fund Managers will be required to present monthly reports to Treasury on Eligible Assets purchased, Eligible Assets disposed, current valuations of Eligible Assets and profits/losses on Eligible Assets included in each Fund.
Prices of Eligible Assets for reporting purposes must be tracked using third party sources and annual audited valuations by a nationally recognized accounting firm.
A Fund Manager may not, directly or indirectly, acquire Eligible Assets from or sell Eligible Assets to its affiliates, any other Fund or any private investor that has committed 10% or more of the aggregate private capital raised by the Fund. Private investors may not be informed of potential acquisitions of specific Eligible Assets prior to acquisition.
Fund Managers must agree to waste, fraud and abuse protections for the Fund to be defined by Treasury in order to protect taxpayers.
Fund Managers must agree to provide access to relevant books and records of the Fund for Treasury, the Special Inspector General of the TARP, the Government Accountability Office and their respective advisors and representatives to enable appropriate oversight and taxpayer protection.
It would take a very elaborate conspiracy for Citibank to hoodwink all the regulators and set up a PPIF of the kind envisioned by Sachs. Even this fantasy of Sachs’ is unlikely to be attempted, let alone to fly.
…the gaming of the system doesn’t have to be as crude as Citibank setting up its own CPPIF. There are lots of ways that it can do this indirectly, for example, buying assets of other banks which in turn buy Citi’s assets. Or other stakeholders in Citi, such as groups of bondholders and shareholders, could do the same.
Yeah…that’s not gonna happen. But what about those 85% (6-1) non-recourse loans in the Loans program? Even those are not guaranteed.
Third Party Valuation Firm will estimate Eligible Asset Pool values and
advise the FDIC on loan-to-value and debt service coverage for each PPIF. In assessing the supportable leverage of the asset pool, the
Third Party Valuation Firm will analyze characteristics including expected cash flows based on type of interest rates, risk of underlying assets, expected lifetime losses, geographic exposures, maturity profiles
and other relevant factors.Leverage will be determined on a pool-by-pool basis at the FDIC’s sole discretion, with input from the Third Party Valuation Firm. It is
anticipated that the debt to equity ratio will not exceed 6 to 1 for each PPIF.FDIC will provide credit support for PPIF financing through guarantees of debt issued by the PPIF. The FDIC guarantee is collateralized by assets purchased by each PPIF.
Financing terms will be as set forth in the FDIC Guaranteed Secured Debt for PPIF term sheet.
The PPIF will be required to maintain a Debt Service Coverage Account (“DSCA”) (as stipulated in the FDIC Guaranteed Secured Debt for PPIF Term Sheet) to ensure that working capital for each
PPIF is sufficient to meet anticipated debt servicing obligations, interest expenses and operating expenses. A portion of cash proceeds
from the sale of Eligible Asset Pools will be retained until cash flow from Eligible Asset Pools has fully funded the DSCA, at which point
the escrowed cash will be released to the Participant Bank.
What does that mean? It means that financing terms will be determined on a case by case basis, that participating firms must demonstrate their ability to repay loans, that the FDIC will hold the assets as collateral (like any mortgage-issuer), and that banks will have some of their money held in escrow until the PPIF’s have fully funded their Debt Service Accounts.
I could go on but, like I said, I’m tired. In conclusion, Professor Sachs got his math wrong and came up with an alarmist scenario that has no connection whatsoever to reality. And Krugman (who surely knows better) goes right along. This post should go down in history with the worst of Judith Miller.
As Jeff says, a bank can create an off-balance-sheet entity that buys bad assets for far more than they’re worth, using money borrowed from taxpayers, then defaults — in effect a straight transfer from taxpayers to stockholders.
If there’s a mechanism to police such deals, it isn’t clear. And the sense that the administration is just too close to Wall Street continues to grow.
The only thing growing is the length of Krugman’s nose.
Could it perhaps be that this Jacques Clouseau of international finance has such a vivid imagination when it comes too the looting of public resources, because he was one of the hapless (?) midwives instrumental in the birth of Russian oligarchism?
I think his rape of Bolivia is detailed in Confessions of an Economic Hit Man.
Those who are concerned about the large-scale impact on taxpayers make these assumptions:
Item 5 is why they think the language of the plans and laws are irrelevant.
As this crisis unfolds, ordinary people are getting wise to each of these five possibilities and the public pressure (fatalism has now been seen to be fatal) on Congress and the administration is beginning to produce a more wary approach on the part of the administration. The bonus issue provoked a “fool me once” response in a lot of people that stiffened spines. Obama laid it on the table with the bankers in his “I’m the only thing standing between you and pitchforks” remark.
Sachs is overreacting to his failure to see the rise of the oligarchs in Russia and to have recommendations for preventing them. I see him like a lot of the “invisible hand” types as having reacted to his naivete with a newfound scepticism brought on by a crisis in his own country.
No, I’m not tired of economists, I’m tired of business managers who think that what’s good for them personally is good for the country. (“Those outrageous bonuses just put money into the hands of people who can invest and create jobs….”) Dude, where are my jobs?
I have to admit, even The Kroog looks bad if he’s letting Jeff Sachs formulate arguments for him. The taxpayers still are going to come out on the losing end of this deal. The No Right Price Problem pretty much assures that.
If you’re going to attack the Geithner plan, there are better avenues to do it with then just lying about the numbers.
I didn’t read the rest of the article carefully (it’s way above my head,) but this is wrong:
Only the primary mortgage is gaurenteed a payoff in default. Second mortgages, HELOCs and so on only get money once the primary is paid off. If the value of the property falls, the value of these loans could easily fall to zero.
Couple of things: first, I’m seeing a sort of double standard here (again), however this time it’s on the progressive side.
over on the orange site, when Krugman, Stiglitz, etc., rightfully criticized bu$hco, there was cheering, backslapping and full agreement with the experts.
now that these same experts are critical of Obama’s financial “strategy”, suddenly, overnight, these same experts are nuts, wrong, full of crap.
????
is Stiglitz really on the progressive crap list now? same as Krugman?
from an 4/1/2009 interview with der Spiegel:
operative sentence: “these institutions have to be nationalized”.
Krugman posited the very same thing four weeks ago when he first heard of the bogus PPIF fund.
So- BOTH Stiglitz and Krugman are NUTSO?
second, please explain to me just why I should trust anything Citicorp does or says at this point, given they are one of the more predatory banks out there and given they have been so poorly managed they had to take a multi-billion dollar cash infusion from a Saudi prince to stay solvent?
WHERE are the zombie bank stress tests promised by Geithner?
all of the details in the diary, i.e. how the PPIF can or might actually work are irrelevant to me– because there is NO transparency from the zombie banks getting our tax money.
Obama and team are clearly afraid of the results of full, independent stress tests of the zombie banks, because this will show the massive fraud committed, and will proceed with the usual slight of hand/smoke and mirrors in a feeble attempt to paint these banks as solvent.
as Huffington points out:
after the next 8-12 months of the smoke and mirrors, the failure of PPIF and other bankster-centric bailouts to actually get credit flowing again, and with unemployment still being double-digit, Obama will be forced to nationalize the banks.
a year and Trillions of our tax dollars will have been wasted– this is the real issue, not that Sachs and others are ‘wrong’.
http://www.spiegel.de/international/world/0,1518,616743,00.html
http://www.huffingtonpost.com/arianna-huffington/the-obama-economic-teams_b_183744.html
the stress tests are going on right now. I forget the date he said they were to be completed, but it is approaching.
As for Krugman, his argument in favor of nationalizing banks has merits but his abuse of the facts and logic do not.
Consistently telling people, for example, that 85% non-recourse loans are available to buy toxic securities when the real number is 50% is dishonest. Then building up incentive schemes for fraud based on the 85% number, is deceptive and irresponsible. At this point, he’ll say anything that he thinks will advance nationalization as an argument, without due consideration for the facts.
That’s what the neo-cons did with Iraq.
“sorry”, I don’t trust stress tests/audits done by companies PROBABLY chosen by the zombie banks themselves, i.e. Citicorp. tell me, you actually believe a bank (Citi) which a few years ago had to resort to a multi-billion dollar cash infusion from a Saudi prince.. this is a “viable”, well managed company?
please give me a break.
there’s no objectivity there, which is why I referred to it as sleight of hand/smoke and mirrors.
as far as Krugman being “biased”; this is getting old. He is not the only financial type calling for nationalization. add to the list Greenspan, Stiglitz and others.
are they nuts, “out to get” Obama, too? this is the same old “you liberals hate bush” sophomoric nonsense we heard from media hacks and clownservatives during the bush years.
so, for you, the important thing is that we nationalize the banks and any argument that advances that purpose is okay regardless of whether it is patently dishonest in its details.
Very results-oriented of you.
Well, we were supposed to have the results by the end of this month. It’s not clear from this whether that date will be missed, but the headline implies that it will. FWIW.
The whole thing actually implies it will be after April 24th and before May 1st.
And if anyone violates this rule…what happens, Booman?
See, this is the part where everyone gets “shocked” and “outraged,” but only after it’s discovered that the “safeguards” didn’t work. For example, we have restrictions on executive pay at companies that receive bailout funds…yet does anyone really believe that executives won’t find a way around them, with our own Treasury department looking the other way? Really?
If you want to smear me as a tinfoil hatter, that’s fine. But unless there are clear answers to the “or else what happens?” question, then I believe it’s rational to remain skeptical of anyone’s assurances of proper safeguards.
Unless consequences are spelled out, there WILL be violations.
the consequences would be exclusion from the program, fines, possible prosecution, loss of licenses, bad publicity, hurt share price, firing of the entire upper management, etc.
This is not going to be come widely traded market that is hard to oversee. Moreover, everyone from the CBO, to the FDIC, to Tim Geithner will have direct access to the books.
I confess I have not downloaded the plan, mainly because I have a hate/hate relationship with .pdf downloads. So, before I go download it, is there a section dealing with enforcement of the rules?
No, there is no section designating fines, penalties, etc. There are rules, however, and there are disclosure and reporting requirements, and assignations of oversight responsibility.
Booman, we only need to scroll down a few posts to see you describe how the Bush Administration taught you that something is not truly illegal unless and until proper authorities deem it to be illegal and act on it. But somehow that doesn’t apply to Geithner why?
So, with no enforcements and penalties laid out, Citi could actually scheme the way Sachs described. Treasury has no plan to block it or penalize them. Correct?
Perhaps the core disagreement here is how much faith we put in to the intent of Treasury & Geithner. If you truly believe that Geithner is actually trying to solve the problem and will vigorously defend the taxpayers, then these rules are absolutely adequate safeguards and the plan’s critics are shrill and overblown (and factually challenged). If, on the other hand, one believes (as I and others do) that Geithner’s true intent for Wall Street is not necessarily to solve the problem but simply to “restore to normal,” then it’s completely rational to assume that Citi could essentially violate the rules with no repercussions- after all, if that’s what it takes to “restore to normal,” then what’s a few broken rules between friends?
Time will tell who’s right on this.
so, you’re saying that the Special Inspector General of the TARP and the Government Accountability Office are going to enter into a conspiracy with the Treasury to simply overlook evidence of collusion and fraud?
Do you at least have a plausible explanation for why such a conspiracy would be undertaken, why the parties would be inclined to participate, and how in the hell it wouldn’t leak?
and I think you know that. Citi could set up a SPE off the balance sheet to purchase its own toxic assets at par. After the auctions closed, the SIG and the GAO discover that Citi’s purchasing SPE was invalid and they decide to do…nothing. To me, that’s simply a passive reaction to an unforeseen event (i.e. incompetence), not necessarily a conspiracy.
You can call it a conspiracy if you want, but then by your definition doesn’t that mean that Treasury is in on a “conspiracy” to ensure executives get their bonuses? I don’t think so, but it’s your definition, not mine.
Play these semantical games if you want, but ultimately it comes down to how much faith we all have in Geithner and his intent. It doesn’t require a “conspiracy” for a person to not have much faith in Geithner. Perhaps you disagree.
There are so many reasons that Sachs conspiracy wouldn’t work that I can’t spell them all out.
But, he ignores that they can only borrow up to 50% of their capital assets, not 85%. He ignores that it is explicitly against the rules. He ignores that all connections would have to be disguised. He asserts falsely that there aren’t any transparent rules or assigned regulators. He ignores that the CitiPPIF would have to demonstrate ability to repay the loan, create a loan financing account, and that a portion of Citi’s money would sit in escrow until CitiPPIF had fully funded their loan financing account.
I could go on…
It’s all a lie.
Go back to my original assertion:
A person can be right, but for the wrong reasons. Sachs may be confused, dishonest, whatever, but that doesn’t mean that what he’s predicting won’t come true. Am I going too fast for you, or are you just trying to use Sachs’ errors against me?
Again: if consequences aren’t spelled out, there will be violations. Come on, this is Wall Street we’re talking about. And, because our government didn’t spell out consequences in advance and perhaps doesn’t anticipate violations, one could argue that their oversight will be insufficient or non-existent. There is nothing dishonest or conspiratorial in asserting this.
what do you want? You want the Fact Sheet to be marked up with §USC codes and sentencing guidelines?
There will be contracts signed spelling out fines and penalties (or referring to applicable laws that spell them out), reporting and accounting requirements, and all the rest.
This idea that that the applicable criminal codes don’t apply because they weren’t set out in a Fact Sheet is a little disingenuous.
Honest question: where do derivative transactions go? The Securities program looks to be just MBSs, so I don’t think they go there. It looks like derivative bets would fall in the Loans program, because there’s more ambiguity in the definition. I might be able to classify a derivative bet as an “asset in substantially sized pool from an insured bank.” Am I wrong about this?
Booman, this is an important point. The derivative bets are truly worthless, and if the government is providing 85% non-recourse financing for purchases at par, then this is not going to end well.
Derivatives are generally excluded (another point that is ignored by nearly all critics, including Krugman), except for certain swaps that have yet to be defined. That could be a gargantuan loophole or merely lawyer talk to keep their options open. But it’s clear that the intent is to generally exclude derivatives.
If derivatives are truly excluded (and it’s unclear how much they are), then I predict this plan will fizzle, neither hurting nor helping the situation. IMO, the banks didn’t blow up because of apocalyptic mortgage defaults, they blew up because of gargantuan bets made with the expectation that default rates wouldn’t get out of whack. Until those bets are rationalized, one way or another, not much will change.
Anyway, thanks for your research on this.
Remember, the entire premise is that truly toxic crap is weighing down the trading price of mildly toxic crap. It would make no sense to sell truly toxic crap. It must be separated out.
Unless there isn’t much of the mildly toxic crap to begin with, and getting rid of truly toxic crap (however you can) helps you avoid insolvency. I guess we’ll find out.
that the mortgage holder gets to take back. In fact there are so many of them right now sitting around empty and vacant that it is astounding. Some have been vacant for so long they have drastically deteriorated and may not be inhabitable again, and this problem will get much worse given the circumstances that we are in. Your idea that a failed mortgage always has value and can never be worth zero…..when nobody can pay you anything for it it is worth zero.
No, it’s not. You can strip the thing of its copper, appliances, or anything else of value. But there are some homes that are pretty close to worthless and in some cases banks are declining to repossess them. However, we’re talking about huge portfolios of mortgage loans, not an individual home.
With the derivatives, they can become literally worthless (wiped-out with no collateral) if a certain default rate is reached. Not so for packages that are actually backed by property collateral.
who says that many of these “packages” are experiencing a failure rate of around 80% right now and that much of was rated AAA was discovered to be fraudulently rated so? And with unemployment growing daily, foreclosure rates are just going to increase. Stripping house gleans only a pittance of what the actual mortgage was for as well in an economic situation like ours and the new houses that all these A.R.M.s purchased have all plastic tubing for plumbing and exterior walls of chipboard.
You have to understand that Black and I are friends and probably will share a beer in about six hours. I don’t like to engage in direct disputes with him and prefer to discuss any differences in a detached manner.
However, he has not analyzed the TARP/PPIF program with enough granularity to make the kinds of distinctions I’m making here, and therefore it is easy to be misled by some of what he writes. This is less intentional on his part than a byproduct of his bias in favor of brevity and succinctness.
In this piece I make distinctions between the Loans program and the Securities program. Has Duncan ever done that? I talk about the actual products that will be Eligible Assets and point out that they will generally not include derivatives. On AAA ratings:
I discuss the Debt Service Coverage and Escrow Accounts that Krugman pretends do not exist.
If you pretend that the auctions will be selling primarily derivatives, that they will focus on the most toxic crap (subprimes), that there is no transparency or oversight to discourage collusion and fraud, etc., then the program looks somewhere between foolish and corrupt.
None of that is true. The idea is to separate truly toxic crap out from mildly toxic crap and rehabilitate the depressed value of the mildly toxic crap. Could that fail because of further housing slumps? Yes. But I have no problem with analysis that focuses on the macro risks and doesn’t distort the actual plan.
my mistake. Atrios has made all those arguments and his name is Black.
and regulator from the 80’s S&L scandal. Who according to a new diary at DKos was called to testify before the Senate only a year ago on deregulation.
okay, I know who are talking about now. My answer still applies.
the financial industry was experiencing an epidemic of mortgage fraud? And then that was ignored and it continued to go on?
that AAA ratings have been given out for a fee and had nothing to do with the rating agencies actually inspecting the securities before they rated them?
That is why Geithner makes the following distinction:
we knew that such frauds existed and given “original” ratings when we now know that ratings for given out for a fee and had nothing to do with them having actually earned the rating? I’m supposed to feel all warm and fuzzy because you say this criteria means this stuff isn’t shitpile?
I’m not going to tell you how to feel. I don’t feel warm and fuzzy about any of this. But I’m getting tired of discussion of undifferentiated shitpile.
You have AAA loans, AAA-ratings enhanced loans, BBB loans, mortgage backed securities, securities derivatives and credit default swaps, etc. Collectively, it’s all shitpile and therefore collectively it is all suspect and priced at .30/dollar. The plan is to differentiate the shitpile. The truly bad loans are not going to be for sale at auction. The derivatives are generally going to be ineligible. Nakedly ratings-enhanced securities will be excluded.
My point, is that Krugman and his merry band make no effort to educate people about the actual plan and actually devise all kinds of fantasy schemes to scare people about the plan that are deceptive and dishonest or unrealistic.
in the market at what it is worth and if nobody is buying without incentive then it isn’t worth it. Sorry Booman but there IS NO WAY that Krugman and Roubini and Galbraith and William Black and so many actual economic intellectuals are wrong and you are brilliant about where Geithner is trying to take all of us.
Roubini.
so many Obama protectors out there. This plan is hardly Roubinis first choice of how to deal with what has happened to us. This is all he’s getting though so he writes up the possibilities and clearly states that there are a lot of ifs here. This plan is probably better than getting nothing though considering how fucking poor Obamas fiscal stimulus is. But people like you can’t wait to flaunt a writing like this everywhere and anywhere high and low like you just got an A in mediocrity. Well goodie for you.
here’s what you’re missing. As Roubini points out, there are risks with Geithner’s plan, including a sustained slide in housing prices and a flood of new foreclosures. Others have pointed out the difficulty in regulating against arbitrage shenanigans. There are concerns about Congress abdicating responsibility or being shut-out of responsibility. These are all real criticisms and concerns.
All of that is fine. But there several well-esteemed progressive economists (Krugman being foremost among them) that want the shareholders to be wiped out as a matter of principle and that do not want the banks to survive in anything like their current form as a matter of policy. And I might even agree with them on those things, depending on details. But they are pushing for their desired outcome and in doing so are leaving behind all standards of honest discourse. I’m not smarter than them. In fact, that makes what they’re doing even worse. I’m supposed to be able to rely on their credibility and expertise, and I can’t.
Booman, that is what happens. Fucking Duh! When you are a shareholder and your investment fails you fucking lose. To remove risk from the market is to sign this country up for an enormous slump feeding the insolvency. It is what Geithner did to Asia and he used the same policies and he even sold it using the same words and Asia was never able to regain footing until they did the exact opposite. They lost so much in real assets though feeding the insolvency they were trying so hard to deny. When this doesn’t work do realize how broke the people will be then? Do you realize that the Republicans will dance Obama’s grave after one term if this fails? You act like you have room for this to fail and forget what moral hazard means and how when everyone is hurting so badly they will only know that you and your ilk ignored moral hazard and destroyed their wealth even more.
how is that really relevant here?
faith in mortgage back securities?