Silk Purses, Sow Ears and Reality

I spoke with a friend yesterday about his new change of career. He is going to become a hedge fund manager. To start his business, he's going to get a business loan from Citi. This should be easy because my friend's going into business to help Citi out. He'll be independent of Citi of course, at least on paper, but they will work closely together. After he starts his business, he's going to get a government loan to buy some bad assets from Citi that have been hard to value. Even though Citi can't sell these assets for more than about 10-20% of their book value in the open market, they still insist that the assets are worth closer to 80-90% of book value currently. These are the so-called “toxic assets” that people talk about on the news.

What my friend will do is negotiate with Citi (a mere formality, really) to purchase these toxic assets at near what Citi wants for them, thus limiting their write downs, and then try to sell the assets himself on the open market. If it becomes obvious that they really are worthless, he will walk away and leave the government with the bad assets and default on the loan he received from them. That's because it's a non-recourse loan and there will be no action against him for defaulting – because really, he was just trying to help.

If the bad assets do increase in value from what he paid for them, then he and the government will split the profits 50-50, despite the fact that the government put up 93% of the money for the purchase.

Wow. And the best part is it's all legal.

Okay, so I don't have a friend who is planning on starting a hedge fund. But the above scenario is not only plausible, but likely. Large banks and financial companies will soon have the ability to set up third-party organizations to buy troubled assets at close to face value to get them off their books. The banks and financial companies get to be made whole, or close to it with government funded purchases of the toxic assets made by the third parties who will negotiate directly with the banks on price. The government puts up money via non-recourse loans to the third party purchasers and bears all the risk, yet only gets 50% of any potential profits on the future sale of the toxic assets.

Fine. If the government and their regulators want to believe that these toxic assets really are worth more than they would get today on the open market, then buy them outright and keep all the profits if they increase in value. Why expose taxpayers to risk and simultaneously limit their potential for profit?

But more importantly, why is it O.K. for the taxpayers to take a huge loss on these toxic assets, but not the banks. Why is it that these banks, the ones who wrote the bad loans to begin with, are excused from their poor decisions and the rest of us are made to pay for their greed and short-sightedness?

Well, that is what happens when the guy who runs the treasury department is in the pocket of the banks. Timothy Geithner is the financial industry's whore and we are all being played for fools.