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Finally, some details.
And the details of Treasury Secretary Tim Geithner's new plan to rid banks of toxic assets actually aren't half bad. Some of the biggest fears -- such as having taxpayers taking on all the risk -- have been smoothed over to a certain extent. The plan is big. It's serious. It'll get private capital in the game. It actually has some teeth to it. And that's why the stocks of JPMorgan Chase (NYSE: JPM ) , Wells Fargo (NYSE: WFC ) and Goldman Sachs (NYSE: GS ) were taking off this morning.
Still, this is hardly a silver bullet that'll usher in victory. It has some big faults -- we'll get to those in a moment. First, here are a few pros of the new plan.
Fair is fair
Rather than having taxpayers give private investors a free ride to no-risk profits, the amount of equity put up to buy toxic assets from banks will be split 50/50. In other words, if private investors make money, taxpayers will make just as much. And if taxpayers lose money, private capital will, too. As Geithner said this morning: "We don't want the government to assume all the risk. We want the private sector to work with us."
That should make pricing a fair game
Overbidding for assets isn't likely, since private investors have as much skin in the game as taxpayers do. If taxpayers were accepting the brunt of the risk, private investors would systematically overpay -- a situation that would almost guarantee taxpayer losses. Since private capital can very realistically lose every dime it puts in, bidders will pay only bargain-basement prices for bank assets. That could turn out to be a boon for taxpayers, with realistic potential for big upside.
Leverage is cheap these days
Since Federal Reserve Chairman Ben Bernanke came out swingin' last week with the intent to buy $1 trillion or so worth of debt securities, interest rates are about as low as humanly possible. The plan also has a provision that allows buyers to issue debt guaranteed by the FDIC. That makes leveraging asset purchases incredibly effective. The lower the cost of capital is, the higher the price private investors will be willing to pay and still make it worth their -- and taxpayers' -- while. For banks, private investors, and taxpayers, that's a win-win-win.
Now for the bad news ….
Will it be enough?
The plan will leverage $75 billion to $100 billion of TARP funds into $500 billion to $1 trillion worth of purchasing power. That's a stupendous amount of money, but it might not be enough to get banks out of the mud. Last month, New York University professor Nouriel Roubini predicted that it would take at least $1.4 trillion to get back on a sustainable path. So although this plan is a big step in the right direction, there's no reason to believe it won't end up like every other bank bailout plan to date: too little, too late.
About that equity-sharing part …
Sure, it's awesome that a 50/50 equity split means there won't be a massive subsidy from taxpayers to private investors. Problem is, banks need a massive subsidy from someone. Private capital can already purchase these assets if it wants to; the market has ground to a halt because (a) there's no transparency in these assets, and (b) banks aren't accepting bids, because selling assets for too low a price means writedowns that they might not be able to swallow. This plan doesn't address either of those problems.
Hence, there's a chance that the gap between what private investors are willing to pay and what banks are willing to accept won't be met. Private investors might be willing to pay only $0.50 on the dollar for assets that banks will be willing to sell for no less than $0.80 on the dollar. The likes of Bank of America (NYSE: BAC ) and Citigroup (NYSE: C ) might not have the capital flexibility to accept anything less than premium offers. If that's the case (and it probably will be), the plan might simply spin its wheels and get nothing done.
Who wants to take part in this plan?
After the AIG (NYSE: AIG ) brouhaha peaked last week with an emotionally fueled piece of legislation to retroactively tax bonuses, any rational investor will have some qualms about making Uncle Sam a business partner. No sane person will participate if he or she thinks Congress will stomp its feet and retroactively tax profits at 90%. As one investor colorfully put it this morning, "No one is putting any money to work because every time you dip your toes in, they get cut off." Don't be surprised if participation in this grand experiment comes up well short of what Geithner and Co. expect.
Your turn to chime in
For the first time since who knows when, the government introduced a bailout plan that the market -- at least at first glace -- seems to like. Did Geithner finally get it right this time? Feel free to share your thoughts and suggestions in the comment section below.
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