The more I think about it, the more I realize Treasury Secretary Tim Geithner's plan to rid banks of toxic assets won't work. At first glance, I thought it had some attractive features -- and it does -- but I'm quickly realizing they're seriously overshadowed by its faults.
Here are four big holes the plan fails to address:
1. Liquidity isn't the problem
Since day one, a major flaw has been treating the financial crisis like a liquidity issue rather than a solvency issue. Liquidity’s all about how quickly money can be moved around, while solvency deals with companies’ ability to remain going concerns. There aren't armies of cash-strapped investors salivating over the prospect of toxic assets. There's plenty of cash out there. Its owners have just realized that bad assets are really, really bad. The idea that investors will suddenly grasp the hidden beauty of these assets if you give them cheap leverage isn't realistic.
Nor is it supported by the facts. Last August, Merrill Lynch (now part of Bank of America
2. Price discovery might backfire
Speaking of prices, the current belief is that bad assets aren't being priced accurately because the market is busy wetting its pants in fear. Provide a little liquidity, the thought goes, and the true price will be "discovered." Once a real price is found, clouds will part, rainbows will form, and markets will regain confidence, wise men tell us.
While an awesome idea in theory, it's only beneficial if the discovered price is higher than what banks currently assume. What happens if a CDO sitting on Citigroup's
3. Will anyone show up?
And who are all these private investors we hear about? A few notable names have announced they'll participate, but a meaningful turnout seems questionable -- and not because Congress has proven to be the world's worst business partner after the AIG
With 6-to-1 leverage, these asset sales are designed so investors will either make a killing, or lose everything. As attractive as non-recourse funding is -- since it limits borrowers' risk -- there simply isn't an appetite for high-risk, high-reward investments these days. This is not the kind of environment where hedge funds are eager to dive into a deep, dark, unknown world of arcane investments.
This is a world where investors are happy to buy 30-year Treasuries at 3.6%, and the default risk of Berkshire Hathaway
4. Haven't we tried this before?
On the other hand, trying to find a true market price won't happen unless a true market exists. While cheap leverage might lure in enough capital to start clearing trades, it's not a true market -- it's a propped-up one. Just like housing supported by subprime leverage, "real" prices can become a cruel fantasy when unsustainable leverage is involved.
Hence, as soon as the cheap funding stops, we're back to square one. No one knows when that will happen, but it will happen. It's also safe to assume the plan could be scrapped if it works so poorly that taxpayers are stuck with massive losses, or so well that hedge funds are vilified for making triple-digit returns off taxpayer money.
If Geithner's strategy doesn't work, what's plan B? Nationalization?
Where to now?
While the plan is a step in the right direction, I'm hesitant to think the Treasury can uncover gold where private capital sees dirt. Maybe I'm just discounting Geithner's alchemy skills. Then again, probably not.
What do you think of it all? Feel free to share your thoughts in the comment section below.
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