Memo to Obama: Six reasons to cancel your $1 trillion toxic waste plan
Filed under: Economy, Investing
President Obama: It's not too late to cancel the plan you're floating to use taxpayer debt and a sliver of private money to buy $1 trillion in toxic waste from banks. Why cancel it? Because it won't solve the problem and it will waste more taxpayer money. I know nothing about politics, but my hunch is that people won't be too happy when they find out that more of their money is going to enrich further hedge funds and private equity firms whose partners make bigger bucks -- one of them made $3.7 billion in 2007 alone -- than the bankers who got $16 billion in bonuses from taxpayer pockets in 2008.
Here's what the toxic waste plan looks like to me. Three of the world's wealthiest investors came up with an idea to use taxpayer money to enrich themselves even more. These three have already played the U.S. for suckers:
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PIMCO's Bill Gross who already talked the U.S. into bailing out his investments in Fannie Mae (FNM) and Freddie Mac (FRE) and now manages two big government investment programs,
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Berkshire Hathaway's (BRK.A) Warren Buffett whose 20 percent stake in Moody's (MCO) makes him strangely mute about Moody's role in giving toxic waste AAA ratings which fueled the financial crisis, and
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Goldman Sachs Group's (GS) Lloyd Blankfein whose firm got $12.9 billion in bailout money from American International Group's (AIG) $170 billion bailout fund.
Their plan is simple: private investors get the profits from buying toxic waste and taxpayers cover the losses. How so? The FDIC would run an auction for a lender to sell, say, $10 million worth of residential mortgages. If the winning bidder -- a hedge fund or private equity firm -- paid $8 million, the FDIC would lend money to pay for those mortgages and then would cover 75 percent of the investor's losses. Treasury would contribute 80 percent of the rest of the cost of the loans.
As I see it, this means that hedge funds and private equity firms will pay virtually nothing for the assets, the taxpayer will incur most of the losses and all the profits, if any, from buying these assets will go to the hedge funds and private equity firms. And since the FDIC and the so-called Public Investment Corp. -- the public/private partnership that will buy the assets -- can only buy $500 to $750 billion worth of the loans, you'll create two other programs whose details have not been worked out.
What's wrong with this idea? Here are six things that come to mind:
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It's too small to buy enough of the toxic waste. If my estimate is correct, there is $13 trillion worth of toxic waste -- mortgage-backed securities and collateralized debt obligations -- that's been issued. This $1 trillion program only buys up 8% of that total. This is not enough to make a difference.
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It does not deal with the pricing problem. As the example above suggests, pricing toxic waste is an enormous problem. Most banks have booked it at 60 cents on the dollar but it's really worth five cents. If the banks sell it at five cents, they take a 55 cent loss which they have to make up for by raising new capital equal to the amount of the write-off in order to maintain regulatory capital levels. If investors buy at 60 cents, it will leave taxpayers with an enormous loss. The pricing problem could make the whole idea a non-starter since neither buyer nor seller will agree on a price.
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It's a government program for the already wealthy. Berkshire Hathaway, PIMCO, and Goldman Sachs are already very wealthy and your program will grant such investors government contracts to manage these assets. And it looks like they could get to invest as well so there's a good chance they'll have inside information from their advisory role that they can use to enrich themselves further.
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Taxpayers are likely to lose money. This plan is too heavily skewed to enrich the private interests who will invest in these assets. As the example above illustrates, the government will take the risk if private investors overpay and the collateral for the government loans is illiquid and likely to be worth little -- therefore government loan losses will likely be high as well.
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Lack of detail could spook investors. In February 2009, Treasury Secretary Timothy "job is secure" Geithner offered the outlines of a plan that was weak on details. After his speech, the stock market fell 380 points. As it stands now, the leaked plan is vague on details of pricing toxic waste and on how the other two programs will work. It might be better to complete those details before announcing another vague plan to investors.
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Money that could be lent directly will go into a black hole. Perhaps the worst part of the plan is that it's not going to get credit flowing into the economy. By creating new banks, the money being used to prop up the zombie banks could be lent directly to those individuals and businesses who would be in a position to use that money wisely and pay it back. Instead, the hundreds of billions of dollars from your toxic waste proposal will go to zombie banks that will not get enough toxic waste relief to boost lending.
President Obama, toxic waste is a problem but the bigger issue is getting money into the hands of people who can use it to fuel economic growth. Instead of propping up zombie banks, we need to get capital into the economy directly. This toxic waste removal plan will not achieve that goal and it creates more problems than it solves.
Back to the drawing board.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing. He owns AIG shares and has no financial interest in the other securities mentioned.
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Reader Comments (Page 1 of 3)
3-22-2009 @ 10:55AM
Charles said...
The magnitude of toxic assets is so overwhelming that there is no hope for any type of purchase plan funded by government to succeed. The real solution is to force the banks and finance companies to allow mortgage holders the equivalent of 30 year mortgages with balloon payments at maturity, which would lower the monthly payment to approximately a third of current P&I requirements and allows homeowners to stay in their properties and have money left over to use for consumer purchasing, the real key to jump-starting our economy.
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3-22-2009 @ 12:09PM
ter said...
The $3.7 recipient achieved that by shorting the banks. Big distinction.
Additionally, I dont think anyone knows what this is really worth since its never expressed in cash flow terms. Somehow out of this exercise we'll determine that its somewhere between the two extremes mentioned. Taking it in tranches will better position the real price.
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3-22-2009 @ 12:01PM
Evan said...
For those that think there's not enough money to make a difference in the toxic asset mess...
There's $5 trillion in money-markets in the US. Another $10 trillion world-wide, another $5 to $10 trillion in sovereign funds, and another $7 trillion in short-term Treasuries that up until recently wasn't even returning an interest, the so-called safe haven investment. Oh, I forgot to mention, the Federal Reserve Board and the Treasury by increasing its balance sheet last week up to $3.2 trillion and with the Treasury's $1 trillion plan respectively, have now in their posession a $4.2 trillion "pin" to prick the US Treasury bubble.
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3-22-2009 @ 12:54PM
czelbst said...
Evan, on the surface you make an interesting argument that there is enough money to meet the requirements, but aren’t you overlooking the basic issue of these assets being toxic and unlikely to return 100% of invested capital let alone a “profit” to the buyer? If that is true, then these purchased assets will have to be deep discounted, and I for one would not want the resources that you identify in your post to be invested in such “no return” assets. Also, while you mention world-wide and sovereign funds, what about the needs of the rest of the world? The U.S. is not the only country facing this very issue.
3-22-2009 @ 12:39PM
dee smith said...
See exactly what your new president is up to. Can anyone say One World Government?
Do yourself a favor, watch this video.
http://www.youtube.com/watch?v=eAaQNACwaLw
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3-22-2009 @ 12:51PM
General said...
Does anybody really believe that Obama and his Congressional cronies are going to get us out of the mess that they got us into? The greedy Wall Street executives and their co-conspirators in the SEC who knew what was happening, but did nothing, should be arrested and put on
trial, live on the Internet. See the plan:
www.youtube.com/watch?v=eQ9vTJLIA8M
www.thirdpositionjustice.net
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3-23-2009 @ 3:43PM
John M said...
Yes, and now most of them are in Obama's administration- crazy !
America- WAKE UP!!!!!!!!!!!!!!!
3-22-2009 @ 2:14PM
toomuchdebt said...
another trillion dollars down the drain...who's to say what these assets are worth? how are these deals going to recoup the money to taxpayers? taxpayers are not working hard to correct the mistakes of bankers, we're not fools! I'm OUTRAGED!!!!
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3-22-2009 @ 2:28PM
wendylotto said...
The Obama supporters got sucked into a dream, they loved the excitement, the tingly feelings. This cult like phenomenon was easy to implement by the fanatic liberals because hate is a powerful motivator. They used this hatred toward the Bush administration as the accelerant . Soon the firestorm was raging and out of control and it engulfed America. Unfortunately those of us who tried desperately to extinguish this fire just could not because we needed all of our resources and many of them thought it was safer to stay locked up in their homes on election day. Now America is burning towards a climax of doom. We need to call out all of those willing and able to stop the distruction and salvage what we can. Call, email, shout as loud as you can to your representatives, do what ever you can to wake these neive victims up out of this this delusional dream the liberals are entranced in. The dream of change and Hope is just a wet dream and with everyone's help we can wake them up before it is to late, if they are allowed to reach a climax there will be no hope and America will be scorched beyond recognition.
Example; Just today, the Obama administration injected a trillion, yes trillion dollars while no one was looking to help pay for the projects from the stimulus package. The problem is they had to just print it because they didn't have the money. The move caused the price of gold to jump over $58.00,in less than 18 hours (It may have reached $75.00, I quit watching to write this) Our dollar is on its way to becoming worthless.
If you were playing a game of Monopoly and all you (America) had was Mediterranean with no houses on it and no money. Your opponent (Obama administration) owned all the other properties with a big red hotel on each one, would you stand a chance of turning it around in your favor?
Would you ask for a loan to try to stay in the game hoping you could make it around the board without landing on any of your opponents properties? If you took that chance and ended up on them would you keep borrowing more money? BECAUSE IN A NUT SHELL THAT IS EXACTLY WHAT IS HAPPENING. There is no money in reserves, they are printing it as needed.
God help us all.
Wendylotto
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3-22-2009 @ 3:19PM
Annee said...
Wendy, you hit the nail on the head. The firestarters are tossing money on the problem and fueling it further.
I have been writing my reps. and senators. They send back "newsy" things about how outraged they are at AIG.
They are clueless and useless.
I write to the President with no effect at all. Maybe I should write to Emmauel, since he seems to be the puppet-master.
3-23-2009 @ 11:07AM
Hey you said...
Gosh, you know our representatives can't listen to us, the logical thinkers, right? Do you know what cable news will do to them if they even TRY to vote no? Olbermann last week, when Chris Dodd was flip-flopping like a fish, was focused on Eric Cantor, a House Republican who voted yea with the 90% increase. Olbermann didn't call him out for doing the right thing. Oh no. Olbermann called him out for going against the grain of the Republican party's holy tenet: not raising taxes. Olbermann called him a hypocrite for doing something in extraordinary circumstances. Go figure. Of course, the whole segment was labeled "No-everything party" implying that the Republicans are the ones who are destroying the president's agenda by voting no on things. I'm not saying the GOP is perfect--far from it--but I'd sure like my party to add its two cents instead of letting the loony liberal left enact every social plan they want. I'm still convinced that the Dems are more at fault here with their Kum Ba Ya attitude toward everyone owning a home, etc. There's a lot that needs to be fixed, but the first and foremost thing that has killed our country is the "I am entitled" attitude, and that's rampant with both Dems and Republicans. Hard work isn't a virtue anymore...it's for idiots.
3-22-2009 @ 3:19PM
Annee said...
As difficult as it may be, time to cut the cord. The pain might be widespread, but it would be temporary.
If we bail/buy them out, our pain will be sustained and felt for generations as we struggled to pay for it.
I suspect that Geithner knows that and perhaps that is why he is slow on giving out the "details". If I were him, I would quit and run for the hills. He is the sacrificial goat. No matter what the truth is, he will be crucified for it all.
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3-22-2009 @ 6:26PM
observerguy said...
To sum up: The "bailout" won't work, because money was given to "the problem," and "the problem" is the extant systems and those within it; so very true.
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3-22-2009 @ 7:00PM
Clay said...
OK! sounds like theres something to what you're saying, and you've told everyone what NOT to do! So NOW tell Obama and everyone here what he SHOULD be doing!
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3-22-2009 @ 8:18PM
wdmurphy said...
How can this plan possibly work if the government has their hands in it. No one in government knows anything about what is going on in this country.
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3-22-2009 @ 9:50PM
Melody said...
Sustaining our economy and country does not come from corporate America. The media likes to convince you of that, that bigger is better, but it isn't true. Medium to small business is where the growth will be, where people know their customers, will do everything to keep them happy and are more service minded than detached corporations. The government should be focusing on its base, not the failures. They are too big to succeed by throwing money at it with no internal changes of personel or procedures. Honestly, AIG has a major PR problem.
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3-22-2009 @ 9:50PM
Olaf Steen said...
You are all too negative. Give Obama a break! He is trying to solve the problem while he rest of you are just sulking.
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3-23-2009 @ 10:59AM
Steve said...
Obama has no idea what he is doing, and I see no reason to just stand back as he destroys our economy and burdens succeeding generations with debt.
Here's a plan to fix the economy:
1.) Let banks, corporations, etc., FAIL. New ones will crop up like flowers in the spring to replace them.
2.) Repeal every penny of the 'stimulus plan' that would not be spent in 2009.
3.) Eliminate mark-to-market.
4.) Eliminate the capital gains tax, and corporate taxes. Permanently. This step alone would send businesses flocking back to the US, and get businesses already here - especially small ones - hiring again.
5.) Announce that no social engineering measures (health care, etc.) will be undertaken until after the 2012 election.
Unfortunately, none of these steps will be undertaken,. because they do not give Obama an opportunity for his radical reconstruction of the American economy and way of life, and they do not give Congress a chance to spend money enriching themselves and their supporters, or cementing their power bases.
Please rebut these point by point.
3-23-2009 @ 7:38PM
Shawn said...
Our President is working around the clock to move our economy. I agree with you, we should support him for his effort. I don't think our President is playing any political game. He is not cut for it. I already see the difference in consumer's confidence and how the news is pumping positive energy. That's what we need and that's what he is doing.
God Bless our President.
3-23-2009 @ 2:03AM
frank turco said...
it is the only way to solve the problem and it should have been done in 10-08
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