Friends Don’t Let Friends Drive Toxic Assets

The Legacy Loans program, a sizable chunk of the Geithner Plan, is dead, reports the New York Times.  The FDIC has “called off plans to start a $1 billion pilot program this month that was intended to help banks clean up their balance sheets.”

I’ve used my car before to explain this program, so maybe I can use it to explain the death.  In this scenario, the role of the Bad Bank is played by me; the Toxic Asset is my car; and Tim Geithner and Sheila Bair, Treasury Secretary and FDIC chair respectively, play themselves. 

^{By CatKaoe}

Remember, if you will, that in our last scenario, my accountant, Tim, had offered to partner with his friend Sheila to offer potential buyers of my car a pretty sweet deal: Sheila would loan 80 percent of the money to any potential buyer, and Tim would invest up to half of the remaining cost of the purchase, which meant someone could buy my car for about 10 percent of its auction price.  That would give me extra money to spend in the economy (hooray!).  It would also allow the dealer that bought my lemon the chance to fix it up and hold onto it until the market for bad cars goes back up.  Win-win, with the possibility of Tim and Sheila taking a big hit (taxpayer lose).

But what’s happened since this initial offer is that I, holder of the toxic car, have fallen back in love with it.  That burning oil smell — it’s the scent of nostalgia, of summers spent on hot tar highways.  The scratches and dents merely make the car more hip, like a worn pair of jeans.  I’m starting to think I could convert it to bio-diesel.  In short, I’m no longer willing to sell for anything less than the original $1,000 I thought it was worth.  I am not willing to put it up for auction, as Tim said I had to do.

Now, maybe I’m being honest about that.  Maybe I really do think the car’s gonna make it.  But maybe I don’t want to put the car up for auction because last month, I applied for a new apartment, and as part of my credit check I listed the car as an asset when I did that — an asset worth $1,000.  Now, I don’t want to put the car up for auction, because it will become clear pretty quickly that the car is only worth $700, and I could lose my apartment. 

Or maybe I don’t want to sell the car because I no longer need to sell it.  The market’s getting a little better, I’m feeling more flush, and I think I can afford to pay to maintain it until the time comes when it will be worth what I’m willing to sell it for.  It will be vintage soon, you know?

Now, Tim and Sheila — Tim in particular — have an interest in making sure I’m telling the truth about my motivation.  Because if I’m not selling because selling will make me look insolvent, well — that means I’m already insolvent.  If I’m not selling because I’m ready to spend, spend, spend anyway, then that means the market is improving, and the healing has begun (and quick, Tim says, let’s get some posters printed about that one, and make sure we send one to Paul Krugman).

Ezra Klein outlined both of these reasons as why the banks might not be willing to jump into the Geithner plan.  Kevin Drum at Mother Jones says it’s probably the insolvency problem, and that’s really, really bad, because it means that not only did the Geithner plan not solve the banks’ problems, but the banks are being allowed — and maybe, post-stress test, encouraged — to live on in denial that will eventually come back to bite us all.

To extend the metaphor: there exists a danger to the community if I continue to drive around a broken car while swearing that really, it’s fine.  Not only am I not spending as much as I could be, since I’m constantly worried about my toxic asset, but I might be actively making the whole community less safe by showing them that it’s cool to keep broken cars.

I think there’s also a third option, here.  Banks might be deluding themselves; they might be healthy enough to afford hanging onto their loans; and they might actually be afraid to deal with the government.  Several banks, post-stress test, raised a bunch of capital in advance of leaving TARP.  If they get re-entangled with the Geithner Plan now, they’ll also get pulled back into the shady land of government regulation over compensation.

In short: am I unwilling to sell the car because I still love it, because I still need it, or because you’re not the boss of me, Tim Geithner?

It could be all three (and none of these are particularly good reasons, really).  But whatever it is, I hope there’s a plan B.  I hope Tim and Sheila and Ben Bernanke have a better idea of what to do next than just what Sheila Bair said they’re going to do, which is wait and see if the PPIP might be needed later.  That’s only an OK plan if the assets don’t get worse — and I am not at all encouraged by our jobless rates, the rise in foreclosure and bankruptcy claims, and the continued need of companies with terrible mortgages on their books (yesterday GMAC got another $7.5 billion).

At some point, Friends Don’t Let Friends Drive Toxic Assets.  Apparently the banks still want to keep the keys — but at some point, Tim, Sheila, or Ben might have to step up and say, no way, man.  The PPIP was the gentlest possible way of doing that, so I’m sorry to see it die.

^{By wireheadinc / CC license}

Small Wonder: A Terrible Day for Tim Geithner

Felix Salmon had a nice post today suggesting that major U.S. banks holding Chrysler’s debt are willing to let the company go into bankruptcy instead of taking a haircut on their debt in part because there’s no real way the public could think less of them.  Being the automatic villain gives one a certain freedom to be horrible, and J.P. Morgan Chase and friends certainly find themselves there.

What this made me wonder is, at what point will Tim Geithner hit the so-hated-he-can-do-whatever stage?

I mean, this has been a totally sucky week to be Geithner.  Consider he went into the weekend with Paul Krugman’s “it’s gonna get so much worse” column and Rachel Maddow having invited the “Hey Paul Krugman” singer onto her show (for the 5 people who hadn’t already heard him sing, “Timothy Geithner, he’s like some little weasel,” via the Internet).  Yesterday, he had the hey-guys, cut-your-budgets Cabinet meeting (check out the body language here, too — that’s Geithner slumped next to Biden).  At this point, I’m not sure the man could buy friends (though I have no doubt at least one commenter will say he’s tried).  Just take the last 24 hours:

• The Special Inspector General issued his report, which initially made news for saying that, contrary to the Secretary’s earlier assertions, firms who wanted to participate on either side of the Public-Private Investment Partnerships would be subject to compensation limits.
• Then it made news because, at The Economist, that sounds like the end of the PPIP.
• Then it made news because there are already 20 fraud cases being investigated.
• Then Felix Salmon pointed out that, within the report, there’s open speculation that it could encourage out-right criminal organization money-laundering schemes.
• The IMF also released its Global Financial Stability Report today, and said that bank losses are over $4 trillion, with more than half of that originating in the U.S.  Oh, and we’re going to need substantial additional investment to recapitalize banks, and may need to nationalize some at least temporarily.  And soon.
• All of this before the real fun started: Geithner testified before Elizabeth Warren’s Congressional Oversight Panel.  You may remember her as the woman who made Jon Stewart feel better last week, or the one who released the highly critical — and commendable, at that — report on the Treasury’s plans so far.  Wanna guess how that meeting went down?  Let Andrew Leonard summarize:

The pattern is now sufficiently well established to be definitive. The treasury secretary appears before a congressional committee, and is asked tough, detailed questions by members of both parties. He invariably compliments and thanks the questioner for a “thoughtful” and “important” question, and then proceeds to answer in vague generalities, rarely committing himself to specifics.

I’ve watched or pored over the transcripts of almost all of Geithner’s testimony before Congress, and it’s getting harder and harder to make a case in defense of his brief tenure. Tuesday’s hearing, before the Congressional Oversight Panel empowered by Congress to watch over the TARP program, ranks as one of his least satisfying performances so far. 

(I would say it was sort of like watching the robot from Small Wonder face off with Minerva McGonagall from Harry Potter — you start off rooting for both sides, but by the end, you just want McGonagall to put the robot out of her repetitve, wide-eyed misery).

• The stock market did rally a bit over Geithner’s assertion that “the vast majority of banks have more capital than they need to be considered well capitalized by their regulators.”  That sounds like great news, until you realize he never said that (he skipped those pages, somewhat dramatically, in his testimony).
• Also, even if he had said that, it was meaningless and earned, again, bafflement and concern (and use of the word “ominous” in the first paragraph) from Paul Krugman.
• Finally, The Wall Street Journal ran an interview with Geithner (“Geithner Weighs Bank Repayments“) where he said he’s considering whether to let banks repay their TARP debt early or not.
• Finance blogger Nemo and a reader point out that, no, he can’t do that — he has to let banks pay the money back whenever they want to.  Strike… what? 56 or so? for Geithner.

It’s those last two points that bring us to the importance of the villain question.  The two banks currently talking about repayment are Goldman Sachs and J.P. Morgan Chase.  Paying back TARP funds would free these two from compensation limits — present and looming — and also make them look strong and solvent.  JPMC CEO Jamie Dimon has called TARP assistance a “scarlet letter,” and he’s looking to shed it as quickly as possible.  This would possibly inspire further investment in these banks and certainly encourage concentration of power into their hands.

Which is partly why the Treasury Department isn’t keen on just letting them repay so quickly.  Banks shedding TARP funds could make other banks want to jump ship — banks whose life-vests aren’t properly inflated.  So you could see Bank of America trying to pay back TARP, and either failing after payback, or failing to payback at all — and either way looking so weak as to inspire (who thought it was possible) less confidence than even now.  Which would, of course, benefit those who do survive the leap — probably a big part of the JPMC/Goldman dream right now.

In fact, the only reason that a firm wouldn’t leave TARP right now is a desire NOT to piss off the U.S. Treasury Department.  It’s in their individual interests to run, even while it might be in the interest of the entire system for them to stay a while.  So let me ask you this: Is Tim Geithner someone you’d want mad at you?  Does a real villain lurk somewhere within the Small Wonder facade, just waiting for the day when it no longer matters what Wall Street thinks — and if so, was today that day?  Does he have enough power, inside or out of the Treasury, to make things more uncomfortable for these banks than they already are?

My guess?  If there’s pressure to be brought to bear, it will have to be done by the President — and if that’s the case, Geithner’s days at the grown-up table are going to be limited.