The Federal government’s toxic asset program

According to my reckoning this is the blog’s 100th post. Thank you for your continued interest in my little endeavor. I hope that each of you is enjoying it and hopefully getting something of use from it as well.

*****

Late in the afternoon on Friday, March 20th, the Federal government leaked that, as early as Monday, it will announce the details of a plan to remove “toxic” financial assets from the financial system. The timing of the announcement is classic in the sense that it gives the public the weekend to mull over how they feel about the plan. Because the information was leaked, rather than officially announced, the Administration retains the right of deniability should any of the plan’s details be too offensive for a majority of folks. Since the details are “rumor” at this point, they can easily be changed without the embarrassment of a public back-pedaling. Also, now the Feds can gather some intelligence, adapt, and plan accordingly. To me this is an indication that they are somewhat insecure about the exact details of the plan and are wanting feedback before proceeding.

Some of the “rumored” details are as follows:

• The creation of an entity, Deposition Finance Program, backed by the Federal Deposit Insurance Corporation (FDIC) to purchase and hold loans. As an aside, don’t you love government names for things? The names are never something that allows the program to have an identity. Instead, they are named for their function. Am I not making sense? Well try this on for size, imagine if Cisco were named Routers, Inc. or Google were named Search Engine Corporation of America. Ugh! This is one thing we have to be thankful for in the modern era, businesses have identities beyond just their function. That means that you are not just a cog.
•  The expansion of TALF, or the Term Asset-Backed Securities Loan Facility. TALF was originally created so that the Federal Reserve could purchase securities backing consumer and small-business loans. In other words, it was designed to provide a “back-stop” for small loans in a similar fashion to that provided by FNMA (“Fannie Mae”) and FHLMC (“Freddie Mac”). However, TALF was originally set up to only back new issuance of these securities and not older, legacy assets. So the expansion mentioned in the first sentence of this paragraph refers to allowing the Federal Reserve to now back securities from as far back as 2005.
• The establishment of public-private investment funds to purchase those dreaded “mortgage backed securities,” or MBS. The funds would be run by private investment managers, but the purchase of the MBS would be funded with a combination of both private and public monies. Both private and public monies would be able to earn a return on the investments. Of course, that also means that private and public monies are also both subject to risk of loss.

The question that begs to be asked is: who are these “private investment managers” going to be? After all, the folks best qualified to run these funds also probably happen to be some of the same folks who have made poor MBS investment choices over the last 5-7 years. It will be hard to find outside money managers not tainted by poor MBS decisions. Because of the tremendous public scrutiny that is likely to be wrought upon these private money managers, I expect very few volunteers to step forward. Yes, there could be a windfall of monies showered on such a firm, but the scrutiny will be very intense. So expect those investment manager choices to be controversial.

Importantly, the Treasury is hoping that the inclusion of private investors will help to establish markets for some of these securities. Right now there is no market because no trading is taking place. And when there is no trading then accurate pricing is very difficult to establish. When the prices are difficult to establish then it is very difficult to manage the crisis. This is because no one knows for sure the size of the problem since the size of the problem is denominated in dollars. Does this make sense? When this problem was first addressed last fall and only public monies were being used the Feds stood at an awkward crossroads. If they paid too low a price of toxic assets then the banks from whom they bought the securities were not as shored up as they could have been. However, if the Feds bid too much for the toxic assets then tax payers were hurt. That’s why they are hoping to include private investors.

There are other details but those are the big ones. My opinion is that this plan lays a good foundation for helping to thaw frozen markets and to increase liquidity. Once the markets start to move again, and transactors realize that they are not getting burned, then they will be willing to trade more and more. That is liquidity and it is necessary. Keep your fingers crossed that a plan, whatever its ultimate details, is put into place soon and that it is successful.

Have a good weekend y’all!

Jason