The Crux of the Matter

Reading about the possible solutions Tim Geithner is going to announce on Tuesday just drives me crazy. Why can't these educated economists see the truth like foolish little me? They are making the exact same choices that our leaders made in 1928-1936 which fueled our last Great Depression for more than twelve years.

Here is the rub. Take for example that 1200 sq ft Miami condo that sold for $1 million in 2005. Its owner could not pay the accelerated monthly payment that his/her ARM charged, and he could not sell it for even $500k. So now he/she has defaulted and walked away, leaving the bank with an "asset" which is worth $1 million on its books, but is really not worth half that. It may not even be worth 1/10th its original price. So if the bank has to write down that asset to 10 cents on the dollar, it would have to take a massive loss for which it doesn't have the equity to cover, thus ending in bankrupcy.

Of course in the case of BofA, Citi, Chase, Wells Fargo and others, we are not talking just $1 million, but hundreds of billions in write downs. Easily more money than they booked in "profits" the past 10 or so years combined! And leverage is the culprit. Not only are our banks leveraged to the abyss but so is our Federal Government.

So Geithner/Obama have been looking at ideas to keep the bad assets off the books of the banks and give them a free ride for taking failed risks. Thinking this will save the economy. We've already tried TARP, which originally was Paulsen's plan to flat out purchase the toxic assets with taxpayers money. Were they going to pay $1 million for that Miami condo? or $800k? or $600k? It doesn't matter because what they did is just hand them some of the money and purchase preferred shares in the banks (overpaying in the process) which did not help the value of those assets go up at all. So TARP 2 doesn't look like it will work to Geithner, so they have floated arount the idea of a bad bank, or using Taxpayer money again to buy up the assets (again at what price?) and put them in a bank created to hold these assets until the value returns. The only fair price for that condo in Miami is $100k, but that would force the banks to book that income at a 90% loss. Something their balance sheet can't handle. That would cause instant bankrupcy.

Then the idea was to "insure" the value of the assets. The banks would pay the government an insurance premium against the value of those assets falling further in value. But that would mean the USA would have to hand over a million dollars for that Miami condo when it finally does sell for $100k.

You see Geithner has to make up something so complicated as to fool the American people and congressmen into believing they are not on the hook for the whole risk taken on the asset to begin with. The crux of the matter is there is only one answer and those in power, weather you argue it is the politicians or Wall Street, are trying everything they can to avoid that answer. What is the answer? Tell the truth! Admit that the Miami condo is worth only $100k. Admit the assets on your balance sheet are worth a fraction of what you say they are worth! Go Bankrupt and wipe out sharehoder value completely and force your creditors to accept the loss of their risk too. Start over from scratch! It is the only answer.

Anything else only makes things much much much much worse.

So the question of the day is what price to pay? Almost any price over 10 cents on the dollar may be too much for that condo in Miami, yet that is what Geithner and Obama are going try to force taxpayers to do. Pay more than they are worth and take the bath for the bankers. Don't they realize that is a recipe for riots?

The numbers I am talking about are real, not because 90% of loans are bad. No it is true that most mortgages and car loans and such out there are pretty good. But when you consider that the most of the big banks' assets are in the form of mortgage backed securities, credit default swaps, and collateralized debt obligations, and that these instruments actually ratchet up the leverage tenfold because they are not regulated, these derivatives will be considered the thing that brought our economy (and way of life it will turn out) to its knees.