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Sunday, February 08, 2009

NY Times on Bank Bailout Plan

by Calculated Risk on 2/08/2009 10:50:00 PM

From Floyd Norris at the NY Times: U.S. Bank Bailout to Rely in Part on Private Money

Administration officials said the plan, to be announced Tuesday, was likely to depend in part on the willingness of private investors other than banks — like hedge funds, private equity funds and perhaps even insurance companies — to buy the contaminating assets that wiped out the capital of many banks.

... The government would guarantee a floor value, officials say, as a way to overcome investors’ reluctance to buy them. ... Details of the new plan, which were still being worked out during the weekend, are sketchy.
By trying to bring in private sector buyers to set prices for the distressed assets, and to take some but not all of the risk that the asset value will continue to decline, Obama officials evidently hope to restore confidence in the banking system. They will also try to avoid the politically perilous course of having the government directly buy the assets at prices that could turn out to be far higher, or lower, than their eventual value.
A possible model for the way the new Treasury plan could work arose in a deal last July that had no government involvement. In that case, Merrill Lynch sold $31 billion in securities for 22 cents on the dollar. The buyer, the Lone Star group of private equity funds, put down only one-quarter of the purchase price and had the right to walk away, forfeiting only the down payment, if it later turned out the securities were worth even less than it had agreed to pay.

Thus Lone Star stands to receive the upside profit if the securities prove to be more valuable, but has only a limited downside risk if they do not.
Liz Rappaport and Jon Hilsenrath at the WSJ had a story earlier: U.S. Weighs Fed Program to Loosen Lending
Some hedge funds, which often use borrowed money to boost returns, are lining up to get in on the Fed program, seeing a chance to make high double-digit-percentage returns with little downside using low-cost loans made on easy terms.
This really depends on the details. If the model is similar to the Lone Star deal, with hedge funds (or others) putting 25% down, the the Fed loaning the other 75% at attractive rates (with no recourse), and the transaction completely transparent (as they should be), I don't think the returns for investors would be in the "high double digits" as the WSJ article suggests.

This structure would definitely increase the price investors would be willing to pay for toxic assets, as compared to current market values (while putting the taxpayers at risk). For any bank that has aggressively marked down assets to current market values, this could mean a potential markup. But I think most banks will have to take further write downs and will need additional capital.