Dear CIGAs,

Is it a new well planned State initiative or a leap in the dark?

Do values hide in the details?

What kind of business model will the banks have on the day after Toxic Assets?

How many banks will there be in 2011?

As it appears now the Treasury will provide up to $150 billion with the Fed lending $850 billion of non-recourse (no payback if you lose) finance for the purchase of defunct OTC derivatives on the books of the largest Fed member banks and primary US Treasury dealers.

In plain language, either the Fed or private money will step into the shoes of the banks from which these binding contracts of the specific performance contracts called toxic assets are purchased.

The mode of purchase by private money (because the Fed finances the transaction) is best understood as buying a call.

The entire transaction then stands on a premise of recovery in the underlying values.

If the underlying values do not recover, which the odds sustain, then the Fed as the lender will also be the owner of these defunct and unlikely to recover so called toxic assets.

The plan succeeds in keeping the one trillion off the Fed balance sheet for now and shows it as a performing loan in good standing. In that transformation lies today’s alchemy.

The money, one trillion dollars, does enter the system once again accruing not to the bank’s ability to loan, but to the counter party of the OTC derivative.

The key to understanding all of this is the fact that the banksters did not invest their own money in the securitized investments, aka their product. They manufactured them leaving the banksters as party to the performance of the OTC derivative. That means the so called toxic assets that the banksters hold and can sell is exactly what I described to you. They are specific performance contractual obligations assembled as packages to the securitized instrument. These items cannot be evaluated even by Karnak the Great.

This initiative is a leap into the dark because it does not necessarily provide funds to the banks from which the toxic assets come. The reason for that is the taking on of a specific performance contract obligation in which the funds paid migrate to the counter party. The funds and the specific performance contract are incontrovertibly attached.

The slimmed down banks may be faced with a lack of business, as there is no guarantee even if they could lend that the economy would be at that level to make lending a profitable enterprise. The banks, pray to God, are out of the OTC derivative business.

What will the banks do to make money? What is their new business plan the day after toxic assets? The answer to that is merge until there will be less than 10 major banks by 2011.

This is the creation of another one trillion as a massive subsidy to the private but fat cat Wall Street banksters.

One result can be counted on – hyperinflation.

In gold I am sure that nothing will change as the average trader buys strength and then sells weakness, endlessly making fools of themselves. It will be this way to $1650 and beyond.

Geithner’s Plan "Extremely Dangerous," Economist Galbraith Says
From The Business Insider, March 23, 2009
Henry Blodget  |  March 23, 2009

Tim Geithner has finally revealed his plan to fix the banking system and economy.  Paul Krugman, James Galbraith, and others have already trashed it. 

Why?

In short, because the plan is yet another massive, ineffective gift to banks and Wall Street. Taxpayers, of course, will take the hit.

Why does Tim Geithner keep repackaging the same trash-asset-removal plan that he has been trying to get approved since last fall? 

In our opinion, because Tim Geithner formed his view of this crisis last fall, while sitting across the table from his constituents at the New York Fed: The CEOs of the big Wall Street firms.  He views the crisis the same way Wall Street does–as a temporary liquidity problem–and his plans to fix it are designed with the best interests of Wall Street in mind.

If Geithner’s plan to fix the banks would also fix the economy, this would be tolerable.  But no smart economist we know of thinks that it will.

We think Geithner is suffering from five fundamental misconceptions about what is wrong with the economy.  Here they are:

The trouble with the economy is that the banks aren’t lending. 
The reality: The economy is in trouble because American consumers and businesses took on way too much debt and are now collapsing under the weight of it.  As consumers retrench, companies that sell to them are retrenching, thus exacerbating the problem.  The banks, meanwhile, are lending.  They just aren’t lending as much as they used to.  Also the shadow banking system (securitization markets), which actually provided more funding to the economy than the banks, has collapsed.

The banks aren’t lending because their balance sheets are loaded with "bad assets" that the market has temporarily mispriced. 
The reality: The banks aren’t lending (much) because they have decided to stop making loans to people and companies who can’t pay them back.  And because the banks are scared that future writedowns on their old loans will lead to future losses that will wipe out their equity.

Bad assets are "bad" because the market doesn’t understand how much they are really worth. 
The reality: The bad assets are bad because they are worth less than the banks say they are.  House prices have dropped by nearly 30% nationwide.  That has created something in the neighborhood of $5+ trillion of losses in residential real estate alone (off a peak market value of housing about $20+ trillion).   The banks don’t want to take their share of those losses because doing so will wipe them out.  So they, and Geithner, are doing everything they can to pawn the losses off on the taxpayer.

Once we get the "bad assets" off bank balance sheets, the banks will start lending again. 
The reality: The banks will remain cautious about lending, because the housing market and economy are still deteriorating. So they’ll sit there and say they are lending while waiting for the economy to bottom.

Once the banks start lending, the economy will recover. 
The reality: American consumers still have debt coming out of their ears, and they’ll be working it off for years.  House prices are still falling.  Retirement savings have been crushed.  Americans need to increase their savings rate from today’s 5% (a vast improvement from the 0% rate of two years ago) to the 10% long-term average.  Consumers don’t have room to take on more debt, even if the banks are willing to give it to them.

The two charts below from Ned Davis illustrate the real problem: An explosion of debt relative to GDP.  The first is Nonfinancial Debt To GDP.  The second is Total Debt To GDP.

In Geithner’s plan, this debt won’t disappear.  It will just be passed from banks to taxpayers, where it will sit until the government finally admits that a major portion of it will never be paid back.

More… ^[1]