Bringing Back the Giveaways: US "Bad Bank" Gaining Steam

Just hours after newly confirmed Treasury Secretary Tim Geithner announced new rules to restrict lobbying from the banking industry, CNBC is reporting this afternoon that the Treasury is in talks with industry lobbyists around creating a federal "bad bank" and that a deal may be announced as soon as next week.

Such a move would mean huge giveaways to the banks and their shareholders, undermining the progressive case for bailouts that I argued for last week and making irrelevant Larry Summers' proposed protocols for the Obama administration's oversight of TARP 2.

More...
Nouriel Roubini pronounced last week that US and European banking systems are effectively insolvent.

But while the obvious, and more progressive and efficient, thing to do is to nationalize the banks, the new Treasury seems as loathe to do so as Hank Paulson's Treasury. (hmmm, is that really such a surprise since Geithner was Paulson's golden boy?) So, instead, we are facing another round of giveaways.

While the details of such a plan have not yet been announced, talk is circulating that a new "bad bank" or aggregator bank will buy up trillions of dollars worth of assets such as bad loans, mortgage credit default swaps and other obscure, illiquid (and possibly worthless) securities at the prices that are already on the banks' balance sheets (or off them, which is where so many of these securities are hiding, helping to obscure the fact that many of the banks are actually insolvent). This would help the banks sidestep the full industry collapse that has thus far been postponed by what Michael Shedlock has called the "Don't Ask, Don't Sell" plan:

The plan boils down to this: Don't Ask - Don't Sell.
* Don't Ask what the asset is worth.
* Don't Sell or you will find out and not like the result.

Thus, being able to sell toxic assets to the US "bad bank" would be a huge boon to the financial industry that would solve the problem of the "Don't Ask, Don't Sell" purgatory. For example:

* There would be no open market for the assets, avoiding the problem of finding out what they are truly worth (which is likely a lot less than what most of the banks are still valuing them at);

* The banks would receive massive amounts of cash that will not be 1) a loan or 2) cost them a tremendous amount in preferred stock that carries high interest rates (this has been the case with past infusions... now the talk is that the banks would only have to issue a small amount of common stock to make up for the difference between what the government is willing to pay for the assets versus what their value is on the banks' books);

* The government might even intentionally overpay for the securities, indeed over-bid even the probably much inflated prices at which the banks are currently valuing the assets.

* Hence, in most likely scenarios, the banks would not have to further write down their losses on these assets due to "mark-to-market" accounting;

* Debt holders and preferred and common stock shareholders would not be wiped out. This also means that the bank execs, who have been given huge compensation packages that include large amounts of stock, will not get wiped out due to their malfeasance;

* Taxpayers/the government will be stuck with all the assets, taking all losses and gains.

The last point in particular is being passed as a good thing by right-wingers and industry-folk. They argue that, at some point in the future, these assets will regain their value and the government is the ideal holder because it can afford however long it takes for that future to arrive.

However, in actuality this is an even worse deal for the government than those that were worked out under TARP 1, as it is much more likely that the securities never recover rather than produce outsized gains. But, because there would be a nominal exchange of assets, the "bad bank" plan will probably pass muster even with many of those who have been decrying the giveaways of the bailouts of 2008.