I’m trying to understand the new “toxic asset” plan Geithner revealed today. As I understand it, the Feds are going to attempt to solicit bids for these assets from institutions (banks, pension funds, mutual funds, hedge funds, etc). In order to encourage bidding, the government is only requiring the bidders to put up 7% of the asset purchase price. The TARP funds then match that amount. The other 86% is loaned to the bidding institution from the FDIC and Fed.
Is this basically correct?
Assuming it is…
What is to prevent the potential bidders from bidding artificially high for these toxic assets?
Imagine Citigroup having a portfolio of assets in an SIV or other off balance sheet vehicle.The original purchase price was $1 billion. The last trade in that particular market was at 20 cents on the dollar. The market has now completely dried up and there is no accurate known price. What is there to prevent Citigroup from bidding 80 cents? Can banks enter bids for in markets for assets in which they have an interest?
If Citi were to “buy” these assets the financing would be as follows:
$800 million total
-$56 million from Citigroup (7%)
-$56 million from TARP (7% match)
-$688 million from FDIC and Fed (non-recourse loan for 86%)
What if the portfolio turns out to actually be a non-performing bunch of junk and is worth essentially nothing? The taxpayer is now on the hook for $744 million, whereas Citigroup takes a loss of $256 million.
The same institutions that are holding the toxic assets are going to be doing the bidding. This is an obvious conflict of interest. Call me cynical, but this seems to be nothing more than a plan to socialize losses - with a confusing little step in the middle.