Jeffrey Sachs: Will Geithner and Summers Succeed in Raiding the FDIC and Fed?

[chimpymustgo]

Sachs, writing in HuffPo:


Geithner and Summers have now announced their plan to raid the Federal Deposit Insurance Corporation (FDIC) and Federal Reserve (Fed) to subsidize investors to buy toxic assets from the banks at inflated prices. If carried out, the result will be a massive transfer of wealth -- of perhaps hundreds of billions of dollars -- to bank shareholders from the taxpayers (who will absorb losses at the FDIC and Fed). Soaring bank share prices on the morning of the announcement, and in the week of leaks and hints that preceded it, are an indication of the mass bailout at work. There are much fairer and more effective ways to accomplish the goal of cleaning the bank balance sheets.

A major part of the plan works as follows. One or more giant investment funds will be created to buy up toxic assets from the commercial banks. The investment funds will have the following balance sheet. For every $1 of toxic assets that they buy from the banks, the FDIC will lend up to 85.7 cents (six-sevenths of $1), and the Treasury and private investors will each put in 7.15 cents in equity to cover the remaining balance. The Federal Deposit Insurance Corporation (FDIC) loans will be non-recourse, meaning that if the toxic assets purchased by private investors fall in value below the amount of the FDIC loans, the investment funds will default on the loans, and the FDIC will end up holding the toxic assets.

To understand the essence of the giveaway to bank shareholders, it's useful to use a numerical illustration. Consider a portfolio of toxic assets with a face value of $1 trillion. Assume that these assets have a 20 percent chance of paying out their full face value ($1 trillion) and an 80 percent chance of paying out only $200 billion. The market value of these assets is given by their expected payout, which is 20 percent of $1 trillion plus 80 percent of $200 billion, which sums to $360 billion. The assets therefore currently trade at 36 percent of face value.

Investment funds will bid for these assets. It might seem at first that the investment funds would bid $360 billion for these toxic assets, but this is not correct. The investors will bid substantially more than $360 billion because of the massive subsidy implicit in the FDIC loan. The FDIC is giving a "heads you win, tails the taxpayer loses" offer to the private investors.

Specifically, the FDIC is lending money at a low interest rate and on a non-recourse basis even though the FDIC is likely to experience a massive default on its loans to the investment funds. The FDIC subsidy shows up as a bid price for the toxic assets that is far above $360 billion. In essence, the FDIC is transferring hundreds of billions of dollars of taxpayer wealth to the banks.

With a little arithmetic, we can calculate the size of that transfer. In this scenario, the private investors (who manage the investment fund) will actually be willing to bid $636 billion for the $360 billion of real market value of the toxic assets, in effect transferring excess $276 billion from the FDIC (taxpayers) to the bank shareholders! Here's why.

-snip-

The bank shareholders, however, come out $276 billion ahead of the game, while the FDIC bears $276 billion in expected losses! This transfer occurs because the investment fund defaults on the FDIC loan when the toxic assets in fact pay only $200 billion, an outcome that occurs 80 percent of the time. When that happens, the investment fund is "underwater" (holding more in FDIC debt than in payouts on the toxic assets). The investment fund then defaults on its debt to the FDIC. The FDIC gets $200 billion instead of repayment of $546 billion, for a net loss of $346 billion. Since this outcome occurs 80 percent of the time, the expected loss to the taxpayers is 80 percent of $346 billion, or $276 billion. This is exactly equal to the overpayment to the banks in the first place.

-snip-

Much more at:


http://www.huffingtonpost.com/jeffrey-sachs/will-geithner-and-summers_b_177982.html

[PM Martin]

1. k/r

[chimpymustgo]

2. And see how much Wall Street loves? Dow up 500! Money party!!

[David Dunham]

3. The plan works.

[chimpymustgo]

4. Loss belongs to taxpayers, gains to investors.

Ben Stein on CNN now saying banks and hedge funds are going to make a shitload of money off this.

[depakid]

6. Bank shareholders stabd to gain around 276 billion at our expense according to Sachs

[notesdev]

5. Ah...

but for whom?

[JackRiddler]

15. Oooga booga! Ooooga booooga!!!

[Karenina]

7. Erledigt.

[burythehatchet]

8. Krugman compared Obama supporters to NIXON's PEEPUL!

:wtf:

[leftchick]

9. this just fucking

SUUUUUUUUUUCCCCCKKKKKKSSSSS!!!!!!!!!!!!!!!!!!!!!!!

:banghead: :banghead: :banghead: :banghead: :banghead:

[chimpymustgo]

11. Another GREAT post by leftchick! WHERE'S THE OUTRAGE?????

:hi:

[leftchick]

12. you are too kind

but it is nice to see someone who agrees we should all be outraged!

:)

[AzDar]

10. K & R & ...

:puke:

[Karmadillo]

13. What's the point of having a government if the rich can't loot it?

nt

[Leopolds Ghost]

14. In this scenario, the private investors (who manage the investment fund)

And why is that? Anyone care to ask AUSTIN GHOULSBEE or LARRY SUMMERS?

[JackRiddler]

16. While they're at it they should throw in the Social Security fund to cover it.

It's about time that was taken too, I figure.

And sell any remaining government properties too. We will pay any price, bear any burden to secure the safety of the life-giving banks, for without them we are nothing.

So what's with Sachs? Isn't this the same guy who sold the Russian privatization "shock therapy" plunder job of the early 1990s, from which Russia still has not fully recovered? Has he developed a conscience since, or is he just not in on this round and hates the scummies running it, or what?

[JDPriestly]

17. I'm probably not supposed to post the same post three times, but here is my two cents:

This seems so crazy to me. I don't think I can possibly be right, but this is the way I understand what has happened. If you understand this better than I, please let me know where I am wrong.

So, basically,
1) These banks loaned money for mortgages to people who could not afford the mortgages.
2) The easy money caused the prices of housing to rise to levels not commensurate with rises in wages.
3) The banks took fees and other money when they gave the new mortgages.
4) The banks got investors to back up the mortgages with the investors' money.
5) The banks leveraged the investors' money into big profits through various insurance scams.
6) The bankers paid themselves huge salaries and bonuses out of the profits from the raging housing market.
7) The bankers raised interest rates pursuant to certain clauses in the homebuyers' mortgage contracts.
8) Many homeowners found themselves unable to pay the new, higher interest rates. (Surprise!)
9) The bankers declared the market a bust.
10) Housing prices went down.
11) The bankers insisted on charging the higher interest rates and foreclosing rather than rewriting the mortgages.
12) The bankers claimed a market bust.
13) The bankers turned to the government for help.
14) The bankers exchanged the now worthless houses to the government for the bail-outs and repaid their foreign investors and investing banks (each other) in full out of the government money,
15) And now -- those same banks which are the biggest megabanks in our system get to buy back the worthless properties that they sold to the government at inflated prices -- for market, post-foreclosure prices.

That is brilliant. What a scam. At each step, the banks made huge profits. And they stand to make even more now that they get to buy the "toxic assets" at low, low, going out of business sale prices.

And, maybe the best part is that, out of fear that the markets would crash, the Fed lowered its interest rates to next to nothing, while those same bankers that caused this collapse raised the interest rates on consumer debt, especially credit card debt and lowered interest paid to consumer depositors.

There is something wrong here. I don't think we are being told what is really going on. Is the real story that China is withdrawing or has threatened to withdraw its support for our economy? Why haven't we made the bankers disgorge the profits they took in compensation during the good years to cover the banks' debt?

Can someone please correct my analysis. Am I wrong here?

If I am right to any extent, these guys belong in jail, every single one of them. And Geithner (and Obama with regard to this bail-out business, sorry to say) and Bernanke are idiots and should be replaced.

Added support info: Citigroup profit in 2005 was $24.6 billion.
http://www.usatoday.com/money/companies/earnings/2006-0...

Goldman profits and executive bonuses soared in the 2006.

The figures were certainly good news to the scores of Goldman bankers and traders who will find out, starting today, what their bonuses will be. Chances are good they will be impressive: the bank is paying $16.5 billion in compensation this year, or roughly $623,418 for every employee.

Wealth on Wall Street is not distributed evenly, of course. Rainmakers in investment banking can expect to see $20 million to $25 million each while traders who booked big profits will take home a chunk of those profits, up to $50 million apiece, according to senior executives at leading Wall Street banks.

“Anyone at the bonus line at Goldman Sachs died and went to bonus heaven,” said Michael Holland, chairman of Holland & Company, a New York-based investment firm. “It doesn’t get any better than this.”

http://www.nytimes.com/2006/12/13/business/13place.html...

Wonder where Goldman plans to find all those private investors? They probably have to look no further than the corner and front offices in their own firm.

This chart compares the profits of the various banks and investment groups for 2006

http://money.cnn.com/magazines/fortune/fortune500/snaps...

Goldman Sachs shows revenues of $43,931 million 70 54.5% from the previous year
Profits are stated as $5,626 million (and they paid $16.5 million in bonuses?)
Assets are listed as $706,804 million.

This list shows that both Morgan Stanley and Merrill Lynch did even better than Goldman in 2006.

And we are bailing them out? These banks should have turned to their own executives and former executives for help before turning to the U.S. government. Who is getting rich here? This is a swindle of massive proportions. These banks are not in trouble. no way. The money is in Switzerland, the Cayman Islands or some other tax havens.

This is appalling. This is the financial takeover of the entire company by a very wealthy few. And Obama does not see through this scam. I think he is either in the pocket of these guys or too close to the decisionmaking to see it for what it is.