Incomplete Valuation of Geithner Summers Toxic Asset Purchase Plan

All the analysis and discussions I have read about the US government's toxic asset purchase plan are incomplete. Many of the discussions focus on the non-recourse FDIC loan for up to 85 percent of the purchase price of the assets, but forget to mention the FDIC contingent liability for the deposits.

All of the discussions overlook that the FDIC is on the hook for the deposits of the bank through FDIC deposit insurance. If the toxic assets own by the bank are worth substantially less than their book value, the FDIC will make up the difference to the depositors. For example, if a banks has $200 of deposits and $200 of market value assets, the FDIC will have zero liability. If the $200 of assets are only worth $100 because a $100 of the assets are toxic and worth zero, the FDIC is liable for the $100 difference.

When the FDIC provides a non-recourse loan to private investors to purchase the assets, the FDIC acquires a contingent liability for the loan. The cash from the loan goes to the bank to purchase its assets. The asset purchase lowers the FDIC deposit contingent liability on the deposits by the amount of the cash.

Effectively, the FDIC's deposit contingent liability is transformed into a non-recourse loan with a contingent liability of default by the borrower. The private public partnership purchase of toxic assets does not increase FDIC contingent liabilities. It just transforms them from a deposit liability to a loan default liability.