Thursday, April 9, 2009

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.

1 comment :

  1. Good suggestion. On the other hand: 1) Sellers to PPIP funds aren't necessarily insolvent. 2) Bypassing foreclosure may support poor ownership teams to aggregate detriment.

    ("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." Payable only if the bank defaults. Insuring selectively unwanted assets severally from a bank in toto surely may increase FDIC's probable payouts opposed to potential. Moreover aiding ownership teams that engendered significant doo doo, relative to conducting foreclosure sales, may increase its probable future payouts to premium payers', and if premiums are paid industry-wide then to their customers', detriment. Both 1&2 appear reasons to beware such transfers.)

    Thanks for the interesting blog. Comments on states impeding rational health insurance look particularly good.