The Treasury has now revealed its plans on how to buy up 'bad assets'.

The Treasury believes, or at least claims to believe, that some 'asset' held by banks can not be sold off because there is no market for them. That is of course wrong. There is a market for any asset as long as it has a reasonable price. The banks simply want more money for these assets then anyone is willing to pay for them.

The Treasury further argues that keeping those assets within these banks currently impairs the general credit markets. I find that a dubious claim as a. money supply and credit is still expanding and b. over-indebted households have no reason to take on more debt.

So from my point of view the Treasury is presenting a wrong view of the real problems. I like others believe that the banks are simply insolvent, i.e. they have more debt than fairly valued assets and the Treasury's real plan is to make them whole at the cost of the taxpayers.

Three plans are presented today but only the first one seems to be really determined.

The first one is the "Public-Private Investment Program for Legacy Loans"

Let's just take the sample from the Treasury site for this:

Sample Investment Under the Legacy Loans Program

Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.
Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.
Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.
Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6.
Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis – using asset managers approved and subject to oversight by the FDIC.

The private capital in this case is only in the game with 7.15% of the total assets bought under this program.

If the payed price for the legacy assets turns out to be 10% above its real value, the private investor will lose just $6. The bank would have gained $8.40 more than the real value for its legacy asset. In this case how do we know the bank that sold the legacy asset is not in cahoots with the private entity here and will share its gain with it? Both would make a profit while the taxpayer would take a loss. How do we know that the private entity does not have a side-bet of this or another kind?

If the payed price for the legacy assets turns out to be 10% below its real value, the private entity will win half of the profits, i.e. $4.20. That is a return of 70% on its maximum capital at risk while the taxpayer would have a return of 5.4% on its $78 maximum capital at risk. That does not look much like 'partnership' to me.

On to the second plan which is an extension of the Fed financed TALF program that lends to private entities to buy up 'legacy securities' defined as:

non-agency residential mortgage backed securities (RMBS) that were originally rated AAA and outstanding commercial mortgage-backed securities (CMBS) and asset-backed securities (ABS) that are rated AAA.

What is the meaning of an "original rating of AAA" if an assets is no longer rated as such? The rating was obviously wrong in the first place and has no relevance to the current real value of the asset. So why is this made a condition?

The details of this program are still totally unclear:

Haircuts will be determined at a later date and will reflect the riskiness of the assets provided as collateral. Lending rates, minimum loan sizes, and loan durations have not been determined. These and other terms of the programs will be informed by discussions with market participants.

Hmmm …

In the third program the Treasury would partner with private investors as in the first one, but the additional financing would not come from the FDIC, but from the Fed through the TALF program like in the second program.The details are again unclear.

So of relevance in this announcement is only the first program. That has skewed incentives that can either be used to screw the taxpayer or to give a highly unfair and unjustifiable advantage to the private 'partner' in the game.

All that said I am not sure I would like to take part in any of these program as the private entity. The programs will be under high scrutiny from several sides and if problems are detected with it Congress might step in and change the rules retroactively.

The program(s) may therefore fall well short of the Treasury's intended size and scope.