http://www.nakedcapitalism.com/2009/03/investor-on-private-public-partnership.html Excerpt 1: Say I am SAC Capital. I get to be one of the bidders on bank assets covered by the program. Citi holds $100mm of face-value securities, carried at $80mm. The market bid on these securities is $30mm. Say with perfect foresight the value of all cash flows is $50mm. I bid Citi $75mm. I put up $2.25mm or 3%, Treasury funds the rest. I then buy $10mm in CDS directly from Citi [or another participant (BOA, GS, etc)] on the bonds for a premium of $1mm. In the fullness of time, we get the final outcome, the bonds are worth $50mm. SAC loses $2.25mm of principal, but gets $9mm net in CDS proceeds, so recovers $6.75mm on a $2.25mm investment. Profit is $4.5mm. Citi writes down $5mm from the initial sale of the securities, and a $9mm CDS loss. Total loss, $14mm (against a potential $30mm loss without the program). U.S. Treasury loses $22.75mm. Great program. It's just a scheme to transfer losses from the bank to the taxpayer with an egregious payout to a middleman (SAC) to effectively money launder the transaction. You've also transmuted a $30mm economic loss into a $36.75mm economic loss because of the laundering. So it's incredibly inefficient. How did fraud and money laundering become the national economic policy of the US? One would have to be a criminal to participate in this. ***************************** Excerpt 2: Now, given that Congress doesn't want to authorize more money, Summers/Geithner are trying to misuse Fed/FDIC authority to hand out cash. This is illegal because the FDIC and Fed are authorized to lend, but not to hand out gifts/grants. Lending non-recourse undercollateralized is a gift/grant.
The CDS leg is unnecessary if the government loan to the purchaser is non-recourse. So the idea is to let the purchaser ride the spread while it's good and then throw the loss to the taxpayer some years down the road when the cashflows fall below the financing cost. It's a delaying tactic to make the future Joe Taxpayer eat the cost. But this isn't going to work for a range of bad assets with distant cash flows. I doubt this program will remove more than a fraction of bad assets from the books of the idiots who bought or created them. This installment of Through the Looking Glass will only work for stuff with an artificially created positive carry.