Monday, March 23, 2009

Well, I guess that scorching rally answers one question...

the banks and the markets like the plan. This is the plan that we have and we have to accept it. This rally is likely to extend for the foreseeable future. The end of the quarter will force many mutual funds that have sat the rally out to buy before 3/31 so it doesn't look like they were sitting on their hands as the markets soared.

I'll repeat though that this plan has too many ways for the banks to game the system. Consider this scenario that was put forth today....

I am Hedge Fund XYZ. I get to be one of the bidders on bank assets covered by the program.

Citi holds $100mm of face-value securities, carried on their books at $80mm.

The market bid on these securities is $30mm.

I bid $75mm for the assets. I put up $2.25mm or 3%, Treasury funds the rest. I also buy $10 million credit defaul swap for $1 million.

In the fullness of time, we get the final outcome, the bonds are worth $50mm

Hedge fund XYZ loses $2.25mm of principal, but gets $9mm net in CDS proceeds ($10 million policy - $1 million fee), so I recover a net of $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 (hedge fund XYZ) to effectively money launder the transaction.

One would have to be a criminal to participate in this."

I'm not sure I'd go so far as to call it money laundering, but it's close. This is an accounting gimmick that is almost certain to end up costing you, the taxpayer, billions more.

The real question remains: Who is beating down the doors of the banks to borrow? Not refinancing, but real, new debt? I've said from day one, that this is not a crisis of liquidity, but a crisis of loan demand. Demand for money has permanently declined and no amount of stimulus or accounting charades will change that.

The market may rally for some time (remember many of the most powerful rallies occur in the midst of bear markets), but just when you think you can see the light at the end of the tunnel you might find out it's a freight train bearing down on you.

No comments: