The Geithner plan is nothing but a scam to stick the taxpayer with the losses that should go to the banks' shareholders first and the banks' bondholders second.
Basically the plan works like this. The Fed or Treasury loans money to some investor. This is a no-recourse loan with say 3% down on the part of the investor.
Yves at Naked Capitalism has already started this thread so lets take her example.
Lets say the bank, Citi for example, has an asset with face value $100MM carried on the books at $80MM and which is currently getting markets bids at $30MM. Lets say that it turns out to be worth $50MM and that it takes 5 years for this to become evident. So if Citi is forced to selling into the market now or mark-to-market they will take a $70MM loss or an additional $50MM loss from the present write-down. If they hold to maturity, they will lose $50MM total and $30MM from the current mark.
Now if some investor shows up and wants to make a bid at $75MM with the Fed's borrowed money, they are risking only $2.25MM (3%) of their own money. Citi now has to write down $5MM more on this sale. This plan saves them $25MM.
In this case, the investor loses their bet and ends up losing $2.25MM. The bank has the $5MM write down and the taxpayers loses $22.75MM. Clearly the bank is getting the best deal.
But what if no investor wants to bid? How can the banks scam this system? It is not hard to come up with ways. Let me list a few possibilities:
1) The bank could make a no-recourse loan to the investor. Now the investor really has nothing to lose. The bank can only lose the difference between their mark and the bid plus the loan to the investor.
2) Another way that Yves brings up is for the bank to sell a CDS to the investor that pays off if the assets go bad.
3) The investor bids high with intent to lose in some quid-pro-quo with the bank. Maybe the bank will give them a loan at low interest rate or some other favor. This would probably be completely undetectable.
4) The investor could just buy call options on the bank's common stock and then bid for all of their crummy assets at face value or even higher. How about that!? They would be throwing away all of their investment purposefully in order to buy a large piece (maybe even all) of a clean bank. This way would maximize taxpayer losses. It would not even have the involve conspiracy with the bank. It is really just a way of using the enormous leverage to manipulate the stock price of the bank.
The reason why it is so easy to think of ways to scam this system is that it is inherently a scam from the beginning. These hedge investors are sophisticated and are sure to find ways of hedging their exposure so that is a chance of a big return with no risk. It is a complete hand-out to them. It is obviously a hand-out to the banks. That is the whole point. The taxpayer is the fish at the table. They are obviously going to get screwed one way or the other. This plan stinks of corruption and must be rejected.
