The NY Times has a story in which Shelia Bair, head of the FDIC, says that the FDIC does not expect to absorb any net losses from Geithner's new PPIP idea. This restores within me a small bit of hope that the banks are not going to defraud their way out trouble at the taxpayer's expense, or rather not as much as the markets seems to be expecting.
Lets analyze this a bit at the macro level. If the FDIC does not take a net loss and the investors do not take a net loss then then the banks have to take the loss as they should. It is as simple as that... well sort of.
What the FDIC can do is raise their insurance premiums to collect back any losses in the future directly from the banks. If it has a cash flow problem, it is possible that they can borrow money directly from the capital markets with an implicit government backing.
If you trust Sheila Bair (I have a warm place in my heart for her) this cannot be good news for the banks or Wall Street. It means that the FDIC is not going to guarantee any loans in which it is likely to get screwed. That is, it is not going to guarantee any toxic asset purchases unless the price is low enough for the FDIC to come out OK in the long run. This probably means, lower prices and less leverage. Lower leverage means the investor's larger down payment will provide a larger first-loss cushion if the FDIC has to take over the assets.
Still, I think the FDIC will take some nominal losses. But I think they intend for the banks to pay for these losses through future FDIC premiums. This means that banks will be less profitable in the future even in they can survive. So really this is just a way for banks to postpone taking losses. Japanese lost decade, here we come!
