U.S Govt Tries Again, This Time FDIC Gets Involved

W.C. Fields is supposed to have said: "If at first you don't succeed, try, try again. Then quit. There's no point in being a damn fool about it."

This quote came to mind today as I was reading the new plan announced by the U.S. Treasury of Secretary Tim Geithner to buy what has been dubbed "cash for trash", the trash being mortgage-backed securities.

The new plan now gets the FDIC involved - why jeopardize the stability of the FDIC? The only reasons I can think of are: 1) everyone else is already involved - U.S. Treasury, Fed Reserve, Fannie Mae, and Freddie Mac; and 2) it's a source of new cash, i.e., the FDIC's credit lines with the Treasury which ultimately means more sales of U.S. Treasuries.

But how much more borrowing can the U.S. do?

As President Obama said on "60 Minutes" last night: "The limit is our ability to finance these expenditures through borrowing. . . . If we don't get a handle on this, and also start looking at our long-term deficit projections, at a certain point people will stop buying those Treasury Bills."

Private investors are cheering, sending the U.S. stock indices skywards today. And according to a source quoted in "The New York Times":

"One institutional investor said he was surprised that the government was lending so much of the money, saying that private investors have been willing to buy up pools of mortgage-backed securities with less “leverage” or outside borrowing than the Treasury proposed on Monday."

Now, the investors bidding up the stock market aren't the same ones buying U.S. debt. The stock market investors are happy today because the new plan gives them terrific leverage to make more money. Here's the example the U.S. Treasury gave today:

A pool of bad residential mortgage loans with a face value of, say, $100 is auctioned by the F.D.I.C. Private investors submit bids. In the example, the top bidder, an investor offering $84, wins and purchases the pool. TheF.D.I.C. guarantees loans for $72 of that purchase price. The Treasury then invests in half the $12 equity, the private investor contributes the remaining $6.

So for just $6, private investors will leverage $100 with backing from the tax payers. The only thing they have to lose is $6 but if that $100 loan package goes up in value to say $110, they benefit from $10 in profit. Of course some will go down too. But let's say it's 1/2 down, 1/2 up so that's $4 profit in this exmaple between the two, won't the govt get some of the upside? Well, AIG, Bank of America and other s paid out big bonuses but did they repay any of it to U.S. taxpayers? No. So the likelihood of any of the upside being shared is pretty low.