Geithner's Plan

Disclaimer: my views here may be simple, naive or even plain wrong. I'm not an economist. Feel free to let me know if you think any of these is inaccurate. Thanks.


US Treasury announced the plan to unfreeze toxic asset from the banks' balance sheets. There are millions of web sites talking about how the plan works so I am not going to reiterate that. However I do a few questions regarding the plan.

Who are eligible for participating in the plan? If I were the proprietary trading desk at Citibank, could I pay like 95 cents for a dollar of those risky assets on my own balance sheet? After all, I only need to put up some money upfront and the money I receive from the government is essentially free.

Okay, the regulator is not stupid so the scenario above is not going to happen. Let's say I were a hedge fund holding 100 million shares of Citibank. Can I set up an investment vehicle and bid up the risky asset, hoping that my bid would dramatically increase the balance sheet position of Citibank and boost the share price? My maximum loss is the money I paid upfront, with the potentially explosive upside on the share price.

I guess there are a number of ways to exploit the plan and get free money from the government. I am obviously not smart enough to figure out the others.

There is one statement in the plan that worries me: "Financing Is Provided Through FDIC Guarantee: If the seller accepts the purchase price....". Does that mean the banks can refuse to sell the assets if they deem the prices as "too low"? If so, then it may not be very different from the current situation, i.e. the banks fail to recognize the loss in those toxic assets.

FDIC is going to guarantee a large portion of financing. This almost means that FDIC is putting a big part of the liquidity created by the shadow banking system on its balance sheet. This also means that in addition to the Quantitative Easing plan announced earlier, much more money is going to be pumped into the system indirectly. Let's say I were Citibank (again) and I received real cash plus guarantees from selling the toxic assets, can I use those guarantees as bank reserves? If so then I would be able to free up the cash by selling the treasury debts used as bank reserve before. If this is true, then treasury debt prices will be depressed at least in the short run.

I think Geithner's plan will be successful in establishing a price of those toxic assets in the primary market since the motivation to create an elevated market price of these assets is big, but whether the price will hold in the secondary market is questionable. I see the secondary market as the venue to determine real market price - will you jump in to buy Citibank's shares only because you see the high price of the assets in the primary market? I guess not.