Treasury Secretary Geithner unveiled a stepped-up program today to stabilize (LOL) the financial system including an initial fund of $500 billion to absorb toxic assets.
The plan includes a public-private partnership aimed at soaking up toxic assets that are in the financial system. It also includes new efforts to boost consumer lending, limit home foreclosures and provide new capital for banks.
Now, let's look at this public-private partnership whereby the government will start with an initial $500 billion to get rid of all that toxic waste that lies within the balance sheets of our financial institutions. This is the good part, especially if you are a hedge fund. As the hedge fund, the government provides you with 95% non-recourse financing (presumably very cheaply), whereby you only have to put up 5% of the face value. In return, you get a 7% coupon, which means that in one year you have recouped your investment, and in two you are making money like a madman, up 200% or more on their original risk capital. Example: You purchase $100 million of the stuff with only a 5% investment, or $5 million. If the coupon is 6%, you receive $6 million ($100 million x 6%) at the end of the year; and, if the cash flow continues in the second year, you have some great profits. But what happens when these instruments default? (I am sure they will default.) The Treasury winds up eating the entire face value, while the hedge fund is completely off the hook and has made off with all of the coupon money in the meantime. Boy, is this a sweet deal. Wish I had a spare billion or two!
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