Geithner Bad Bank Alternative May Rely on Loans to Hedge Funds

By James Sterngold

Feb. 23 (Bloomberg) -- Treasury Secretary Timothy Geithner’s financial-rescue plan may be doomed if he doesn’t offer low-cost loans to hedge funds and other investors to help them buy toxic assets weighing down bank balance sheets.

Creating a “bad bank” or “aggregator bank” that would use federal funds to acquire and warehouse the assets, as some have proposed, would be costly for taxpayers and require too much government interference, say two experts on distressed securities who have pitched an alternative plan to officials.

John Ryding, chief economist at RDQ Economics LLC in New York, and Matt Chasin, chief operating officer of Sorin Capital Management LLC, a Stamford, Connecticut-based hedge fund that manages about $1 billion, say the Treasury Department should provide loans at commercial rates to investors for up to 50 percent of the purchase price of securities. The financing would be for as long as the maturities of the assets being acquired.

“One of the problems the banks have been facing is that the markets have forced artificially low prices on these assets because there’s not enough financing available for buyers,” said Ryding, 51, a former Federal Reserve economist who advises hedge funds. “There’s a lot of capital looking for distressed assets, if hedge funds can get good financing.”

Geithner sketched out a rescue plan on Feb. 10 that was short on specifics. It called for a “public-private financing component,” with up to $1 trillion, that would enable financial institutions “to cleanse their balance sheets of what are often referred to as ‘legacy’ assets.” He said it “could involve putting public or private capital side-by-side and using public financing to leverage private capital.”

Aggregator Bank

Treasury officials said in background briefings that the plan would include some kind of government financing for private purchases of toxic assets, mostly mortgage-backed securities. Details are still being worked out, they said.

Ryding, who was chief U.S. economist at Bear Stearns Cos. until last June, when JPMorgan Chase & Co. acquired the failed securities firm, first offered his plan in a Sept. 30 investor note. His proposal, which he says was presented to Treasury and Fed officials last fall, would limit taxpayer losses, allow the market to determine prices for troubled securities and restart trading in the assets.

Realistic pricing set by the markets would unlock a freer flow of capital, Ryding and Chasin say, and avoid claims that the government is subsidizing either the banks, if prices are set too high, or the purchasers, if they are set too low.

Spokespeople at the Fed and Treasury declined to comment on the plan.

TATL, TALF

“Lack of financing is a huge problem for the market,” said Laurie Goodman, a senior managing director at Austin, Texas-based Amherst Securities Group LP and a former head of mortgage research at UBS AG. “Extending the lending facility would raise the value of the mortgage assets, as the yield required by the marginal buyer, a hedge fund, would be lower.”

Ryding and Chasin, who also worked at Bear Stearns, call their fund a Troubled Asset Term Lending facility, or TATL. It would be similar to one developed by Treasury last year, the Term Asset-Backed Securities Loan Facility, or TALF. That fund is scheduled to begin operating in early March and will provide up to $1 trillion of financing for buyers of new securities backed by credit card, auto and small-business loans.

The TATL fund would provide financing for so-called legacy assets, such as mortgage-backed and other collateralized securities that are declining in value and corroding bank balance sheets.

‘Increasing Liquidity’

Under the plan, the government would charge rates similar to those for commercial loans before the credit crisis, about 125 basis points over the London Interbank Offered Rate. The financing would be for as long as the maturities of the securities acquired, and it would cover a maximum of half the purchase price.

That would make it more likely, Ryding and Chasin say, that the government would recover the full value of the loan in the event of a default. In that case, the U.S. could seize the securities provided as collateral and would only lose money if the value of the asset fell more than 50 percent below the purchase price.

“This is potentially a way of increasing liquidity, and if you could do that it may get you to a place where you can start making new securitizations,” which would allow increased lending, said Lee Cotton, an investor and former president of the New York-based Commercial Mortgage Securities Association.

Price vs. Leverage

Some hedge fund managers expressed skepticism. Eric Banks, a partner at New York-based Tolis Advisors LP, which invests in distressed securities, said the real problem is that many banks are unwilling to sell toxic assets at depressed prices and take additional writedowns.

“Although government loans could improve secondary market participation and liquidity, legacy distressed assets owned by banks have been offered with seller financing included, yet only sporadic transactions occurred,” Banks said. “The primary cause of the ongoing stalemate seems to be price rather than leverage.”

Ryding and Chasin agree that, even if the plan works, it will force banks to absorb additional losses, which might require more taxpayer money.

“At the end of the day, this will not relieve banks of their capital-inadequacy problems,” said Chasin. “The government is probably going to have to fill that hole.”

To contact the reporter on this story: James Sterngold in Los Angeles at jsterngold2@bloomberg.net