According to the New York Times, pools of distressed mortgage-related assets of US banks have been 30 cents bid, 60 cents offered, in recent weeks. The bidders are hedge funds, the potential sellers under-capitalised, but State-guaranteed, US banks.
The Geithner plan appears to include a new type of investment vehicle with capital structure 3% private equity, 12% taxpayer equity, and 85% debt, also provided by the taxpayers. The holders of the 3% private equity would provide management and would bid for the distressed assets at auction. The expectation is that they would bid more than 30 cents on the dollar, thus improving banks’ balance sheets.
If the State equity is fully participating, it changes nothing from the standpoint of the fund manager. Only if the 85% debt is available at terms better than debt currently available to the hedgies (who will bid no more than 30 cents) can the plan work. The NY Times says that the 85% debt will be non-recourse, which certainly helps, and that it will be ‘cheap’, details to follow!. If it is provided at anything close to T-bill rates or short Treasury note rates, it’s a steal, and the Geithner hedge funds will of course bid more than 30 cents. I suspect that 85% non-recourse lending to distressed-asset hedge funds is not available at non-stratospheric prices right now. This is not a certainty-equivalent game since nobody knows the true value of the distressed assets, but cheap, non-recourse leverage will improve the bid price for any plausible distribution of returns.
The government could achieve the same objective by lending cheap non-recourse money to existing hedgies, unless I am missing something. But this would lack opacity. The critical economic component in all of these plans (including bad banks and insurance schemes) is the distribution of gains and losses. The critical political components appear to be fig-leaf involvement of private equity, the avoidance of overt nationalisation, and non-transparency.