The Federales’ latest announcements – $1 trillion in financing from the Fed and the latest Treasury plans to use public-private entities to buy ‘toxic’ assets – have one thing in common: Leverage used to finance assets that are valued at a questionable amount.
Subprime borrowers also used leverage to finance homes whose prices looked to ‘never’ go down.
What is the major difference between the subprime borrowers and ‘we the people’ (UST and Fed)? Most subprime borrowers used financing that was recourse in nature, while much of this latest batch of federal financing is non-recourse. So, arguably, with these brave new initiatives, the Federales are in a worse financial position than the lenders that originally made those subprime loans.
That’s all well and good, you might say, but will these new programs work? Most likely, yes…and there will probably be more to come.
What other entity used similar public-private arrangements and bidding processes to clear ‘toxic assets’? In the 1980s and 1990s, Resolution Trust Corp (RTC) issued long term bonds to fund their activities…bonds that were repaid within 2-3 years of issuance in many instances. Today’s RTC is merely occuring without required additional Congressional approval, making it easier to execute, but perhaps, subject to lesser scrutiny.
Those with strong memories of the RTC will also remember the unusually good investment opportunities that were generated in many cases. And, as these programs become even clearer, it may be worthwhile to have discussions with your investment manager about similar opportunities.
We may all be ‘sub prime’ lenders now, but it seems like the currently announced programs have an excellent probability of working to begin a ‘great releveraging’ of the financial system. Whether that is the best course of action for both the short and long term time horizons remains to be seen.