Summary
Critical questions remain unanswered, and these questions will in all likelihood not be cleared up until the plan begins operation, such as: Will investors (through auction via FDIC) offer high enough bids to entice bankers to sell illiquid assets? Will regulators force banks to participate regardless of where bids are at? How quickly will the plan be implemented? What loans are eligible for the auction? Is this whole process too bureaucratic?
Analysis
The whole issue with buying the troubled assets is the pricing issue – this has been the issue from the onset, and remains the chief issue at hand. No financial institution wants to sell them too cheap, but too expensive – who is going to buy them? FDIC Chairwoman (Sheila Bair) conceded that the willing buyer and the willing seller may be too far apart to create a trade by acknowledging that she could not guarantee the process would create a good deal for the investor, the bank, and the government.
Pressure from the Treasury department and the results of “stress tests” on the banks could force many to participate, resulting in a “common middle ground”. For example, if the stress test results are lackluster it may push the banks to lower their price, and given the lucrative financing to investors, that could get them to raise their price such that both arrive at a "common middle ground". In order for the auction to work properly and effectively, the Treasury will likely need to “push” both the buyer and the seller.
The Treasury split its program to address troubled assets into two parts. Under one, the FDIC would host auctions designed to let banks sell pools of residential and commercial real estate loans. Under the other, the FED would accept legacy securities as collateral as part of its Term Asset-Backed Securities Facility (TALF). Treasury and FED officials said the program could be expanded to reach $1 trillion. To me, it is still unclear when either program will be up and running, however, the FDIC said it plans to release more details on its auction process shortly and would put it out for public comment. Under that program, banks would identify loans they wish to sell and would seek approval from their primary federal regulator to offer them as part of the auction. If the FDIC agreed, it would then conduct an auction of private investors, which could include private-equity firms, insurance companies, pension plans or even individual investors.
With all of these different plans that have been initiated comes an array of potential administrative problems – different rules for and throughout each plan – this is not only cumbersome and bureaucratic, but expensive. Congress could present another headache, if they were to impose compensation or other restrictions for those private equity players that are willing to participate in the program.
On the positive side, the U.S. equity market (barring the market’s rally since the low of March 9th) is now trading at close to its lowest valuation levels in 30 years. Conventional wisdom dictates that stocks are considered cheap when earnings yields are higher than bond yields; today, the difference between the earnings yield of the S&P 500 and that of 10-year U.S. Treasury bonds is near a level that is unprecedented in three decades. Some of the decline in equity valuations is due to legitimate business deterioration and the overall economic environment, but the balance is simply due to indiscriminate, fear-based selling.
2008 was indeed a very disappointing year for equity investors, as has been YTD 2009. However, the U.S. market is still trading at multi-decade lows. Fiscal stimulus initiatives announced by the government, the recent moves by the FED and Treasury (alongside the battery of interest rate cuts delivered by the FED), should help to quell the financial and economic crisis at hand, although these efforts will take time. Through the careful selection of well-valued stocks in this tumultuous period, one can position their equities portfolio for a strong return once capital follows investor confidence back into the markets in a strong, steady, and sustained manner; but until further clarity is attained we have a way to go yet.
