Timothy Geithner’s proposals for hedge funds and private equity funds to buy the mortgage-backed assets that clog financial institutions’ books have not been met with the enthusiasm the US government might have wished for.
In February, the Treasury secretary said: “By providing the financing that the private markets cannot now provide, this will help start a market for the real estate-related assets that are at the centre of this crisis. Our objective is to use private capital and private asset managers to help provide a market mechanism for valuing the assets.”
Industry participants are somewhat bemused by the vague plan. David Beim, a professor at Columbia Business School, says: “It sounds like Geithner intends to set up a new entity with joint ownership of government and the private sector to buy up these bad assets but I’m not sure why private investors would want to buy into that. The goal seems to be a government purpose and not a profit-seeking purpose and that is unlikely to attract interest. It would be better to let the private sector own the assets and support that ownership with insurance or leverage. Without that support it will be hard to get investors to commit.”
Incentives
Craig Lilly, a hedge fund and private equity attorney at law firm Squires, Sanders and Dempsey, agrees that more guarantees will be needed to encourage hedge funds and private equity funds to buy into the idea. “Unless there is some guarantee or loss-sharing arrangement to reduce the downside, in addition to a sweetener such as preferred shares or warrants, there will be little incentive for funds to invest,” he says.
The main problem with the proposal is simply that the toxic loan portfolios of banks keep deteriorating and valuation is still difficult. A hedge fund manager says: “The difficulty for Geithner is – what price is going to be paid? There is a wide bid-ask at the moment and I’m not sure how you can get clarity on that. What hedge funds are willing to pay and what the banks want to get paid are totally different. How do you get those two sides on the same page?”
No answer
Geithner himself clearly does not know the answer. The proposal contained no details, leaving Geithner only to say: “We are exploring a range of different structures for this programme, and will seek input from this committee as we design it.”
Lilly suggests that there will need to be some suspension of mark-to-market accounting because of the valuation difficulties. “How do you value these assets on FAS157 when it impacts the banks even after they sell,” he says. “There is too much concern that we have not seen the worst yet and the government has not come up with a plan that makes people feel comfortable.”
