Interest Rate Roundup

Monday, February 09, 2009

Bank bailout on a 24-hour hold; Details leak anyway

Good Monday morning! I'm back from New York and ready to resume normal posting here. The big news of the day has to be the 24 -our hold put on the latest bank bailout plan. It was slated to be released today; Now, Treasury Secretary Tim Geithner won't be rolling it out until Tuesday. The stated reason for the delay? So that everyone can focus on the economic stimulus package instead.

Of course, Washington is leakier than a sieve these days -- and most details of the package are already finding their way into the press.

Here's one update from the New York Times. It discusses how the government is trying to structure any bailout in such a way that private investors will help foot the bill:

"Wall Street helped produce the global financial and economic crisis. Now, as the Obama administration prepares to unveil a revised bailout plan for the banking system, policy makers hope Wall Street can be part of the solution.

"Administration officials said the plan, to be announced Tuesday, was likely to depend in part on the willingness of private investors other than banks — like hedge funds, private equity funds and perhaps even insurance companies — to buy the contaminating assets that wiped out the capital of many banks.

"The officials say they are counting on the profit motive to create a market for those assets. The government would guarantee a floor value, officials say, as a way to overcome investors’ reluctance to buy them.

"Details of the new plan, which were still being worked out during the weekend, are sketchy. And they are likely to remain so even after Treasury Secretary Timothy F. Geithner announces the plan on Tuesday. But the aim is to reduce the need for immediate federal financing and relieve fears that taxpayers will pay excessive prices if the government takes over risky securities. The banks created those securities when credit and home prices were booming a few years ago.

"Besides devising a way to bring private investors into the bank bailout, the Treasury plan is expected to inject more capital into some banks and to give many homeowners relief from immediate foreclosures."

As for other possible plan elements, the Wall Street Journal weighed in on several of them today:

"An expansion of the Fed's Term Asset-Backed Securities Loan Facility to include assets beyond the student-loan, auto-loan and credit-card debt it was set up to absorb. Under the revamp, the so-called TALF is likely to buy securities backed by commercial real estate and possibly other assets as well. The program was set up during the Bush administration to spur the consumer-loan market by providing financing for investors to buy securities backed by such loans.

"A second round of cash injections in financial firms but with tougher terms, such as a requirement to modify troubled mortgages and better track the federal funds. The government is looking to get money into banks by buying preferred shares that convert into common shares in seven years; the idea is to avoid diluting current shareholders' stakes while helping banks better withstand losses. The Treasury may also allow banks that have already received capital to convert the Treasury's preferred shares to common stock over time.

"Giving the Federal Deposit Insurance Corp. power to help dismantle troubled financial firms beyond the depository institutions over which it now has authority. This could require legislation.

"Mr. Geithner, his predecessor Mr. Paulson and Fed Chairman Ben Bernanke have said there needs to be a government entity empowered to wind down failed financial institutions that aren't banks. Regulators have said one problem the government faced when Lehman Brothers Holdings Inc. and American International Group Inc. ran into trouble was that no federal body had authority to step in and steer the firms toward an orderly demise.

"Having the FDIC guarantee a wider range of debt that banks issue to fund loans is also a likely element of the plan, said people familiar with the matter. The guarantees could help free up credit to both companies and consumers. Currently, the FDIC temporarily backs certain debt with a three-year maturity. Government officials could increase this to maturities up to 10 years.

"More help for homeowners, at a cost of between $50 billion and $100 billion. The administration is expected to create national standards for loan modifications that would be adopted by mortgage giants Fannie Mae and Freddie Mac. The plan could include a mechanism to determine the value of homes facing foreclosure, which could speed negotiations with borrowers. The difficulty of valuing such homes is one reason many loan-modification efforts have stalled.

"A related move would see the government using taxpayer dollars to give mortgage companies an incentive to modify loans. One idea would help reduce interest rates for consumers by having the government match mortgage companies' interest-rate reductions to some degree. For instance, if a mortgage company agreed to shave one point off the rate on a loan, the government might match that so the rate would be reduced by two points. Mr. Geithner is also expected to express support for legislation that would allow judges to modify the terms of mortgages in bankruptcy court."

Of course, the COST of all these bailouts is continuing to unsettle the Treasury bond market -- a trend I have discussed many times in many venues. The long bond futures are off ANOTHER 13/32 as I write. At a price of just over 125, they're down almost 18 points since mid-December.

The cost of insuring Treasury bonds against default in the derivatives market continues to rise, too. Credit default swaps on U.S. 10-year notes traded up to 82 basis points on Friday, according to Bloomberg data. That’s a fresh high, and a large increase from the late-2007 low of 7 basis points.

Stated another way, it now costs $8,200 to insure $1 million in 10-year notes against default, up from $700. That's still peanuts compared with many private credits. But the trend is clear: Investors are downgrading their assumptions about the credit quality of the U.S. itself.


  • Being that these are dollar denominated debt, and the govt can print as much as they want - how can they default? It's not like the 10yr is in euro's (yet).

    By Anonymous Anonymous, at February 10, 2009 at 1:05 AM  

  • With regards to your post, whether or not the U.S. government actually does default at some point in the future (I happen to think that is unlikely though I'll never say never), isn't the question at hand. The important thing for the here and now is the increased market perception that U.S. credit quality is deteriorating.

    Clearly, the CDS spread widening is a symptom of that underlying fact. I believe the sell off in Treasury bonds stems, in part, from this increased supply/credit risk perception as well. These forces are helping drive up sovereign interest rates, and yet no one in Washington seems to be talking about this (or even caring, for that matter). So I feel it's ample fodder for a discussion on the blog.


    By Blogger Mike Larson, at February 10, 2009 at 9:00 AM  

  • I really want to know the answer to my following questions, maybe I missed something. I am curious regarding how BofA plans on paying the government back? What interest rate does BofA have with the people (the taxpayers)? What does BofA do if they fail to pay the government back the money borrowed on time? Does there interest rate go to 36% maximum? Not counting late fees and such. These are the questions I want to know besides I want a bail out deal too … I’ll pay it back promise - I guess it’s called foreclosure or bankruptcy. Thanks to anyone able to answer these questions. Mr.D

    By Anonymous Mr.D, at February 26, 2009 at 2:20 AM  

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