Intro to TARP — TARP III: The Geithner Plan
We have so far:
- created our example of Large Bank;
- described TARP I, in which the government would buy bad assets from banks; and
- described TARP II, in which the government made direct equity investments in banks.
The Bush Administration implemented TARP II as the $250 B Capital Purchase Program (CPP), although less than $250 B has been allocated to specific banks.
Today I would like to describe TARP III, the Geithner plan now being implemented by the Obama Administration. I should warn you that this is more complex than TARP I and TARP II.
Here is the summary:
TARP III = (TARP II + stress tests + more capital targeted at big sick banks) + ( TARP I with private sector participation and more money through the Fed & FDIC)
Let us begin with the Obama Administration’s expansion of TARP II. They have:
- Left the Capital Purchase Program in place.
- Stress tested the 19 banks that have more than $100 B. Based on those stress tests, regulators will require some of these big banks to raise more capital.
- These banks “will be given a six month period to raise any additional capital needed to establish [a] buffer from private sources.” If the bank cannot raise this capital privately, then Treasury will provide it from the TARP.
The Administration calls (2) + (3) their Capital Assistance Program. It is an expansion of the Capital Purchase Program, targeted at filling the capital holes of big sick banks that cannot or will not raise funds from private investors.
Now let us turn to the Administration’s new plan to address the downside risk that Large Bank has on its balance sheet, what they call their Public-Private Investment Program.
It comes in two parts, one to help Large Bank sell its loans with downside risks, and the other to help it sell those securities with downside risks.
I will start with the Legacy Loan program, which is a little easier.
Large Bank shows their 120 of bad loans to the FDIC. The FDIC evaluates those loans and sets a ratio and a price. The ratio can be as high as 6:1. Let’s assume for these loans that the FDIC will go up to 5:1. I will describe the price in a moment.
Let’s also say that your friend Fred runs Fred’s Hedge Fund.
- Fred puts up 10 of investment capital.
- Treasury matches Fred with 10 of capital from the TARP.
- FDIC uses its 5:1 ratio to match the 20 […]