Why aren't authorities looking at this plan?

I was just reading a blog and came across a proposed plan (The Genesis Plan) that will unlock the gridlock in credit markets that is being caused by lack of trust in counterparties. The plan will go a long way in restoring trust in our financial system. The blogger notes that yesterday’s Lehman CDS auction not failing provides proof that letting inter-connected companies go under will not result in Armageddon. A leveraged company such as Lehman still had enough value left to pay some of their debt. Yes, a mere 8 cents on the dollar, but their losses DID NOT exceed equity and debt. Any thoughts on the plan below? Here’s the plan copied from the blog: 1. Everyone must expose their balance sheet; all Level 2 and 3 assets must be declared and all models disclosed in full immediately and every quarter hereafter. 2. The CDS monster must be caged by forcing it onto an exchange where O/I and margin supervision can be maintained. This is already in process and must be completed. 3. Leverage must be returned to no more than 12:1 across the system - no exceptions. The last point is obvious - every firm that has detonated has had leverage well beyond 12:1. None that have had less leverage have blown up. Game, set, match. #2 is obvious and in process. This leaves #1. Now doing #1 will cause some insolvencies to be uncovered. Maybe a lot of them. For each of those firms perform a “cramdown” of the debt to equity, using the retained value in the bonds to cover the liabilities that rendered the firm insolvent. If there is recovery value (in most cases there will be, as we saw with Lehman) then the bondholders get newly-issued equity in ratable proportion to their (former) ownership of the bonds. The existing equity is wiped out. The firm, having no balance sheet debt whatsoever, can then immediately raise capital in the market to recapitalize itself (having a clean balance sheet this is a trivial task) For those firms that have zero equity remaining, the government can step in and inject capital via a super-senior tranche as necessary to establish a working capital base. Remember, with a 6% Tier 1 capital requirement a little goes a long way - $10 billion injected results in over $160 billion of available gearing! Bingo - the firm is back on its feet. Protect the taxpayer in these transactions by attaching an onerous coupon to the issue so that it will be rapidly repaid (e.g. 3mo LIBOR + 600 bips) and cleared. The objection to this plan will be that existing equity holders will be wiped out and bondholders will take a haircut. Well, bond holders are no worse off than if the firm went under. They would get their recovery value anyway, and they still do - its just in the form of equity instead of cash. As for equity holders, they’re wiped out in a bankruptcy too. The real objection to this is going to come from the executives, who will see their stock options rendered worthless along with their restricted shares. However, they remain in place (if the shareholders will have 'em) and as a consequence can rebuild their equity over time. I have a solution for that problem too - make clear that any firm that turns down this demand is free to do so, but they will receive exactly zero access to the discount window or any other Fed or government borrowing facility, and if they go down, that’s too bad - no help. We let Mr. Market take care of 'ya. Either take this deal now, or take your chances. The Genesis Plan is demonstrably superior to the TARP/EESA for the following reasons: 1. The Genesis Plan immediately restores trust to the credit markets as balance sheets are instantaneously exposed and remain able to be evaluated by the marketplace. EESA does nothing to guarantee the return of trust to the credit markets as it does not deal with the underlying issue at all - the lies told by executives and firms in terms of their exposure to credit risk of all types. 2. The Genesis Plan addresses the root cause of all of the large-firm failures since the first of 2008 - excessive leverage. TARP/EESA is silent on the root cause of these business failures. 3. The Genesis Plan can be represented in a half-dozen pages of legislation. The EESA required over 100 to put in proper oversight. Since there is nothing other than ministerial activity required under The Genesis Plan and no discretion to abuse, such oversight is not necessary as with the EESA. 4. The Genesis Plan uses no taxpayer money at all for most institutions, and where taxpayer money is required it is intrinsically protected since it will sit at the top of a (new and clean) capital structure. The TARP/EESA uses all taxpayer and no private funds. 5. The Genesis Plan, when taxpayer money is used, goes directly to Tier 1 capital and thus is “high power” money; that is, it supports lending of $10-12 for every dollar put in. TARP/EESA is twelve times less efficient in the use of funds in that by purchasing assets zero leverage is obtained for each taxpayer dollar deployed. 6. The Genesis Plan promotes restoration of normal lending activity as it clears the impaired firm’s balance sheet debt and immediately eliminates the issue of counterparty trust. TARP/EESA does not clear (although it does help remove items from) the firm’s balance sheets and does nothing to address counterparty trust. 7. The Genesis Plan requires no lengthy administrative or “start up” time. It can literally be “up and running” immediately, with the exception of the CDS exchange, which is already under way. TARP/EESA was claimed to be required “immediately” but now is said to not be likely to actually go into effect until November at the earliest. 8. The Genesis Plan uses existing agencies who are already tasked with the required functions - auditing and reporting (OTS, OCC and the FDIC) and thus has very low “parasitic” costs. TARP/EESA establishes a new government agency and thus has a high parasitic cost requirement. 9. The Genesis Plan exposes the taxpayer to no credit risk. EESA/TARP exposes the taxpayer to $700 billion in taxpayer risk - or more.

I think the Genesis plan isn’t anything very new and I don’t think it really solves much. 1) I don’t think #2 and #3 are really slam dunks. “leverage” doesn’t mean much (my favorite is always what’s the leverage of a short Eurodollar option?). “Caging the CDS monster” means interfering with the ability of corporations to make private transactions if all are to be forced onto an exchange. An exchange is a good idea. Forcing them there isn’t. 2) The problem with the LII and LIII assets isn’t ultimately about transparency and disclosure; it’s about valuation. The valuation problem has gotten even worse with the recent market disruptions because interest rate and credit models are messed by nearly unprecedented vol and credit spread widening. What models are you going to fit that would be reasonable? In the end, all the models will say stuff like “We think these assumptions are reasonable for normal times” or something. There is also the whole issue of liquidity and how should that affect valuation. That’s not modelling really, but philosophy. 3) Telling equity holders that you are going to institute a plan that might automatically wipe them clean is probably not a great think for highly troubled equity markets. 4) Saying that the gov’t can overcome the gov’t’s rules for Tier 1 capital by giving them Tier 1 capital is bizarre. There’s a reason for Tier 1 capital that is not well-served by the gov’t handing it to them.

Bump. Why can’t we discuss plans for getting out of this? Mention Sarah Palin, the Bosox, WB/WFC/C, etc and a ton of comments but a plan to get out of this goes nowhere. By the way, a plan to get out of something should be called ‘Exodus’ not ‘Genesis’

I don’t really like the 12:1 leverage plan. If a company has such strong operating performance that it can lever itself over 12:1, is that such a bad thing?

JoeyDVivre Wrote: ------------------------------------------------------- > I think the Genesis plan isn’t anything very new > and I don’t think it really solves much. > > 1) I don’t think #2 and #3 are really slam dunks. > “leverage” doesn’t mean much (my favorite is > always what’s the leverage of a short Eurodollar > option?). Are you talking about selling a put option on a Eurodollar contract? If so, theoretically isn’t your leverage is (100-X-P)/P where X is the strike rate and P is the premium expressed in rate terms? “Caging the CDS monster” means > interfering with the ability of corporations to > make private transactions if all are to be forced > onto an exchange. An exchange is a good idea. > Forcing them there isn’t. Why is it a bad thing to force private transactions onto an exchange? If parties want to transact a CDS on a very illiquid asset the rules surrounding margin requirements should take into account things such as periodic appraisal value, depreciation, amortization etc… > 2) The problem with the LII and LIII assets isn’t > ultimately about transparency and disclosure; it’s > about valuation. The valuation problem has gotten > even worse with the recent market disruptions > because interest rate and credit models are messed > by nearly unprecedented vol and credit spread > widening. What models are you going to fit that > would be reasonable? In the end, all the models > will say stuff like “We think these assumptions > are reasonable for normal times” or something. > There is also the whole issue of liquidity and how > should that affect valuation. That’s not > modelling really, but philosophy. If we want confidence and trust to return we need to mark to market all of these things. Everything will be crystal clear and there will be no uncertainty as to what institutions have on their books and why they are using X assumptions instead of Y assumptions. This argument goes back to Bernanke’s hold-to-maturity value proposition. It’s bogus because you do not know the hold-to-maturity value. Sure some of these asset prices may be reflecting the worst case scenarios, but it is what it is, and the market is never wrong. You can say the same thing about current stock prices being at ridiculous levels due to liquidation and de-leveraging and forced redemptions. Is it reasonable to carry stocks at values preceding this week because “my models” show that over time credit expansion will return and so will growth and as a result people will come back to the market and new hedge funds will spring up that will buy stocks up? That’s ludicrous. And I just want to add, that by suspending mark-to-market accounting, did more damage than good to the market. More uncertainty, less trust, more panic. > 3) Telling equity holders that you are going to > institute a plan that might automatically wipe > them clean is probably not a great think for > highly troubled equity markets. Why wouldn’t this be a great thing? If it is determined that an institution is insolvent based on the appraised value of its assets then the govt should inject equity into those institutions. People will know which institutions are solvent and which ones are not. If equity holders get wiped out, so be it, that’s what risk is. > 4) Saying that the gov’t can overcome the gov’t’s > rules for Tier 1 capital by giving them Tier 1 > capital is bizarre. There’s a reason for Tier 1 > capital that is not well-served by the gov’t > handing it to them. Can you expound on this? I’m not seeing what you’re trying to get at here. What do you mean by the gov’t overcoming its rules for Tier 1 capital by giving Tier 1 capital to institutions? What rules are you talking about?

cfa_gremlin Wrote: ------------------------------------------------------- > JoeyDVivre Wrote: > -------------------------------------------------- > ----- > > I think the Genesis plan isn’t anything very > new > > and I don’t think it really solves much. > > > > 1) I don’t think #2 and #3 are really slam > dunks. > > “leverage” doesn’t mean much (my favorite is > > always what’s the leverage of a short > Eurodollar > > option?). > > Are you talking about selling a put option on a > Eurodollar contract? If so, theoretically isn’t > your leverage is (100-X-P)/P where X is the strike > rate and P is the premium expressed in rate > terms? > A eurodollar contract is on the 3 month interest on $1M. An OTM ED put might be worth $0.08. > “Caging the CDS monster” means > > interfering with the ability of corporations to > > make private transactions if all are to be > forced > > onto an exchange. An exchange is a good idea. > > Forcing them there isn’t. > > Why is it a bad thing to force private > transactions onto an exchange? If parties want to > transact a CDS on a very illiquid asset the rules > surrounding margin requirements should take into > account things such as periodic appraisal value, > depreciation, amortization etc… > That can be included in the CDS (although usually isn’t). It’s a privacy issue. Suppose I am a supplier to GM and I want to hedge myself to GM bankruptcy. I want to buy GM CDS and I don’t want anyone to know about it. > > > 2) The problem with the LII and LIII assets > isn’t > > ultimately about transparency and disclosure; > it’s > > about valuation. The valuation problem has > gotten > > even worse with the recent market disruptions > > because interest rate and credit models are > messed > > by nearly unprecedented vol and credit spread > > widening. What models are you going to fit > that > > would be reasonable? In the end, all the > models > > will say stuff like “We think these assumptions > > are reasonable for normal times” or something. > > There is also the whole issue of liquidity and > how > > should that affect valuation. That’s not > > modelling really, but philosophy. > > If we want confidence and trust to return we need > to mark to market all of these things. If so, we don’t need models. We need market prices. LII and LIII go away then. > Everything > will be crystal clear and there will be no > uncertainty as to what institutions have on their > books and why they are using X assumptions instead > of Y assumptions. Yep and radical MTM pricing causes financial disaster. The SEC even relaxed all the requirements on it. > This argument goes back to > Bernanke’s hold-to-maturity value proposition. It’s obviously bogus and he knows it. > It’s bogus because you do not know the > hold-to-maturity value. Sure some of these asset > prices may be reflecting the worst case scenarios, > but it is what it is, and the market is never > wrong. You can say the same thing about current > stock prices being at ridiculous levels due to > liquidation and de-leveraging and forced > redemptions. Is it reasonable to carry stocks at > values preceding this week because “my models” > show that over time credit expansion will return > and so will growth and as a result people will > come back to the market and new hedge funds will > spring up that will buy stocks up? That’s > ludicrous. The difference is liquidity. Liquid stocks do get MTM as is probably appropriate. > > > 3) Telling equity holders that you are going to > > institute a plan that might automatically wipe > > them clean is probably not a great think for > > highly troubled equity markets. > > Why wouldn’t this be a great thing? If it is > determined that an institution is insolvent based > on the appraised value of its assets then the govt > should inject equity into those institutions. > People will know which institutions are solvent > and which ones are not. If equity holders get > wiped out, so be it, that’s what risk is. No! Any plan that automatically kills equity holders by MTM pricing means that equity holders can have no judgement on future solvency. It says that if the liquidation value of the company <= 0, you can’t own equity in the company. Apply that everywhere and we have no companies that can be traded in development stage. > > > 4) Saying that the gov’t can overcome the > gov’t’s > > rules for Tier 1 capital by giving them Tier 1 > > capital is bizarre. There’s a reason for Tier > 1 > > capital that is not well-served by the gov’t > > handing it to them. > > Can you expound on this? I’m not seeing what > you’re trying to get at here. What do you mean by > the gov’t overcoming its rules for Tier 1 capital > by giving Tier 1 capital to institutions? What > rules are you talking about? The gov’t made the rules. If we want to slime around the rules, just get rid of the rule.

>A eurodollar contract is on the 3 month interest on $1M. An OTM ED put might be worth $0.08. Right. The formula I presented is all in rates terms not dollar terms. >It’s a privacy issue. Suppose I am a supplier to GM and I want to hedge myself to GM >bankruptcy. I want to buy GM CDS and I don’t want anyone to know about it. Private transactions are adding fuel to the fire which is the current financial market panic. What about if the CDS seller doesn’t tell the supplier that he doesn’t have the money for a “default event”? Sorry but I just don’t buy the privacy issue when it can cause dire systemic effects. >The difference is liquidity. Liquid stocks do get MTM as is probably appropriate. If your argument is based on liquidity why did you post your disbelief of the stated NAV of the REIT in another post “shady valuations”? These companies are not only not disclosing their valuation models for LII and LIII assets but they are not even disclosing the composition of their LIII assets. Shady valuations? Nah, more like shades of Enron. >No! Any plan that automatically kills equity holders by MTM pricing means that equity holders >can have no judgement on future solvency. It says that if the liquidation value of the company ><= 0,you can’t own equity in the company. Apply that everywhere and we have no companies >that can be traded in development stage. I disagree. If the liquidation value of a company is <=0 then the debt holders become the new equity holders. Equity holders are wiped out. In reality, the gov’t is most likely not going to take 100% stakes in failing institutions so current equity holders will take a big hit but not be zeroed out. We’re not talking about firms in development stage here, we’re talking about the possible collapse of the financial system. Sacrifices have to be made in conjunction with radical measures.