Viewpoint: Nonrecourse Flaw in Toxic Asset Program - Americ...

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Viewpoint: Nonrecourse Flaw in Toxic Asset Program

American Banker | Friday, March 27, 2009

By Robert M. Pardes

Under pressure to take action to resolve the banking crisis, the Treasury Department has revealed a plan to facilitate the
cleansing of bank balance sheets through the auctioning of toxic assets to the private sector.

As described, the plan is likely to attract the private investment critical to execution. However, a closer inspection of the
limited detail exposes severe flaws from a monetary and fiscal perspective.

The key elements described at this point are auctioning "toxic" or illiquid assets to the private sector, expanding the asset
classes that can participate in the Term Asset-Backed Securities Loan Facility to include legacy (2005-2007 vintage)
residential and commercial mortgage securities, attractive pricing to drive investor interest, profit sharing and aggressive
financing through the Treasury or the Federal Reserve Board.

Most of the elements, which are subject to greater clarification, are critical to restoring confidence and transparency to the
global banking sector. Treasury Secretary Timothy Geithner is on target by focusing on leveraging private-sector resources
as a means to that end. Similarly, expanding the Talf focus to deal with legacy assets is right on point. You simply cannot
stimulate widespread participation in new securitization programs without handling the dirty laundry of the past.

The strategy takes a wrong turn when aggressive nonrecourse financing is thrown into the mix.

One only has to observe the historic highs for credit default swaps on Treasuries to realize that there is worldwide fear in
the continuation of a monetary policy that is becoming increasingly reliant on the printing of money to finance a rapidly
expanding menu of crisis remediation and stimulus activities.

Individually, these activities may intuitively make sense. However, in the absence of a comprehensive plan that accounts
for all the moving parts and provides an exit strategy that is comprehensive and understandable to the American taxpayer
and foreign investors in our debt, fear and uncertainty will continue to be a dominant force driving the markets.

From a monetary perspective, the financing of these assets at high leverage levels will further crowd the field of Treasury
financings otherwise needed to support a yet-to-be-formulated comprehensive plan with an exit strategy. As it stands, the
trend towards unbridled deficit spending is perceived as a path that can only move the country from one economic crisis to
another and pass the problems on to future generations.

From a fiscal point of view, bloating the federal balance sheet to support aggressive financing terms defeats the very
principles of transparency that has been preached by the administration almost daily.

It promotes the deferral of accountability for the costs (potential losses) of the economic recovery until such time as the
performance on the leverage can be determined.

Should the assets underperform, the high leverage and nonrecourse attributes virtually guarantee that the taxpayer will
continue to bear the true risks.

Finally, a review of the criteria for private-sector participation in the Public-Private Investment Program for legacy securities
requires eligibility standards that will limit the program to five institutions.

These stringent requirements create the perception of a club rather than a public/private collaboration and virtually assures
a noncompetitive bidding environment. There are certainly many smaller firms with considerable expertise and the
operational capacity to meet the program objectives and allow for broader private-sector participation.

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Leveraging the private sector to cleanse the balance sheets of our largest institutions makes sense. So does providing
attractive enhancements (even perhaps a conservative level of financing) to facilitate the expedient execution of the
strategy. But providing aggressive nonrecourse financing is not the answer.

Robert M. Pardes is a managing director of RRMS Advisors LLC, a New York provider of strategic and tactical advisory
services to financial institutions.

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