Taunter Media

So far we have been told that the private sector so misprices securities today that with public funds the private sector would accurately price securities.

The folks who brought us this logic now want us to believe that the public-private partnership will work.  And the system they have devised is sufficiently complicated that some folks have emailed me to wonder what is wrong with it.

Nothing is wrong with the system if you want to shovel an enormous amount of money to a few folks on Wall Street.  How do I know?  Here’s how you can game the system if you are a bank (based on the system of Karl Denninger, but turbocharged):

I am a bank sitting on an enormous amount of damaged assets.  I am carrying them at 80 cents, but I am terrified they are really going to pay out at 50 cents.  I don’t dare mark them to 50, since I will immediately have negative book equity and will need to plead for my life.  I don’t even really want to sell them, because arms-length buyers have similar fears and aren’t going to offer me much more than 50.

So I drive to Greenwich and sit down with SAC.  Here’s the deal.  We create an offshore vehicle.  In the proudest tradition, let’s call it Anakin.  SAC will put up 51% of the equity, my bank will put up 49%.  Remember, I have TARP cash floating around.  Together we only need to seed 15% of the enterprise value of Anakin; the government will kindly front the rest.  Quite decent of them for my purposes, as we shall see.

I tell SAC that the deal is Anakin bids 80 cents.  Stevie Cohen tells me I’m a jackass and asks me to leave.  We both know the stuff is worth 50 cents, or, more precisely, we both think it is worth 50 cents and know it is not worth 80 cents.  Why should he stump up any money for overvalued securities?

Hold on, I’m not through.  We also create another investment partnership, Amidala.  Amidala buys out of the money options on my stock.  Thank you, I notice you have brought me another cup of coffee.

One of two things will happen when Anakin bids 80 cents.  Either Anakin will get the assets, or someone else will bid more than 80 cents and get them.

If Anakin is outbid, Anakin returns its capital.  No harm, no foul.  My bank is going to show a very unexpected gain in its books next quarter.  Good thing Amidala has those options; they’re going to be worth a lot.  We all make out like bandits thanks to our shill bid.

If Anakin gets the assets, now it owns some crap.  Not ideal, granted.  But here’s the thing: my company just unloaded a huge liability.  The day before the bid, we were on the hook for all 80 cents, and that could have taken us down.  Now my bank’s maximum loss is fewer than 6 cents (5.88 cents: the 80 cent purchase price x the 15% equity contribution x my 49% of the contribution), and even this loss won’t be known until very, very far from now.  When it is known, it will be known only to very few people – SAC, me, and someone at Treasury – since it takes place in a minority investment in Grand Cayman.  Stevie, what do you think is going to happen to my share price the day after it is announced that some SAC vehicle has bought all of my crappy debt at face?  Won’t you be happy you had your position in Amidala?

I can imagine the objections.  Hey, that’s really complicated.  Isn’t it close to insider trading?  Didn’t I just restrict Stevie by telling him my plan?

Perhaps it’s a bit close.  The government is hardly going to be looking to prosecute people if there is a successful auction – successful meaning the assets vanish from publicly filed documents, and reemerge only years later as FDIC losses.  They didn’t bat an eyelash when Vikram Pandit sent around a memo disclosing two month results in an effort to goose his share price, apparently forgetting that it was not a reporting period.  Are they really going to come after little ol’ me?

OK, you scared me.  But here’s the catch – we don’t need to create Amidala.  We just need to find it.  My bank has a large prime brokerage business, and my CFO and IR team are obsessed with knowing who is in my stock.  I just need to reach out to someone who is very long my stock; he’ll figure out his hedge once he hears the plan.