I SUPPOSE some action is better than the lack of direction which seemed to have characterised the US government recently.
US Treasury Tim Geithner’s latest plan to take toxic assets off the hands of troubled US banks seems to have set global financial markets on fire.
After a slow start, the benchmark Straits Times Index is now comfortably above the 1,700 level for the first time in six weeks, after gaining 2.8 per cent.
I am not too sure why markets should be so exuberant over the plan. It has to be approved by the US Congress which may yet derail it if there is a big outcry from an indignant US public.
To explain in layman’s language, the plan goes like this: There is a bank which has $100 million worth of doubtful debts. If it cannot make good this sum of money, it will have to close shop.
It asks the government for help.
Instead of handling the problem all by itself, the government wants to set up a 50-50 joint venture with a private investor in which each party would take $5 million of the doubtful debt.
The JV then goes to a government agency (the Federal Deposit Insurance Corporation) to borrow the remaining $90 million.
The bank gets its $100 million back while the JV becomes the owner of the doubtful debt.
But here is the catch: If the doubtful debt cannot turn “good” and turns bad, with the borrower refusing to pay a single cent at all, all the JV will lose is the $10 million. It will not have to repay the $90 million loan it owes the FDIC.
It is a “heads you win tails I lose” situation for the pension funds and insurance firms if they come up with the small outlay to participate in Tim Geithner’s programme.
Most borrowers would love to be in such a situation – you get to keep the money you make, but the bank takes the bulk of any losses you may incur.
But doesn’t it remind you of the mess which caused the the world to plunge into this credit crunch crisis in the first place?
In the United States, banks were lending large sums of money to people to buy houses which they could not afford in the first place.
When these people could no longer service the loans, they simply went to the bank, left it with the keys to their houses and walked away.
There was no legal way – at least in the US – to make them repay their loans.
The rest of the world have been paying for this oversight eversince - as a staggering US$30 trillion in asset value was wiped out last year alone due to this mishap.