Write on! Write off!

Treasury Secretary Timothy Geithner has announced the toxic asset plan! So now investors can get government loans to lift (buy) those terribly depreciated “toxic” assets (now politely referred to as “legacy assets”) off the books and records of those big old banks. Without those nasty old assets, the conventional wisdom goes, the banks will now be free to rise from the ashes and lend again. Well, not exactly. Unfortunately, existing accounting rules let banks to carry these debt instruments/loans on their books at their original value but require a set-aside percentage of the losses expected over the lifetime of the loan.

So, if a bank wants to discharge that loan asset in an auction under the new Treasury plan, well the minute the asset sells at auction, the value becomes the selling price. And since the selling price is very likely to be less than that asset was carried on the books of the bank, guess what happens?

Once the balance sheets are adjusted to the lesser value reflected in the cash selling price of the toxic assets (except in the very, very unlikely event the bank carried that asset on its books at a lower value than the sales price), particularly as the federal regulators apply the “stress test,” the banks will actually have less value on their balance sheets, which will require more investment capital, most likely from the government, to generate true lending capacity. Ouch!

So maybe the banks won’t sell these assets to avoid the above embarrassing situation? Sheila Blair, the FDIC head, politely indicated that the decision to sell such assets would be “in consultation with the regulators.” Does this mean the government would force banks to sell the assets? Frankly, we just don’t know the rules yet, but trust me, this is not the clear-cut winner that made the market soar almost 500 points after the announcement. Good news for the buyers of the assets – the government will lend you the money and take part of the risk; bad news for the banks – if you sell the asset, you are probably tanking your own balance sheet, and it looks like the government plans to do some pushing.

As is normal in the case of new government programs, as one delves into the details, the golden goose may be a spray-painted, air-brushed pigeon. A train wreck if you want another image. From the March 24^th Financial Times (FT.com): “Richard Bove, an analyst at Rochdale Research, wrote in a note to clients: ‘[The plan] will not happen because it would destroy bank capital. It might cause a bank to fail the new stress tests under way. Banks will not take this risk.’”

FT.com continues: “Policymakers say the Geithner strategy is intended to fix the disconnect between the market and the banks by restoring investor confidence in their financial statements… Outside investors and bank executives are miles apart in their assessments of the true capital position of the banks, making it impossible for them to agree a price at which to recapitalise. [yes, it is the British spelling!]” It seems rather obvious that the feds – Treasury, the FDIC and the Federal Reserve – plan on getting the banks to deal with this asset valuation issue, one way… or another. It won’t be pretty.

I’m Peter Dekom, and there seems to be a catch.