MacFadyen: A TARP Solution
So how do you put a value on toxic assets?
February 11, 2009
New Treasury Secretary Timothy Geithner unveiled the latest version of TARP earlier this week, promising to goose the Federal Reserve lending program and pour yet more capital into the banks. The lynchpin to TARP 2.0 is for the government to entice private investors to help corral the so called “toxic assets” that nobody else wants to touch. The details of this plan seem ambiguous at best, but even if more details emerge, I’m not sure I’ll be convinced.
The catch, as so many people have already pointed out, is that nobody will put a value on these toxic assets. It’s not that people can’t, it’s that the lenders that oversee these loans – be it mortgages, student loans, whatever – aren’t incentivized. To overturn the cliché, they only want to see the forest for the trees.
Part of the problem with these loans is that in many cases they were made toxic by the issuing lenders. Take student loans: The institutions spent years cozying up to schools to gain preferential treatment. The banks’ efforts ranged from the questionable, such as simple gifts, to the outright egregious, such as kickbacks and revenue-sharing arrangements. They then capitalized on their status as a “preferred” lender to impose conditions and terms that would make Frank Calabrese blush. All this, of course, made headlines two years ago when the Student Loan Sunshine Act was introduced.
So you now have a firm like Wells Fargo charging as much as 19% on a $25,000 loan. By the time the loan is paid off, the borrowers may sink well over $200,000 into the interest payments. And people wonder why these borrowers’ are classified as “subprime”?
The only way to gauge whether or not these loans will be paid off is to maintain some sort of dialogue with the borrowers. This is where private equity can actually provide an answer – not as a buyer of these assets, but rather as a model to follow.
We’ve seen a number of firms, for instance, arrange debt exchange offers as a solution to an onerous debt load. Apollo Management and TPG were able to negotiate a deal with the Harrah’s Entertainment bondholders that chopped roughly $1 billion off of the debt load. CIT Group, which ironically used to control Student Loan Xpress, also successfully negotiated a debt exchange offer prior to receiving TARP funds.
However, the lenders that hold these toxic assets will rarely engage in any sort of dialogue with the individual borrowers. In fact, the only way for a debtor to initiate a conversation is to antagonize the lender by withholding payments. So what you have is a game of chicken: the lenders are betting that the borrowers won’t ruin their credit score, while the borrowers are left to choose between bankruptcy and a $500 monthly payment that doesn’t even begin to scrape away at the principal. Lose a job, go screw; have surgery, go screw; miss six straight payments, let’s talk.
In the buyout world, the lenders and borrowers will have a dialogue that allows the banks to put a value on the actual loan, even if it’s below what the loan was initially worth. In commercial banking, the lenders don’t care, and that’s why value is so elusive. It’s also why Wall Street is such a pariah to the rest of the world. (That, and the fact that some banks saw fit to guide taxpayer money directly into their bonus pool, but that’s a whole other story.)
I’m not saying that the banks should start handing money back. I’m not even saying that the borrowers shouldn’t shoulder much of the blame. But the answer shouldn’t be, “We never negotiate.” If the banks would deign to give Joe Blow the same courtesy as they give David Bonderman and Leon Black, they might be able to solve a couple of problems in one go.
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