US Bailout Plan

The US government has announced a bailout plan, estimated at around $1 trillion to repair the US financial system. This is different from the Paulson model which calls for the setting up of a "Bad Bank" model to purchase the toxic assets in the bank's balance sheet. This package will combine public and private funds to purchase toxic assets from the top 8 banks like Citigroup, BOA, Goldman, Well Fargo, JP Morgan. The first step is to provide funds to private investors like private equities and hedge fund to purchase the toxic assets at a discount. The financing will come from the US government with low interest rate. The sweeterner of the deal is Uncle Sam will guarantee these private investors against any lossess beyond a certain limit. For example, if the book value of the toxic asset is $10 million. At this point of time, bank would have written down at least 50% of its value. That is $5 million or the banks will not sell. Private investors will be provided with $ 5 million loan at, say e.g., 2% with a maximum loss of $ 1 million. That means if the value of the asset drops below $ 4 million the lossess will be borne by taxpayers, which is the US government. At this moment, the details are still sketchy. The US Treasury will be conducting a stress testing on the bank's Value at Risk to assess whether anymore new capital needs to injected in the coming months to replenish the bank's capital to facilitate more lending to the tight credit market. Secondly, in order to prevent foreclosure, the US government will be asking the banks to modify the loan agreement with their borrowers with the government providing subsidies. One form is interest rate. Suppose the interest rate is at 5%, the bank reschedules the interest to 2% with the US government paying the 3% shortfall, thus guaranteeing cash flow to US banks. It was reported that $50 billion has been earmarked to fund this subsidiy. One good thing that comes out from this plan is all US banks that accepted the government recovery plan will have to publish quarterly report detailing how these taxpayers money has been spent. CEO salaries and bonus are capped at $500,000 per annum plus there will be restrictions on dividends and corporate perks. The government is instituting a series of drastic best practices of corporat governance on these executives. They will be under spotlight from day one until they pay back every single cent of tax payers money. The government promised no nationalization. I agree with that policy because government are lousy bank managers. They will make matter worse. Having said that, it is good to have Big Brother watching over these corporate lizards for any misdeeds.