Andrew Ross Sorkin in the NYT says (we added the emphasis):

“…the F.D.I.C is trying to stabilize the system by adding more risk, not less, to the system.

It’s going to be insuring 85 percent of the debt, provided by the Treasury, that private investors will use to subsidize their acquisitions of toxic assets.

These loans…are, for example, “nonrecourse,” which means that if an investor loses money, he owes taxpayers nothing. It’s the closest thing to risk-free investing — with leverage! — around.

So where did the risk go this time?

To the F.D.I.C., and ultimately, to us taxpayers.”

So if there is no risk of loss, then why won’t private investors buy the assets without FDIC gaurantee? The FDIC is effectively answering that private investors perceive risk where there is none.  To substantiate their claim, they have asked their accountants  to carefully evaluate these non-existent risks.

” “We project no losses,” Sheila Bair, the chairwoman, told [Sorkin] in an interview. Zero? Really? “Our accountants have signed off on no net losses,” she said.”

Sounds like famous last words to us…

Henry Blodget may be disgraced as an internet stock analyst but his argument makes sense.  We raised a similar idea.  The basic idea is that when one bank receives and accepts an offer on a particular asset, the argument that “there is no market price” can no longer be used by that bank or others. Thus, banks all over will be forced to take additional write downs, making insolvency in many cases not just rumor but fact.  Bank reluctance to participate may be moot as they may be forced.

If the banks go through the exercise of putting assets up for sale only to have the bids come in at, say, 40 cents instead of the 60 cents on the books, the banks’ accountants and/or federal regulators might notice. So even if the banks recoil in horror and refuse to sell at 40 cents, someone somewhere might insist that assets now carried at 60 cents be written down to 40 cents (after all, they won’t have the “temporary illiquidity discount” excuse anymore, will they?). This will blow another huge hole in the banks’ balance sheets.

Given this, banks would probably be wise not to participate in Geithner’s plan. Which is why the government is already talking about forcing them to:

As the FT reports: “The unspoken fear here is that selling off loan portfolios would lead to more government capital injections into major banks,” said an executive at a large bank…
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.”

But while banks in theory have discretion over whether to sell loans, Sheila Bair, chairman of the Federal Deposit Insurance Corporation, said this decision would be made “in consultation with regulators” – a sign that the authorities might put pressure on banks to sell toxic assets.

Phillip Moore’s article in Euromoney describes many investors and much money (from both UK and US investors) allocated to snapping up distressed commercial real estate debt.  What’s interesting to us is the indications in the article that it’s the banks that are unwilling to sell – that is preventing the investments – NOT a need for federal financing…

“There are three principal reasons explaining why, to date, so much of the cash that was earmarked for investment in commercial real estate debt remains “hors de combat”. The first is that in spite of the precipitous falls in values in the commercial property market over the past year, the general consensus appears to be that values still have further to drop.

Another reason explaining why there appears to be a disequilibrium between supply and demand in the commercial real estate debt market is that in spite of the bleak outlook for values, there is still a reluctance among European banks to offload their holdings, or even to acknowledge how distressed their exposure has become.

“There has been a widespread misconception that as commercial and investment banks looked to restructure their balance sheets they would start by marking their real estate books to a more realistic valuation and then look to sell significant volumes of those assets at those prices,” says Cairn Capital’s Henriques. “We have seen very little of that happening, largely because the markdowns the banks are being quoted on their debt valuations are such that they regard the benefits of selling them as somewhat ambiguous. The capital write-downs they would have to take from such a strategy are such that they would erode most if not all of the capital relief they would generate by selling. So while we are confident that there will be opportunities to acquire bank debt, it won’t be the avalanche that some people were expecting at the tail end of last year.”

We think the debt will not be available for the investors to “snap up” until the banks are willing to take what is offered. Granted, the Geithner plan makes overbidding easier, but to bridge the yawning gap that exists now, is going to make the plan very difficult to implement.