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Turbo Timmy’s Sneaky Scam (Part One)

Justice Litle, Editorial Director, Taipan Publishing Group

On close inspection, there are only two possibilities for the Geithner “Rescue Plan”: It’s an honest effort doomed to fail… or a blatant scam that just might work.

Treasury Secretary Geithner,, we hereby dub thee “Turbo Timmy.”

As a number of you have informed me, the “turbo” moniker – as in, “doesn’t know how to use Turbo Tax” – has been around for a while now. With my many sources and ears on the street, I’m surprised I hadn’t heard it prior. (Or maybe it just went in one ear and out the other.)

Other honorable mentions in the SecTreas nickname contest include:

• “Tycoon Tim” (for serving his rich masters)

• “Torpedo Tim” (for threatening to sink the economy)

• “Little Timmy Geithner” (after a hapless cartoon character with wish-granting fairy godparents)

• “Lollypop Guild” Geithner (after the obscure Wizard of Oz character)

• Tim “The Beaver” Geithner (because his earnest, goofy manner has a “Leave It to Beaver” feel)

And then there was the following reader submission, which defies all description:

How about “All in, Tim” or IRONMAM “I Ran Over Nouriel Making Another Mistake” Or maybe tim, I can’t stop sucking Hank Paulsons A[**], Geithner. Tim, hey I got an idea Geithner. How about Tim the dollar killer? Gangster Tim? The 6 trillion dollar man? Tug boat tim? (No reason, it just rolls off the tongue) or maybe because he is printing boatloads of money? Tim the terrible? 2 face Tim? I don’t know, what do you think?

Tony

Tony, I think you gave me the best laugh I’ve had all week.

No Laughing Matter

It’s good to start off this piece with a little humor, because the storm clouds are about to roll in.

I’ve looked over the details of the new Geithner “rescue plan” announced earlier this week. I’ve read everything I can get my hands on and plowed through the proverbial “stack o’ stuff” pertaining to the topic. And after a fair bit of reading and thinking, here is what I have come to conclude:

• As it has been presented, there is no way this so-called “rescue plan” can work.

• If the Geithner rescue plan is implemented honestly, it is almost certainly doomed to failure.

• If the plan is an elaborate ruse, however – that is to say, a sneaky scam… a con job designed to fool the public into seeing what isn’t there and believing what isn’t true – then it just might actually work.

This whole deal is more twisted and distorted than a room full of funhouse mirrors, so it will take some effort to explain my thinking. It’s important, though, so stick with me here.

First off: To understand why the Geithner plan can’t work as advertised, we have to understand the nature of the problem that Turbo Timmy is trying to solve. To that end, I will use an analogy that you should easily be able to grasp.

Meet Franky Flipper

We have all heard how the crux of the problem relates to “toxic assets” buried deep in bank balance sheets. But what does that mean exactly?

To get a mental picture, let’s rewind to the heady days of the housing bubble. Remember when “flipping” was all the rage? There was even a popular show called “Flip This House” on A&E. (I just did a quick Google search, and apparently the show is still going. Amazing!)

The basic idea behind flipping a house works like this:

• Franky Flipper buys a house for a low down payment – say, $10K down on a $150,000 property.

• Franky cleans up the joint and sells it at a markup – say $180,000 ($30K more than he paid for it).

• In this example, Franky’s total investment is $10,000 down, plus effort and materials spent fixing up the house. (We’ll leave out interest payments to keep it simple.)

• If we assume Franky spent $5,000 on time and materials – cleaning the place up himself – his total investment is about $15K (fix-up cost plus down payment). So if he sells the house for $30,000 more than he paid for it, that represents a quick 100% profit – $15K in, $30K out. Franky doubled his upfront investment, thanks to the power of leverage.

You can see why the “flipping” concept looked so attractive against the backdrop of a relentlessly rising housing market. Ordinary joes could do this without a lot of time, effort or money. (Many ordinary joes did.)

But it got out of hand when Franky Flipper started reasoning like this: “If low down payments are good, then ZERO down payments must be better!”

When the down payment drops all the way to zero, the theoretical return on investment shoots through the roof. And if there are no fix-up and repair costs – as is the case when flipping brand-new properties as opposed to old ones – the theoretical return approaches infinity.

Franky Gets Wiped Out

You remember what happened next in the great housing saga… the Franky Flippers of the world went nuts, and nobody tried to rein them in. (Hell, the media and the government all but egged them on. But that’s another kettle of fish…)

At the height of the bubble, there were any number of stories – you saw them – of uber-aggressive flippers leveraging a portfolio of 10 or 15 different properties, all purchased with no money down, against a single stream of income amounting to $50,000 or less. Everyone just went crazy. You had school teachers, bus drivers and traffic cops all playing the cookie-cutter suburbia version of Donald Trump.

Going back to our friend Franky Flipper… let’s say that Franky has $300,000 in the bank. He’s doing pretty decently for himself – and he also has a hotshot sales job – but $300K is all the cash he has for now.

Franky also has a $3 million portfolio of 10 homes – average purchase price $300K each – all purchased on generous lending terms with no money down. (Rather than fixer-uppers, these are all new homes or soon-to-be constructed homes bought on “spec.”)

You’re with me so far, right? You can see how a relatively average joe like Franky could go out there and buy 10 new houses at the height of the housing bubble, courtesy of stupid lenders and the zero down phenomenon, figuring he will sell all those houses at a profit and make a mint?

The plot thickens… for whatever reason, Franky loses his job at the luxury auto dealership. Lexus sales are down and he hasn’t been hitting his quota, let’s say – too much stress taking him off his game – so he’s out.

Without the cash flow from his job to make his monthly mortgage nut, Franky has to sell all 10 houses – $3 million worth of real estate – before he can get square and put his life back on track.

But here’s the kicker: Because Frankie has a $3 million leveraged portfolio and only $300,000 in cash, it only takes a 10% decline in real estate values to wipe him out.

Franky paid an average $300K for each of those 10 houses. So if the average price falls by just 10%, $30K times 10 equals $300K equals all the cash Franky has left. Any real estate decline beyond 10% leaves him insolvent (effectively bankrupt).

You see how that works? If you buy an asset (like a house) with lots of leverage relative to your capital base, and that levered asset falls by even a modest price percentage, it can be enough to wipe you out. This is true for everyone. It doesn’t matter if you’re Donald Trump or Joe Blow or Gigantic MegaCorp. Leverage is leverage, and it’s a double-edged sword for all.

Drinking Their Own Kool-Aid

So why did I just walk you through all that? After all, it isn’t the real estate flippers who are getting bailed out here – it’s the big dumb banks with their dumb toxic assets.

Here is why we went through it: Because the big banks in trouble now are in the exact same situation as Franky Flipper.

Whether it’s 3 million, 3 billion or 3 trillion dollars we’re talking about, the math is still the same. Whether it’s a straight-up mortgage note on a house or a more exotic form of “mortgage-backed security,” the leverage issue is the same.

It’s pretty ironic, really. Those of us with good sense had a cynical belly laugh at the madness of the flippers when the stories started hitting the wires. “You mean there’s a guy in Vegas who bought 14 houses on a $35K income? What a maroon!”

And you would think the bankers, of all people – the clean and sober belt-and-suspenders types who did the lending – would be smarter than the jokers they lent to. If real estate speculators were hot-to-trot gamblers, then the banks were supposed to be more like “the house,” i.e. the casino.

(No well-run casino would ever give its clientele enough rope to hang the house, by the way. That’s why the high roller tables always have posted limits. To refer to banks as “casinos” then is to actually give casinos a bad name.)

At any rate, there was no sobriety to be found anywhere. The big banks went just as crazy as Franky. After a time, the bankers drank their own Kool-Aid and started believing all that crap being shoveled out to the punters about how home prices never go down and any home-related risk is a good risk.

And so the banks decided to load up on super-risky mortgage-backed assets themselves, leveraging up their own books to the moon, with all the zero-down exuberance of a Franky Flipper… and they did it in mega-size fashion. We’re talking multi-trillion large here.

And now the banks are screwed, and staring down the barrel of insolvency (“bankruptcy” to schleps like Franky) because the value of their overleveraged loan portfolios (to the tune of trillions) has tanked, and that’s how we got to where we are with this whole “rescue plan” business.

Turbo Timmy’s Tough Problem

We can take the analogy further, so let’s do it.

Say that Franky Flipper is a good friend of yours – he got you a great deal on your Lexus, maybe – and you just happen to be a government official.

For whatever reason, you have decided that Franky Flipper must be saved. The situation looks bad, but you are a loyal pal, and you don’t want Franky to go bust under any circumstances if you can possibly save him.

So in your capacity as a government muckety-muck, how do you save your friend?

In an honest world, there would just be no way to save Franky. His liquid assets ($300,000) are only a tenth of his liabilities ($3 million worth of mortgage notes), and the value of his illiquid assets (the homes he owns) has gone into the crapper along with the real estate market.

Barring a miracle, Franky is toast. Apart from a windfall cash infusion out of the blue – the death of a rich uncle maybe – there is no way to make the math work. There’s just no way to save Franky’s bacon… and the same is true for the banks as they exist today.

See, the toxic garbage sitting on banks’ books right about now looks as attractive to potential buyers as a half-finished mega-mansion with a bulldozer out front, tucked way in the back of a deserted cul-de-sac, in the middle of some nameless, empty, ghost-town subdivision 30 miles due east of Tumbleweed, Arizona. You wanna live there? You wanna invest there? I don’t think so. Does anyone else in their right mind? I don’t think so.

With me so far? Analogy holding up? Let’s keep going…

Geithner’s brilliant solution – the thrust of the “rescue plan” that juiced Wall Street this week – is to bring private investors into the toxic asset mix, in a “public-private partnership” between Wall Street and the government… and then, via that public-private partnership, to buy up all the bad assets from the banks (with a huge helping of taxpayer-funded leverage).

Just imagine Turbo Timmy saying the following (as a giant light bulb goes off over his head):

“Hey! Here’s how we can solve Franky Flipper’s problem. We’ll just get other real estate investors to buy the 10 houses off him… and we’ll convince those other investors to do it by offering them sweetheart deals on leveraged loans and limiting their total risk to a small down payment only. Franky sells off his housing portfolio, the private investors get a deal, and everyone is happy. Hooray!”

Now… do you see why this plan can’t possibly work? Here it is in plain English:

• Franky is so leveraged, even a 10% haircut on the value of his portfolio is enough to wipe him out. (Remember, he only has $300K cash against $3MM worth of mortgage notes.)

• No real estate investor in his right mind would buy Franky’s houses at just 10% off. To keep their investment protected, they would need more like 30% off… or 40%… or maybe even 50%.

• Therefore, there is no way both parties’ interests can be satisfied.

• For Franky to get a price he can live with – one that doesn’t wipe him out – the new investors have to pay far too much. For the investors to get a price that they can live with – one that makes sense to them as investors – the bid price has to fall far too much, making Franky toast.

That’s why all this shiny happy stuff about a public-private partnership is total baloney. The banks are just as bad off as Franky Flipper. If the toxic assets in question were sold at anything approximating their true value, the banks would be wiped out.

Shockingly, the word is that players like Citi still have huge piles of assets on their books marked close to “bubble valuations” like 90 or 95 cents on the dollar. That’s nowhere close to the real value. It’s like Franky Flipper pretending that the half-built spec house 30 miles outside Tumbleweed – a house more likely to be torn down for scrap than to ever see someone living in it – is still worth 90% of what he paid for it.

And again, the much-touted “private investors” being invited into Turbo Timmy’s plan have no reason to pay anything but fair prices (i.e. extremely low prices) to the banks for these assets, because private investors are not stupid as a general rule and will want to protect themselves against risk of loss.

So, in a nutshell, the whole private-public partnership thing is Mission Impossible. The natural interests on both sides – of the banks and the putative investors – are way, way, waaay too far apart.

And that means Turbo Timmy’s brilliant rescue plan is DOA… dead on arrival.

Unless, of course, the whole rescue plan is just a complicated scam… a con, a shell game, an elaborate ruse designed to hoodwink the public.

More to come next week…

http://www.taipanpublishinggroup.com/taipan-daily-032709.html

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