The German GSI bad bank plan - the new deal

* The German GSI bad bank plan is potentially a huge deal

After the first German bad bank plan collapsed once the authorities realised that any mark to market of German banks bad assets would make the vast majority insolvent, they have been swift to launch yet another suggestion. This one looks much better from a market risk appetite point of view.

The German bad bank plan - the GSI (Government sponsored institution), if approved, could be the missing piece to really get riskappetite going shortterm.
Basically, this is how it would work; German banks will transfer bad/Toxic assets to a German Government/taxpayer owned "Bad bank". These tranfers would be done at book value. Basically emptying the German banks of toxic assets without having to take any immediate losses.


*No mark to market
This solution means there would be no mark to market of the German bank´s toxic assets whatsoever during the remaining lifetime of these assets, apart from the book value they were transferred at.

Once the toxic assets matured, the German banks would have to pay/(receive) the difference between the booked and the realised value to the German government. During the remaining lifetime of the toxic assets, the German banks would be required to put aside further capital along the way for their toxic assets.

However in this scenario they would be able to match the cost of capital put aside vs their positive net cash flow, resulting in a netting effect over time. Steep yield curves, wider spreads and highermargins have set the stage for it. Just like the governments and the banks wants it. Unless the Government required capital set aside by the banks would be "too high", this should immediately remove the credit plug and credit multiplier plug from the system, creating a swift upswing in economic activity.


*Financing
To finance it, the German treasury would issue government backed bonds on the "bad bank" toxic assets á la Brady bond style. History shows this has a high success probability.

CDS spreads would widen both for Germany and for the Euro area, which could pose a shortterm and longterm problem. The removal of credit and multiplier plugs from the credit system would however increase the probability of generating much longed for growth, although a steroid generated such, with potentially horrible sideeffects. However, I doubt many politicians would care for those sideeffects today.
The impact on shortterm market sentiment could be hugely positive, if approved.



*Drawbacks;
-No active riskmanagement whatsoever
-Increased risk for taxpayers due to no riskmanagement.
-German bank shareholders do not get hit.
-High risk of further misallocations, increasing the overall risks
-Increased risks of misallocated investments leading to yet another "bubble" growth
-Increased risks of high inflation
- Increased risks of yet another , much bigger economic disaster


* I like the idea of getting the credit and multiplier plugs out of the way -but handle with care, this sweep under the rug is not what the doctor ordered
As readers already know, I am in favour of dealing with the underlying problem. Although I recognise the shortterm positive effects, the problems are not really dealt with, just swept under the rug, financed by yet more financial institutions hunting down "high" government backed yields.

Question is if anyone will properly be able to value these toxic assets for what they really are, garbage. The yields will most likely be way lower than they should to compensate for any real risks. However, the perception of a government guarantee will probably keep them relatively low.
It begs the question; Would the German Government be even close to cover all this government guaranteed debt, should it mature worthless? I have to guess most of it would be categorised as having junk bonds / subprime status?


*Changing the market rules
This procedure is changing the market rules with risk and reward becoming out of whack.
Taxpayers, (as usual) will be bearing the brunt of the risks (the Brady bond set up better work). At the same time this "Brady bond" set up will suck in a lot of riskcapital available, hampering other businesses in much need in the process.

However, with the liquidity and multiplier plugs removed, they might very well be able to get new capital from - the banks. Full circle.

* Synthethically "clean" banks to be bought
If this plan goes through, I guess I would have to buy these "clean" banks. Basically everything I would be looking to sell now. Why not? If shareholders have gotten their risk extremely subsidised by taxpayers in an "under the rug" scheme. Shareholders stand to benefit - big time. I will definitely monitor any further development closely.

*Position changes
- No changes




As usual, good luck



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