Simit Patel

In its simplest form, the financial mess could simply be explained as a bunch of bad loans being made -- loans to home buyers who couldn't really repay the loans, banks taking on too much debt due to the securitization of loans, and government issuing more debt than its tax base can handle.

The government response has been to try to bailout the bad debts through the usage of taxpayer funds and obligations. To this end, the Obama administration is now considering the creation of an "aggregator bank" -- one that will buy up bad loans, under the rationale that this will relieve the banks and cause them to lend.

As market speculators, there are a few things we should consider:

1. Whoever holds the bad loans is holding an asset that needs to fall in value. If the US government creates an aggregator bank specifically to acquire bad loans, the US government will bear the loss. As the US government borrows money, it would mean Treasury holders would bear the loss. Should appetite for Treasuries dry up, the dollar will be devalued, and US dollar holders will bear the loss.

2. As such, bailouts are a way of transferring market losses from financial institutions to taxpayers. An opportunity to trade this would be in going long XLF, an ETF that tracks the financial sector, while going short TLT, an ETF on 20+ year Treasury bonds.

The XLF chart is pictured below; currently, the market is at 9.66, almost 100 points above its 52 week low at 8.67. Government actions may hold up XLF and lead to a rally back up to resistance near 13.20, another key price point to watch. Over the long run, though, increased nationalization of the banking industry will limit the potential market capitalization of finance sector ETFs like XLF.


Other Discussions on the Web Regarding the Aggregator Bank

Real Time Economics : WSJ Interview: FDIC's Bair Fleshes Out 'Aggregator Bank' Idea
Marginal Revolution: Is the aggregator bank a good idea?
Bloomberg.com: Worldwide
Bad bank bafflement - Paul Krugman Blog - NYTimes.com
LOLFed » Shamwow! Aggregator Bank To Absorb Toxic Assets
Nathan's Economic Edge: Aggregator Bank Concept… Who Are We Helping?
http://www.informedtrades.com/259654...bank-idea.html

__________________
IT Instruction Manual | Shopping Guide

Shootanappleoffmyhead

Hey Simit,
Great article.

So, isn't the central bank already an agreggator bank? I mean, the source of the money is still the most abundant resource on the planet, thin air. Why reinvent the wheel here and build another printing press? Shoot.

Lawtrade

To your points of transferring the losses. Mr. Waring pointed out in his article that the bank ultimately thinks that many of these assets are undervalued based on current market valuations. Assuming they DID sell them to a government formed "Aggregate bank" at or near their current levels, wouldn't that effectively be a positive investment for them over the long period of time?

I agree with you that in the short run this would impact the XLF positively and the TLT negatively which may amount for a great long/short trade respectively, but at what time point is the reverse true.

Just wondering what your thoughts are on this, thanks.

Simit Patel

hey shoot, yes i'm not really sure why the fed doesn't just continue buying up assets, this seems to be similar to what they are already doing.

hey lawtrade, as a general rule of thumb i don't place much importance in what the word from government is; there will always be political pressure to make things sound more appealing. for instance the government was saying the economy was doing very well and there was no need for concern up until weeks before they started saying bailouts were needed otherwise the market would collapse. so personally, i discount the official explanations when trying to assess real value.

__________________
IT Instruction Manual | Shopping Guide