Pat Dorsey: Hi, I’m Pat Dorsey Director of Equity Research at Morningstar. Well with the market is waiting with fainted breath for one more day for Tim guideless big plan to rescue the US Phantom system it’s a grandson perhaps of Tarp at this point. The rumors have it that they’re going to be changing name from Tarp, because Tarp is now a little bit of bad PR. Enough details have we got however that we can talk about some of the broad strokes of the new plan. With Senior Analyst Jamie Peters give us a few of for how this might differ from the plans that are in place right now, thanks for joining me Jamie.
Jamie Peters: Nice to be here.
Pat Dorsey: So big picture the broad strokes don’t seem like they have change that the hills might you know are the participation now of private capital into the bail out plan, as well as a change in the types of securities that will be use to inject capital into the banks. Let’s start with the private capital angle.
Jamie Peters: Well there is one of two ways that it seems like it could potentially happen, the first would be to create separate entity of bad bank really that would be funded not only through the governments $350 billion at the second half of the tarp funds. And a private capital to create a kind of private equity shop that would buy this bad assets from the bank and run them where a lot of upside can go to the government. But also go to this private investors who will enable it to get large enough to really make a meaningful impact.
Pat Dorsey: Concern that private capital co-invested along side that treasury money essentially.
Jamie Peters: Exactly and when you get private capital the idea is that you will also get the intelligence surrounding the private capital. Where you can potentially over come this hurdle of how much would really should you pay for this bad assets because if you get everybody who does this for a living out there hopefully they could come up with a reasonable fair value.
Pat Dorsey: And the second model is essentially for the government to purchase some of this bad assets but then turn around and then immediately sell them to private capital with some kind of a—kind of a floor guarantee of sorts.
Jamie Peters: That’s exactly right, you're looking at potentially something that you would see and what Merryl Lynch did with Lonestar earlier last year when they were selling their CDO. Which is the government will buy the bad assets off the banks balance sheets again which an important thing to get off the balance sheets. And then turn around and sell them but say were going to guarantee them up to this level it wont fall below and as a result they kind of have locked in at least a minimum value for the assets.
Pat Dorsey: So the participation of private capital basically gives the bail out more ammunition in the sense by sort of you know allowing it to level up in a way.
Jamie Peters: Exactly.
Pat Dorsey: Okay, and then the second part is that some of this securities, some of the capital indigenous maybe not be their preferred securities that are senior to the common shares that most people own. Its going to be preferred shares that are perhaps convertible into common.
Jamie Peters: Exactly, so the first round of tarp was with we call perpetual preferred shares and some warrants that gave them a little bit of an upside on the comment. That the new version is potentially to do a convertible preferred share where the government would receive for at least the first seven years preferred dividends like they kind of did on the first but they would eventually convert to common shares.
Pat Dorsey: And what is the advantage of this, it seems from the governments prospective they’re in a less senior position in the capital structure. So it’s not as good as place to be, well why would they want convertible prefer.
Jamie Peters: Well it does give them more upside actually in the—if the banks would survive in the long run. The other thing would be of course is that if you are voluntarily saying, you know, what right now were going to be in this middle range but then were going to you know voluntarily move down to the bottom along with the capital better. You’re really saying were pretty confident that this banks are going to survive they’re trying to inject confidence into the banks.
Because without confidence that’s where you start getting problems with the banking system.
Pat Dorsey: And that’s sort of investing at the same level as a common share holder gave dealer to perhaps stop some of this mass in decline in share prices that can then have a kind of spiral effect on worries about the bank viability.
Jamie Peters: Exactly.
Pat Dorsey: And then finally and this is perhaps a little bit more problematic and less clear cut, there are some rumors about new home owner resistance program whatever you want to call them to quote and quote keep more people in their homes. Now that’s doubles in the details isn’t.
Jamie Peters: It’s very difficult to understand because it’s keeps changing every time you read something but it’s very politically attractive to talk about modifying home mortgages and keeping people in their homes. But the reality is that were not quite sure how it’s going to work there has been suggestions that potentially the government could buy down interest rates and give incentives or banks to continue to modify mortgages. That they would impose things on Fannie and Freddie kind of regular rules about how to modify mortgages, but the end result is really that there are a lot of people in trouble.
And in unless the modification that are so big that you're actually giving somebody who cant afford to be in their house, to stay in their house. Then you’re not really helping very much your just postponing the inevitable base.
Pat Dorsey: This obviously a band-aid on things because at the end of the day if someone is one the holiday can afford, you know modifying the terms of loan maybe making an afforded for six month more but it doesn’t mean they're going to be in there for the next three or four years.
Jamie Peters: And that’s really the evidence that we’ve seen in the past modifications that I have gone on, the evidences is that if you’ve had your home modified your more likely to default then not again.
Pat Dorsey: And bottom line this is not necessarily a good thing for the banks no matter how well it sorts of plays on the political front. Because at again it’s basically sort of encourage them to do what got us into this trouble in the first place, which is to lend the people who can’t pay you back against the doggie assets.
Jamie Peters: It’s very possible.
Pat Dorsey: Well let’s hope that that aspect of it is tone down a little bit and we would get the details tomorrow, thanks Jamie.
Jamie Peters: Thank you.
Pat Dorsey: I’m Pat Dorsey and thanks for watching.
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