Leverage


In Tim Geithner’s Public-Private Investment Program for buying up toxic waste, just how much is public and how much is private?  The Washington Post seems to have the right answer:

With the government financial support, private investors could end up putting down only about 7 percent of the price of an asset, with the rest contributed by the government and by private lenders who receive government guarantees.

This appears to be based on TARP funds providing half the equity stake and the FDIC loaning money for the rest at leverage not to exceed 6:1.  But is this enough?

We’ll see.  One of the key sources of tension in this plan is getting this number right.  If private investors have too low a stake, the opportunity for gaming the system is high.  They might overbid on assets, for example, because their stake is small enough that they can make more money on side bets than they can on the main investment.  Conversely, if the private investors are required to put up too much money, they won’t participate.  Without some leverage, the projected returns just aren’t good enough.

Overall, Geithner’s plan provides leverage of about 12:1.  That strikes me as too high.  I’d rather see private investors having at least a 10-15% stake.  But I guess time will tell if Geithner got this component of the plan right.

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