Observers are praising the apparent lack of risk to the taxpayer in Tim Geithner’s banking plan. To wit: The FDIC will only lend private investors $6 of taxpayer money for every $1 of crap assets the investors buy, for a 6X to 1 leverage ratio.
Given the rate at which debt “assets” are depreciating these days, 6X actually isn’t wildly conservative. If an asset leveraged at 6X falls 17% in price, the equity is wiped out.
And in reality, unfortunately, the leverage ratio will be far higher than 6X. Why? Because the Treasury will be providing half of the equity. So the taxpayer’s money is really leveraged 12X to 1.
With 12X leverage, an asset only has to fall 8% to wipe the equity out. As long as the taxpayer’s equity is treated the same as the private equity (not clear), it would still take a 17% fall to zero out the equity. But the taxpayer still has $12 for every $1 of private equity on the line.