Already, various models have emerged for gaming the Treasury plan. Karl Denniger posts one scenario where an institution has $100 billion in toxic assets with a current value of 30 cents on the dollar. That institution -- call them Screw Bank -- bids on its own assets at 75 cents on the dollar. Screw Bank provides 5% of the equity, with the rest covered by Treasury, The Fed and the FDIC via guaranteed bond issuance. The loan, save for Screw Bank's bit of equity, is non-recourse, so they can lose 5% of the total portfolio purchased, but nothing more. If the assets bust in that scenario, Screw Bank loses 5% of $75 billion, or $3.75 billion. The taxpayer gets hit for the remaining $71.25 billion dollars. Or imagine a hedge fund buys a pool of assets for 50 cents on the dollar. They also buy a credit default swap against the pool proving worthless. If the pool jumps in value, they make money. If the pool busts, they walk away from the original loan and collect money on the CDS contract. There are ways, of course, to protect against some of this. But this is what Wall Street is good at: Arbitraging markets and coming up with inventive ways to make short-term cash. And it's not hard to imagine Wall Street being better at coming up with these schemes than the Treasury Department will be at protecting against them.
