One of the core missions of the Texas Holdem Investing program is to educate people about investing using Texas Holdem Poker as a learning tool and as a medium for explaining investing decisions.
So I always like to see poker being use to teach investing concepts elsewhere.
And today there was yet another example of this on the Huffington Post (one of the internet’s biggest blogs) – “Economists Laid End To End: Judging The Geithner Plan”.
This article explains the huge tax-payer subsidy being given to investors that wish to acquire toxic assets using the “Public-Private Investment Program”.
Firstly, here is the example given by the Treasury itself:
“Sample Investment Under the Legacy [Read Toxic] Loans Program”
“Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.
Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.
Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.
Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6.
Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis – using asset managers approved and subject to oversight by the FDIC.”
And here is the explanation of what is on offer using the medium of poker:
Consider a game of no-limit poker where the buy-in is $84. The possible upside to playing in this game is high (since it is no limit). And the downside is the loss of the entire buy-in amount of $84.
Then along comes a well-dressed but slightly panicked gentleman named Ulysses S. Treasury who offers to “stake” you for a significant part of the buy-in for this game. He offers to loan you $72 (provided by Frank De Infinite Cheque) which you have to pay back, and to “invest” a further $6 in return for 50% of your winnings. Therefore, all you need to “get into the game” is $6 yourself.
Mr. Treasury and Frank has some faith that you will do well, but he doesn’t have a crystal ball and recognises that the game could go either way – you could be toxic!
So let’s imagine that you go on and shoot the lights out and make $200 above your $84 buy-in. You take $72 and use it to pay back Frank’s loan and take $6 to repay Mr. Treasury’s equity stake. Then you give $100 to Mr. Treasury as his 50% share of the profits you have made. The upside for you and Mr. Treasury is unlimited. If you made a profit of $2,000 then you would have made a profit of $1,000 on your original investment of $6.
However, if you bust out and lose all of your buy-in, well, you’re only down $6 and Frank De Infinite Cheque (lucky for him) is down $72, and his friend Mr. Treasury is out $6. So you got to buy into a game with much bigger upside potential than you could have done without the help of the two guys – and they won’t whack you if you lose all their money.
So, the conclusion is, that with that kind of staking policy Frank and Ulysses aren’t very good investors in poker players. They are encouraging the player to take excessive risks and they are not getting nearly enough reward for the upfront investment and loan that they are giving to the player.
However, there may be a greater plan at work in the latest iteration of the Geithner plan which in some way compensates for the skewed risk-reward profile. If it does reflate the economy then the taxpayers will get Frank’s loan repaid and make a decent profit. But, more than that, the economy in general will recover so that all taxpayers (and many non-taxpayers) will benefit, which may mean that the plan has more than just a monetary reward to consider.