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 leverage is really 12X to 1.
With 12X leverage, an asset only has to fall 8% to wipe the equity out.
UPDATE: Felix also worries:
The minute the Treasury plan is put into action, we'll have a lot of public price discovery for the banks' bad assets. And if the prices don't clear -- if the minimum price the banks will accept is higher than the maximum price that the public-private partnerships are willing to pay -- then no one will any longer be able to perpetuate the fiction that America's banks are solvent. And without that fiction, the Hempton plan -- the muddle-through status quo -- is toast.
The big hope of the Treasury plan is that the private sector will be willing to pay a higher price for leveraged assets than it would for unleveraged assets. The returns on private capital are being leveraged by five or six to one in this scheme, if not more, which means a high chance of them making lots of money, and also a high chance of the capital being wiped out entirely. During boom years, that was a wager that many investors were willing to take. But now? I'm not sure. Chalk it up as yet another thing-which-has-to-go-right in order for this scheme to work. There are far too many of those for comfort.
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