What's worse than toxic?

The plan to sell the toxic assets using government guarantees (the PPIP) has finally made its first sale. The only problem is that it is an incredibly bad deal for the US taxpayer.

The toxic assets they sold are not from a struggling, but still functioning bank, which will then be able to resume normal operations unencumbered by the consequences of its previous bad decisions. The toxic assets that the FDIC arranged to be sold are from an insolvent bank. This means the FDIC already owned the toxic assets.

So why is this bad? James Kwak of The Baseline Scenario lays it out for us:

Our government is providing large subsidies to private investors to buy toxic assets. The only possible justification for these subsidies is that they are necessary to restore health to the banking system, by taking toxic assets off the balance sheets of banks. But these toxic assets [in this deal] are already the property of the U.S. government. This means that the government owns 100% of the upside and 100% of the downside on those assets.

Or at least it did until last week. Then it gave half the upside to an investment fund....and kept all of the downside to itself. What could they possibly have been thinking?[E.A]

So we gave away half of the potential gains on these assets. But for what? So that this particular bank can start lending again? No! This bank is dead.

The taxpayer is providing a government guaranteed loan to a private enterprise called Residential Credit so that they can buy mortgages that the taxpayers already own. Residential Credit is using that loan to bet that this particular pool of mortgages will eventually be worth something to someone and that they can then sell it for a profit, which they will split with the FDIC.

I thought privatizing profits and sticking taxpayers with the risk in the name of restoring bank lending was a bad idea. Doing so for a bank that will not ever lend again is even worse.