It's the Liquidity, Stupid: Why Not Put the $700B Into Good Banks?
The Paulson proposal to purchase mortgage-related assets (MRAs) focuses entirely on the health of distressed banks. Presumably, the government will pay above-market prices for the MRAs, perhaps doing terminal value analysis with a discount to present value, and paying that inflated price will improve the banks' balance sheets (assets vs. debts) so that they can lend money. Otherwise, we are told, the banks' assets vs. debts is too thin to support additional loans no matter how good the creditor might be.
I confess that my initial focus was to analyze to the Paulson proposal itself. "Treasury Bailout Proposal: Zero Pain for the Perpetrators, Toxic to Taxpayers", September 21, 2008, focused on the impropriety of financial institutions valuing assets of others when they themselves had similar assets so that an inflated valuation of the other's would serve as a "comparable" in valuing their own. It is a sleight-of-hand. It also pointed out that the perpetrators of our fiasco would actually benefit.
Analyzing the Paulson proposal, however, is less important than zeroing in on the crisis itself, and thus what really needs fixing.
Paulson wants to focus on the health of the banks that are exsanguinating from self-inflicted wounds. But, there is no guarantee that artificially fixing those banks balance sheets will heal the illiquidity that is the real problem.
So, let us assume we have $700B smackeroos to deploy in the economy. Instead of buying the bad debt at inflated prices from the bad banks, why not use it to enhance the capital of the good banks, whose track-records of lending and risk assumption have been demonstrated.
By improving the capital positions of the good banks, they will extend more credit and facilitate transactions. That is the liquidity crisis that is to be resolved. The government would not have to take on bad debt at inflated prices, and the bad banks holding those assets would have to determine how to work them out.
Liquidity would be restored without sticking the shareholders of this country, its citizens, with mountains of bad debt.
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Really good article but the democrats in Congress are falling over themselves to pass Bush's bill. Meanwhile, Obama is endorsing it. This makes no sense at all and I feel that Obama will lose support when he votes for this bill. This is Shock Doctrine in the flesh and America is the loser once again.
The doctor is an authority on malignant conditions & the control of such conditions or even cures. He may be using his mindset to treat our ailing economy. It may resemble a treatment plan for a person afflicted by malignant conditions in that the healthy parts are saved & malignant tissue is removed or otherwise prevented from spreading to healthy tissue. Save what is healthy; discard the malignant. It may enable the patient to survive or thrive for years.
I don't really see the problem here.
Do we actually agree on what the REAL PROBLEM is?
Is it illiquidity?
And, doesn't that mean there is too much debt and too little equity, or other sources of cash?
Not enough cash to pay the short-term debt bills that were used to purchase long-term debt thingies like RMBSs and suchwhat?
And, isn't that, like, the definition of insolvency?
And, if the ENTIRE SYSTEM is insolvent, with too much debt, and not enough cash, then can creating MORE DEBT be the solution to the real problem?
Oh, wait !!
NOW, I think I see the problem.
What we need is MORE NEW MONEY to pay those short-term debt obligations coming due, and, lo and behold, ALL NEW MONEY THAT IS CREATED IN THIS COUNTRY IS CREATED AS DEBT !!
Could THAT be the problem?
Kind of like the Doctor is the disease kind of thing?
Paul, try to wrap your mind around that point there.
The problem is that we have created too much debt, and that all money created in this country is created as debt.
It's like the dog finally catching that truck he's been chasing.
The only solution is Treasury-issue, debt-free credits.
More to follow.
Good banks, of course, have sufficient capital. And they have sufficient liquidity. Their decision to lend or not lend is not a function of "patriotism", it is return and security. The cancer is the issue and it needs to be removed and excised. The toxic elements are embedded in separate securities and the complexity of this "unraveling" casts serious suspicion about the mentality and experience of those who dreamt them up in the first place.
If there were $2 trillion in defaults (a big number) and the sum total of all collateal homes was worth $1 trillion... and Henry Paulson could buy them(the mbs) for $0.40 cents on the dollar, then this would calm the market place i.e. "clean the books" so the issue of imminent death left the air.
It's similar to bad milk in China. The toxics need to be separated and expunged.
You sound like Paul Bremer in Iraq handing out brief cases of shrink wrapped $100s! That is no solution.
The article sets up an artificial construct and then tries to demolish it. If, as the author suggests, you use a discounted cash flow type of analysis to pick the price paid for assets and pay that amount, you are paying a fair price, and not acquiring "bad debt". That is finance 101. That amount would certainly be above the value banks are carrying the paper at today as they are forced to "mark to market" when there is no market that is functioning. So banks get to sell at a premium, increasing their viability and the gov is buying paper at a fair price. Whats the problem????
Trying to pick a "good" bank to invest in is fraught with peril, if there are any out there, which I highly doubt. Just exactly how would you do that?
Unravel the mortgages, sure...lets just abolish rule of law and contracts. You think the government is in hot water now, just see what happens if they try that one.
No one is focusing on the ripple effects of having these institutions go broke. Beyond direct employment, do you have any idea how many companies have the financial services sector as their number one or two industry segment they sell to??? Many.
By suspending the "mark to market" rules you could end this crises very, very quickly. If those rules were in place during the S&L crises we would all be living in mud huts right now.
>>Whats the problem????
You can't do a cash flow type analysis, when you don't know how these MBSs are going to perform (i.e. how many mortgages in the package will default - a growing problem in a declining housing market). That's why there is no market for these instruments.
>>By suspending the "mark to market" rules you could end this crises very, very quickly.
Seemingly, but if you don't mark-to-market, how do you value these securities, when deciding whether a bank is meeting its capital requirements? So, the "bailout" plan is intended to create a market for this stuff and aid everyone from having to take (bigger) write-downs when marking to market. Calling it a bailout is a misdirect. It's really intended to maintain pricing support for the MBS market, so it should really be called the "prop up" plan. Of course it doesn't help to have it be viewed as such, which is why Paulson and Bernanke haven't been candid.
Reverse auctions would be the best way to create this market, but Bernanke and Paulson want to pay top dollar for these MBSs to prop up the market (Bernanke said if theTreasury pays close to the hold-to-maturity value, there will be substantial benefits). So, while they're saying the problem is that prices for these MBSs are irrationally low, they actually want to pay more than the MBSs are even reasonably worth. They should at least be required to hold reverse auctions.
How would you "enhance" the capital of good banks? Purchasing equity? Lending money? Wouldn't the government be likely to get less favorable terms working with institutions that aren't in trouble?
Also, if you do not help those that are faltering, chances are they will go under. While i hate saving poorly managed companies as much as the next guy, a large portion of the industry is in trouble. Would it be better to have a really concentrated industry with two or three large banks having all the market share? In this process, how many financial service jobs would be lost? Would your plan be worth the costs?
The author apparently didn't think any of that through.
You'd use the Fed to lend them the money.
When this is all said and done, the 700 billion will not save bad companies. They are going to be sold off and we're still going to end up with fewer institutions.
His plan would be worth the cost because its risk to the taxpayer is minimal. Solvent institutions will borrow the money and they will loan it and exercise due diligence because they have to pay it back.
The troubled institutions will liquidate. Someone will buy that paper, but that's their concern, not mine.
Another option is to force the investment banks to unravel all those mortgages they've bundled so one bank owns one mortgage. The government establishes a baseline based on geographical areas, rural versus urban based on house prices before the boom (say 2001). It then buys those mortgages (on average they are 65 to 70 percent) offering the 2001 market value.
It then turns to the owner and offers them the chance to purchase the house at the price they paid for the note. The buyer would have to prove he can afford the house. If he can't he moves out and another buyer is found.
Paulson, Bernanke, and Bush have zero credibility. These are the guys who should have seen this coming months if not years ago and didn't. What makes you or anyone else think they have the answer?
See Paul Abrams's Profile
THere are many good banks, but a lot smaller than the ones that need the bailout. This would enable them to grow larger.
The way to enhance their capital is to purchase preferred stock , and the govt can sell that off over 10 years or more so, from the taxpayer perspective, it becomes somewhat like a bond. As good, and now larger banks, the preferred the govt buys should be more valuable over time. That beats buying distressed assets and praying.
Your point about financial service jobs being lost is correct to some extent...since the financial sector itself would not shrink, most of those people would wind up with jobs in the now-larger good banks.
Actually, one could even use the money to open up new banks, it would be easy to find people to hire, and new banks would be totally without baggage.
Would the good banks even want to sell to the government? Would the common shareholders of good banks want their equity to be diluted even more? Even if they did see their dilution offset by future prospects, why wouldn't they sell to a sovereign wealth fund or somebody willing to pay a high price?
I think the economic costs of destroying so many existing institutions would be great. I also think Congress is more focused on punishment than resolution of the crisis. There will be plenty of time for that in the coming weeks, months and years. We could place capital back into the economy by having the government lend directly to businesses or creating one large state bank. I don't think either option is good for our country or economy in the long run.
Most of the banking entities that are currently having difficults are not "bad banks." Companies like Goldman Sachs, AIG, Merril Lynch, and Wachovia are far from "bad banks." These are best in breed companies that are suffering from liquidity issues, not "bad banking" issues.
This proposal makes way too much sense. It'll never fly.
This is the only logical idea I've heard of in several days.
Good idea Paul Abrams.
You're overlooking that fact that "sticking the shareholders of this country, its citizens, with mountains of bad debt" has been the whole point all along.
Yes, Paul, what peterg76 said. They are out to ruin the chances that the middle class can once again have power in this country by putting us so far into debt that we can never escape a kind of forced servitude of debt. Your idea is good, Paul, but of course will never be considered in this rush to "clean the clogs" of the financial system. Reminds me that Nixon used plumbers too.
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