Bargain Prices?

CNNMoney.com describes the planned $700 billion bailout as follows:

The plan would allow the Treasury to buy up troubled assets from U.S.-based companies and foreign firms with big U.S. operations. The aim is for the government to buy the securities at a discount, hold onto them, and then sell them for a profit.

Here’s the question: if these troubled assets are so cheap, why doesn’t anyone else besides the U.S. government want to buy them?

There are plenty of hedge funds out there with ample cash. Perhaps, if the assets are such a good deal, some European governments will want to get in on the bargain also, rather than let the U.S. Treasury get all the spoils.


NathanG

If the banks are in trouble because many of the mortgages they hold are likely to go into default, then, rather than give money to the

banks and/or take the mortgages off their hands, why not give money to the homeowners who are having trouble paying their mortgages?

That way, the mortgages that the banks hold won't become worthless,and the homeowners won't lose their homes.

Maybe congress and the administration intend to give some relief to homeowners, but couldn't this be the main thrust of the bail out? Bail out the people who pay the mortgages, and, by the magic of

Trickle Up Economics, you bail out the people who hold the mortgages.

LJ

"I would rather lose an election than lose a war". Seems to me that the real player here is "President" McCain. John - do the right thing. Flush this system. Vote against this bailout. Allow the market to do what it does best - self correct. Collapse and destruction is part of the cycle of markets. Contractions ultimately lead to expansions and, if allowed to self heal, the markets will ultimately prevail for the betterment of the U.S. citizens. It is better to let the system reach its natural bottom and then allow the government to aid in clean up. We can't stop hurricanes. We can only run for shelter. We can, however, clean up after them.

adun

I think it's ridiculous to buy bad assets at the cost that worth much more than the assets and wait for the right timing to sell them for profit. Isn't this genuinely to continue to maintain the bubble that should have pop or at least shrink one or two presidents ago?

That may profit those financial firms that have caused this mess mainly, much more than the nation and shrink the value of the 7000 billion dollars.

Sergio Dominguez

I think the reason these financial assets would not be purchase by the market is simple, no one is willing to take the risk. Only goverment who faces greater risks than the one embodied in these assets is willing to do it. These greater risks could afect the intertemporal budget constrain by reducing future taxes for the goverment.

bill

Hedgefunds are required to make money, goverment can buy at a much less profitable rate because it's purpose isn't to make money. Apples and Oranges.

Kevin L.

I wish we were being given information about what the real state of this thing is!

I heard on NPR this A.M. that only about 1.5 million of 51 million home mortgages in the U.S. are in series arrears. If the average loan is $250K (What is it?) and we assume all these delinquent loans are worth zero, we still are far below $700 trillion. How much has residential real estate prices dropped since their peak? 10-20% based on numbers I find but there is little agreement. Why are we not told hard numbers here? Regardless, even the foreclosed houses return a substantial portion of their loan value. What is the national average? If it is 66%, then the 1.5 million loans currently in arrears will cost on the order of $100 Billion.

I read all the time that the "market evaluation rules" have created a self reinforcing downward spiral since the market for these "toxic" securities is so bad. Why not simply change such silly accounting rules? It seems to me if the income being paid each month on the Mortgages is 80% of that which was expected when the interest rate on the bonds was calculated (which must have included some default rate), then the bond should be valued at 80% of its nominal face value. I heard this AM that Merrill Lynch recently was forced to sell some mortgage backed bonds for 32 cents on the dollar. Surely two thirds of the mortgages are not in default! What is going on?

Why does the government not have to lay all the hard financial facts of the table like a company would in an investment prospectus? Why are we not told what income these investments are currently making? How that income has changed over the last 12 months?

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RR

One man's junk is another man's Treasury.

Bobby G

@ Hunter (#36)

A fine argument, and on that level I certainly agree... much efficiency is lost in our various systems. However, lest we stray off topic, the point is still the market for distressed mortgages.

This is another piece of information, this price floor, yes. How it will be set will be another interesting thing to analyze, should the proposal go through. However, this price floor would be temporary, at least in so much as it is relevant to the market, and will create some sort of desperately needed stabilization; banks (or other lenders) will know at least some minimum value of a foreclosure. Of course this assumes that it works and the economy recovers... if it doesn't, well, this extra layer of information will be the least of our worries.

Ultimately, I'm of the opinion that the so-called price floor is a necessary idea. Further corporate bailouts should become unneeded once the market relaxes and (in particular) investor confidence begins to return. Much of the strain on those distressed corporations came from an investor run on the bank, so to speak. It's difficult to demand punishment of the executives of some of these companies requesting government aid when, sometimes, mistakes were made over 10 years ago and they were being made across the industry. I'm not condoning such a lack of standards in loaning, but the guilt should be spread more evenly, not just focused on the unlucky first targets. Maybe.

Ultimately, I think that this proposal could, if properly implemented, have a much needed beneficial effect on the financial sector.

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JO

@ #23 (MS)

That idea would only work if this administration had two things: balls and common sense.

Of course, this government has no evidence that it has either

Bobby G

We would, Adrien (#31), in the form of a reduced national debt.

Hunter

#26 - Bobby G

I agree with you that a perfect market is an impossibility. In fact, information asymmetries are *required* for a market to work. To that extent, I unabashedly adore them.

However, I take issue in artificially *creating* imperfections - distortions, if you will. In fact, I am of the opinion that much of the progress of our economy (primarily, but not limited to, the financial sector) has been predicated on the purposeful creation and shameless exploitation of information asymmetries. Whether it is complex derivatives (where no one except the contract drafter understands it), or patent/copyright issues (fear of lawsuit or DRM), or outright fraud (mortgage appraisals, applications, securitization, insurance), a great deal of economic activity is dedicated to preventing the marketplace from timely impounding relevant information into price decisions.

Health care is a fine example. There are frequently at least four parties involved in a simple doctor's visit: the patient, the doctor, the patient's employer, and the insurance company. The patient has a contract with his employer that provides access to the group insurance policy. The employer has a contract with the insurance company. The insurance company has a contract with the doctor. The doctor has a professional relationship (and probably a contractual one, too) with the patient. An historically two-way street is now a four-way intersection.

And how many legally-enforced information asymmetries are present there? Each of the four contracts is routinely confidential (try asking your doctor for a copy of his insurance contract), and then layer in HIPAA, doctor-patient confidentiality, etc. If we were to allow information to flow freely among the parties, there is little doubt the insurance industry would collapse overnight. The difference between health insurance and artificially propping up mortgage securitizations is that at least some evidence exists that spreading the risk of sudden overwhelming medical costs among a large group results in benefits that outweigh the costs. I can safely say that the jury is still out on the costs and benefits of a government-owned financial system.

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AlleyGator

Re: 29.

I understand that this is Bernanke's intention, to create a price ceiling for bad mortgages that no investor will purchase. However, the problem is less that the investors won't purchase them and more that the banks can't afford to reduce their capital enough to sell them at a reasonable price.

We allow banks to pick and choose the value of their regulatory capital, and they pick and choose numbers that simultaneously allow them to call themselves "well capitalized" even though they don't have enough money to lend to each other.

I'm fine with the idea of "recapitalizing" the banks, but let's be honest about Bernanke's fiscal--not monetary--policy here. This is not a liquidity crisis, it is a solvency crisis. There are not going to be any thrift-store bargains to pick up during this bailout.

We need to take adequate steps to make sure that companies don't just get in line for their turn at the $700 Billion punch-bowl.

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Adrien

Do we all get a dividend from the profit?

MS

There is something I don't understand. Reports top the number of distressed households in the low millions of households (2-4 million).

Let's say there are 5 million distressed homeowners. The way I see it, $700 billion/5 million is about $140,000 for distressed household. Doesn't this sound like a crazy amount?

It would be better for the government to tell distressed households to sell their properties for a loss. And then tell provide the creditors with tax deductions over the next ten years that cover for these losses. It would be good for the distressed homeowners, because they will go back to renting (they should have never been owners); good for creditors (their losses will be cover by lower taxes); good for potential home buyers (there will be plenty of housing to buy at fire sale prices). And it would surely be cheaper than $700 billion.

John Powers

Given the complete over-reaction of Congress to the telco/internet bubble, it is quite likely that you could go to jail for being involved in politically unpopular transactions.

I think there is a huge upside in buying like Lone Star did with Merill, but who wants to risk jail time depending on the whims of a politician?

JBP

Kevin H

The underlying value of a true cross section of all mortgages is not that bad http://www.realtytrac.com/foreclosure/foreclosure-rates.html . Most people can still pay their mortgages, and most houses still have some value in them. I think the problem here is that no-one is quite sure which of these mortgage securities really represent a large enough cross section of the market to be worth it. If you pick the wrong group of 10,000 mortages, you might loose a huge amount. Once you get up into the hundreds of billions of dollars, you are dealing with massive numbers of mortgages, and your risk should be pretty well distributed. You are probably not going to end up loosing all of your money.

Something like 27% of mortgages will fail within 30 years if the current rates of failure continue, but there is no reason that rate should continue to stay so high. Most people who overstretched their resources to buy a house should have financial troubles earlier on rather than later.

Even then, if we say rates of failure stay constant, factor in the fact that the 73% or so of successful mortgages will be paying a bit less than 2x the home price over the 30 year length of the loan. So at the very least your value will stay flat if you allow for 2% inflation/year over those same 30 years.

So, while the government doesn't look like it is set to be a big winner, I don't think the tax payers are really incurring that much risk of losses.

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Kit O'Connor

@25:

You misunderstand - hold-to-maturity is a far different price than par. What Bernanke is saying in that statement is that he intends to create a market that values these distressed assets fairly. Once a market is established, then companies can mark their assets to a more real price, rather than the price currently existing in the almost non-existent market, as accounting rules currently require. This follows more in line with #12 - will the government set a realistic rate of return / interest rate on its new market? That, I believe, is the biggest question of all.

Geoff

Well said. Of course, not everyone is getting saved by the US government - Mitsubishi bit a chunk of Morgan Stanley, & Merrill Lynch sold itself to Bank of America.

But you're right, the words "bargain" & "discount" don't accurately describe the government's action in this dire situation. More precise would be words like "rushed", "exaggerated", & "CYA".

Geoff

#38 mentions changing the accounting rules. This seems obvious to me too - less need to expensively deleverage at the worst possible moment, and how do you mark to market without a market - so what are the obvious problems I'm missing that mean it's not being discussed?

jonathan

What assets? Are we talking about credit swaps and other derivatives? If so, then realize the market over the last year was $1,000 Trillion and that each Wall Street firm holds more of these obligations than our total Gross Product. These instruments have value because they were traded in a market; they weren't directly a pool of mortgages or other assets but bets on the movement in value of those assets. How will those markets ever recover now that everyone knows they were based on completely wrong assumptions about risk? Are those instruments worth anything? If we're backing the derivatives markets, then we could spend every penny in existence and not make a dent. If we're betting that those markets will recover, then try to imagine how we'd get turnover of trillions of dollars when there's regulation and real accounting - meaning somewhere from unlikely to uh-uh, no way. Without that turnover, wouldn't we have an overhang of trillions of dollars of instruments - an overhang that would take roughly 500 years to work off if we use the S&L debacle as a guide.

My belief is becoming that these markets are on life support and the best thing is to kill them with the least amount of pain to the public. Ask yourself: do you believe the credit swaps market will turnover $1,000 Trillion in the future? If not, then those markets are toast and we need to accept that and work out a burial.

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