Wednesday, September 24, 2008

Wrapping my head around the RTC like proposal

I actually never considered that the Fed/Treasury would have to purchase the "toxic" securities in an RTC like bailout.

Here's Luigi Zingales:
The major players in the financial sector do not like it. It is much more appealing for the financial industry to be bailed out at taxpayers’ expense than to bear their share of pain. Forcing a debt-for-equity swap or a debt-forgiveness would be no greater a violation of private property rights than a massive bailout, but it faces much stronger political opposition. The appeal of the Paulson solution is that it taxes the many and benefits the few.

1. Removing assets from the balance sheet of the firms only decreases regulatory capital. Likewise, buying them at a steep discount forces firms to realize their losses and thus decreases their capital. From Krugman:
“Removing these assets from institutions’ balance sheets” — what an evasive phrase.
I mean, any bank that wants to remove toxic assets from its balance sheet can do it at a stroke — just declare them worthless, and poof! they’re gone. But of course, that would reduce confidence and capital, not increase it — ...
More from Krugman:
The Treasury plan, by contrast, looks like an attempt to restore confidence in the financial system — that is, convince creditors of troubled institutions that everything’s OK — simply by buying assets off these institutions. This will only work if the prices Treasury pays are much higher than current market prices; that, in turn, can only be true either if this is mainly a liquidity problem — which seems doubtful — or if Treasury is going to be paying a huge premium, in effect throwing taxpayers’ money at the financial world.

2. This means that Treasury will have to buy the securities at "above market prices":
Paulson is trying to swap $700 billion of US Treasury assets in return for $700 billion of assets valued what I suspect effectively amounts to their original value when the asset was created. Presumably, once this swap was complete and the questionable assets were purged from the system, financial institutions could raise any additional new capital needed via private sources. Such a swap would make sense if the assets the Treasury was purchasing could be sold back into the market at some future date at their purchase price. But no one actually believes this is possible; those assets will undoubtedly fetch less than their $700 billion purchase price, and the taxpayer will eat the difference.

3. A lot of vitriol is directed to Treasury is asking for dictatorial powers in trying to solve this crisis. Again, from Tim Duy:
That Paulson should even propose that he be given authority that supersedes all other should be grounds for demanding his resignation. I am not prepared to anoint Paulson or Federal Reserve Chairman Ben Bernanke or anyone to the position of economic dictator, regardless of the danger to the economy. How ironic would it be if the unbridled push toward free market capitalism brought about the same dictatorship via economic chaos that a worried Frederick Hayek opined would be the end result of socialism in The Road to Serfdom?
From Interfluidity:
The oldest technique for the usurpation of power by the executive from the legislative is the manufacture of a state of emergency. That is not to say the present financial crisis is not actually an emergency. But the how the crisis is understood by legislators and the range of options by which it might be addressed have been set by Messrs Paulson and Bernanke. They have presented a single option, one more radical than seemed reasonable even at the height of the depression.
From Naked Capitalism:
This puts the Treasury's actions beyond the rule of law. This is a financial coup d'etat, with the only limitation the $700 billion balance sheet figure. The measure already gives the Treasury the authority not simply to buy dud mortgage paper but other assets as it deems fit. There is no accountability beyond a report (contents undefined) to Congress three months into the program and semiannually thereafter. The Treasury could via incompetence or venality grossly overpay for assets and advisory services, and fail to exclude consultants with conflicts of interest, and there would be no recourse.

4. Again from Naked Capitalism (same link):
Losses on the paper acquired are guaranteed. This is not a bug but a feature. The whole point of this exercise is an equity infusion to banks. The failure to be honest about it upfront will lead to a taxpayer backlash (or will lead to the production of phony financial statements for the rescue entity, which will lead to revolt by our friendly foreign funding sources).

Taxpayers have no upside participation.

There is no regulatory reform as part of the package. This would seem to be a minimum requirement for a donation of this magnitude.

There is no admission that deleveraging is inevitable. This plan seems to be a desperate effort to keep bad debt from being written down. Yet the sorry fact is that a lot of these assets simply will not be repaid.

There appears to be no intention to do triage. The financial services industry, on the back of an explosive growth in debt, has reached an unsustainable size. The industry will have to shrink. Yet the Administration does not address this issue; indeed, it appears it intends to forestall the inevitable. Regulators need to decide who will make it, who won't, and figure out what to do with damaged institutions. Instead, the reaction is ad hoc.

5. Investors Consigliere considers the upsides:
Another potential defense of the Paulson plan: as far as I can tell, the plan does not specify when Treasury is obligated to buy toxic assets, nor does it prevent Treasury from doing another AIG. Conceivably it could wait until the maximum moment of pain to get the best price possible for its assets. Or it could continue to do AIG-style bailouts followed by purchases of the toxic assets, in a sense bailing out itself. Suppose for instance that tomorrow Treasury buys AIG's entire CDS book at something close to market value--wouldn't it instantly make a lot of money on its $85 billion bailout, while over time perhaps making money on the CDSs?

Bottom line: It may be time to join the mortgage bailout protest.

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