Repeat after me: bye bye the US’s AAA rating and the dollar. Although the Paulson’s plan is only sketchy, on the surface, it is utterly ridiculous. The authorities propose to save the economy by buying mortgage paper at market prices.
Why do we need the government to create a massive and costly effort to buy paper at market prices? Institutions can sell paper at market prices now. This is clearly ether a massive game of smoke and mirrors (f we are lucky) or a plan to buy bad assets at above market prices but somehow pretend that they are indeed correct.
The latter takes us straight down the Japan path. The government is left holding lousy paper it will have to dispose of at a loss, the banking system gets subsidized not based on triage, on who might it make most sense to rescue, but who gets enough of the crappy assets sold at a high enough price. It’s a terrible, inefficient way to recapitalize the banking system. Why should taxpayers underwrite banks without getting some upside and a measure of control?
And as we have said before, Japan had high enough savings that it could manage its crisis internally. We don’t. Foreign central banks are already coming under pressure from domestic constituencies over their dollar holdings. It isn’t at all clear that they will support these initiatives by buying even larger amounts of Treasuries.
Oh, PS, and who gets to decide if the mortgage prices are fair? Consultants hired by the Treasury. Given how costly and ineffective this Administration’s outsourcing has been, I have little faith that this would be implemented well separate and apart from the confused (or more likely misrepresented) objectives.
And the prospect of turning on the spigot has others clamoring for bailouts. There are calls for underwater homeowners to get handouts too.
Pray that this measure does not pass, or better yet, call your Congressman and Senator and raise hell. The importance of these initiatives and the dollars attached says they should not be rushed through in a panic, particularly when the underlying premise is so dubious.
From the New York Times:
The Bush administration, moving to prevent an economic cataclysm, urged Congress on Friday to grant it far-reaching emergency powers to buy hundreds of billions of dollars in distressed mortgages despite many unknowns about how the plan would work.Henry M. Paulson Jr., the Treasury secretary, made it clear that the upfront cost of the rescue proposal could easily be $500 billion, and outside experts predicted that it could reach $1 trillion.
The outlines of the plan, described in conference calls to lawmakers on Friday, include buying assets only from United States financial institutions — but not hedge funds — and hiring outside advisers who would work for the Treasury, rather than creating a separate agency. Democratic leaders immediately pledged to work closely with Mr. Paulson to pass a plan in the next week, but they also demanded that the measure include relief for deeply indebted homeowners, not just for banks and Wall Street firms.
However, it is not clear that Congress is going to roll over:
As of Friday evening, Mr. Paulson had yet to deliver a formal plan to Congress. House and Senate leaders pledged to work through the weekend, but they insisted that Mr. Paulson bring them a detailed plan rather than just an outline.An even bigger obstacle was the goal of the plan. President Bush and Mr. Paulson made it clear that their primary, and perhaps only, goal was to stabilize the financial markets by removing hundreds of billions of dollars in “illiquid assets” from the balance sheets of banks and financial institutions….
But Democratic lawmakers insisted that any plan would also have to provide relief to millions of families that were poised to lose their homes to foreclosure.
The House Speaker, Nancy Pelosi of California, said she would insist that the plan “uphold key principles — insulating Main Street from Wall Street and keeping people in their homes by reducing mortgage foreclosures.”
The Wall Street Journal discussed the need to sort out pricing:
However, the government may find itself in a quandary: Does it pay more than fair-market value for hard-to-assess distressed assets, putting taxpayers on the hook for any losses? Or does it drive a hard bargain, buying for pennies on the dollar? The latter approach would further hurt financial institutions, since they would have to write down the losses and take additional hits to their balance sheets. The Treasury department, which hasn’t commented on specifics about the plan, is expected to propose issuing debt in $50 billion tranches to fund the purchases.
The SIV rescue plan, the MLEC, did not get off the ground because the objectives of the sellers of bad mortgage debt, did not want to show much in the way of losses, while investors in the Entity, as it was called by some, were only interested in bying fairly-valued assets.
Since ideas along those lines haven’t worked, we are now having the taxpayer stand in place of private buyers. And I guarnatee if this program sees the light of day, it will not pay arm’s length prices. There’d be no point in doing that. This is a complete charade. But Paulson cannot say that this amounts to a recapitalization of banks, done in a very inefficient fashion. It would be too controversial to admit that. But Congress may figure it out regardless.
The New York Times’ Joe Nocera, in “A Hail Mary Pass, but No Receiver in the End Zone” takes a very dim view of recent Treasury moves, including the latest bailout plan. The whole piece is very much worth reading, Key bits:
So rather than help solve the crisis, the Treasury Department has actually contributed to the biggest problem in the market right now: an utter lack of confidence….Will this latest round of proposals end the crisis? I know the stock market reacted joyously on Friday, but I’m not hopeful. One solution being promoted by the Securities and Exchange Commission — to make life more difficult for short sellers — is a shameful sideshow. A second solution, which Mr. Paulson announced Friday morning, requires money market funds to create an insurance pool to cover themselves against losses.
That may provide comfort to investors who equate money funds with savings accounts, but it is fraught with moral hazard.
And the third solution — the big megillah — is Mr. Paulson’s plan to create a new government mechanism to buy mortgage-backed securities from big banks and investment houses. Once they are off those companies’ books, life can return to normal — or so Mr. Paulson hopes.
He acknowledged that it would likely cost taxpayers “hundreds of billions of dollars.” I think it will cost more than $1 trillion.
Anonymous 
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Since there is wide consensus that the root cause of the current financial crisis are declining housing values, allow me then to use some real estate terminology to express my view as to the proposed remedy:
Inflation, Inflation, Inflation.
P.S. 3 or More Trillion will be the final cost.