The New York Times Spreads Disinformation About the Paulson Plan

Vikas Bajaj of the New York Times is an able reporter and I have often enjoyed his work. I was therefore taken aback when I read his article, “Plan’s Basic Mystery: What’s All This Stuff Worth?” since it misleads readers as to the intent and thrust of the so-called Troubled Asset Relief Program.

This is part of a disturbing pattern in the mainstream media as far as the plan is concerned. Despite the considerable diversity of opinion and political orientation among economists, the criticism of the plan among economists has been widespread, verging on unanimity (with Alan Blinder a notable outlier). Yet the press has treated the plan with vastly more deference than it deserves.

How did this come about? Perhaps select members of the media got a version of the scary talk that Paulson gave to the Congressional leadership behind closed doors. But that still does not explain the obfuscation of how the plan will work.

In a nutshell, the article seeks to explain why a lot of the assets likely to be bought by the program are hard to value, and does a good job on that front. Fair enough. But get a load of the premise:

A big concern in Washington — and among many ordinary Americans — is that the difficulty in valuing these assets could result in the government’s buying them for more than they will ever be worth, a step that would benefit financial institutions at taxpayers’ expense….

A big challenge for Treasury officials will be deciding whether to buy the troubled investments near the values at which the banks hold them on their books. That would help minimize losses for financial institutions. Driving a hard bargain, however, would protect taxpayers.

Huh? How can Bajaj not understand what this program is about? First, it is going to pay above, in fact considerably above, current market prices for the illiquid (frankly, often dud) assets. There is no point to this exercise otherwise. The banks are free to sell now at market price, but they aren’t willing to. Hence the government is stepping in, paying over the mark.

This is a feature of the program, not a bug. The financial firms most assuredly do not want price discovery at current levels, and paying above market serves as a back door recapitalization of the banking system. But the operation is badly flawed, since it’s the companies with a high proportion of assets for which the Treasury overpays most who benefit most. That given priority to those with the biggest exposures, when not all of them may be worth saving, and within that group, the level of subsidy will likely be arbitrary, since the degree of overpayment will vary from asset to asset.

If you doubt my take on this, consider this Bloomberg article, “Paulson, Bernanke Put Bank Aid Ahead of Best Deal “:

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke have signaled that their priority is shoring up the nation’s banks even if it means they don’t get taxpayers the cheapest prices for the devalued assets the government buys.

“I am not advocating that the government intentionally overpay,” Bernanke told the Joint Economic Committee today, in response to a question from U.S. Rep. Jim Saxton, a New Jersey Republican.

At the same time, Bernanke also repeated his view that the government won’t pay “fire-sale prices” for the mainly mortgage-related securities Paulson aims to buy in a proposed $700 billion rescue. Officials want to set a long-term value on assets, holding them until they mature or markets improve.

If you believe the last statement, I have a bridge I’d like to sell you. Henry Blodgett reads the intent of the program the same way (boldface his):

Bernanke and Paulson want to pay a phantom “hold-to-maturity” price that is above the prices at which the banks are currently valuing their trash assets. The logic is that the banks’ carrying value is somehow artificially depressed by a lack of liquidity. (This logic is weak: If anything, the banks are trying to conceal how badly off they are by overstating the value of the assets).

In the vast majority of markets in the US, real estate has not bottomed. The last serious real estate recession in the US, in the late 1980s-early 1990s, was 15 quarters peak to trough. The high point in the cycle just passed was third quarter 2006, so by that standard, we are a bit more than half way through. Similarly, for housing to return to long-standing historical relationships to income and rental prices means the peak to trough fall nationwide would be about 35%. Other indicators also point to a 35-40% decline. And that assumes that prices do not fall below “fair” value, which often happens in a bear market. Commercial real estate may not fall as far, but is much earlier in its trajectory. Corporate defaults have only started to rise, but some distressed debt experts forecast that they could go as high as 16%. LBO loan paper will fall much further in value as defaults rise. So across the board, there is every reason to expect pricing of debt to worsen appreciably.

The hold to maturity idea is bunk. With a national price decline of 35-40% for housing, a very high percentage will be in negative equity territory. And do you think banks will unload the loans that are likely to be good? Hell no, they’ll get rid of their worst dreck. If the Treasury winds up with any assets that pay 100% at maturity, it was a mistake.

Another not-trivial detail: many structured credits, particularly collateralized debt obligations, have what is called high embedded leverage. That is, a small fall in cash flow (due to defaults) has a disproportionate effect on value. That’s why some tranches were downgraded directly from AAA to CCC (super junk) in a single downgrade. A change of that magnitude is simpl unheard of in corporate bonds. So a small increase in defaults or delinquencies can trash this paper.And delinquencies ARE increasing.

And that gets us to the next fantasy, or misrepresentation, namely, that the Treasury will buy these dud assets, and somehow, miraculously, be bailed out by an improving market.

First, as we discussed above, things are going to get a lot worse before they get any better. For housing in particular, once it reverts to the mean, there is no reason to think it will bounce back to an unsustainable price level.

Second, the Treasury isn’t simply buying paper at above market prices. It will be buying it at price high than the banks are carrying it on their books. Remember, that’s a requirement. No bank will take a writedown. That would lead to a reduction in equity.

And despite the requirement that banks mark assets to market, the reason that so many of these markets are illiquid is that banks do not want the prices for assets to be discovered, since it would force them to mark their positions accordingly and take further writedowns. Look at Merrill’s sale of its AAA CDOs. The price was 22 cents on the dollar (actually, the cash portion was a mere 5 cents, the rest was contingent) . Note that Merrill’s had previously written down that paper. But in this program, Merrill would sell it only for its current book value, which for the CDO would have been a huge premium to the 22 cent market price. Otherwise, it would hang on to it and offload some other paper it could sell for at least its current carrying value.

So with book values in some cases above where the market would really be, banks having an incentive to offload their most mis-marked paper, and prices of risky credit instruments just about certain to fall further, the odds of Treasury showing a profit look to be sheer fantasy.

Print Friendly, PDF & Email


  1. Anonymous

    You write beautifully, compact, clear, accessible and tight.

    Yep, in a nutshell it’s fraud.

    Now what do we do?

  2. Anonymous

    Don’t you remember Judith Miller of the NYT? The one who wrote about the WMD in Iraq? The one who was involved in the Valerie Plame case?

    Ever since the Judy Miller affair came to light, I don’t trust much that is printed in the media. The mainstream media appears to be the publicity arm of the White House.

    I agree that the entire bailout appears to be a fraud.

  3. Anonymous

    On the one hand, you could argue that Merrill blundered by selling off their toxic waste at 22 cents since they could have gotten more for it, in hindsight, from Paulson.

    But on the other hand, it was only because Merrill was free of the toxic stuff that Bank of America was willing to buy them without a federal government backstop. Nobody was willing to touch Lehman without that backstop. An interesting what-if exercise.

  4. eh

    The financial firms most assuredly do not want price discovery at current levels,…

    This is exactly why the ultimate cost is right now unknowable. Once the government voids price discovery by buying crap debt from one institution, it will have to do likewise and buy the same or similar crap debt from any and every other institution that owns it. Otherwise imagine the outcry if they try to do some sort of triage, i.e. decide which insitituions will avoid this price discovery — and hence probably be more likely to survive — and which will not.

    The whole thing is a disgusting abomination.

  5. eh

    You write beautifully, compact, clear, accessible and tight.

    Very true.

    Yves, I am just a casual reader, but I would like to add that IMO you have one of the best financial blogs, if not the best financial blog, that I have seen. I am not a finance/money professional, so I really appreciate your clear explanations and trenchant commentary.

    I hope you will continue your very good and right now very important work.

  6. eh

    What did you think of Buffett’s comments on the bailout.

    I now put him in the same category as Bill Gross of Pimco. A bit more charming in an avuncular way, but just as unseemly, at least in this matter: I heard that he said he’s sure the bailout will pass, otherwise he would not have invested in GS.

  7. schmidty


    [[I now put [Warren Buffett] in the same category as Bill Gross of Pimco. A bit more charming in an avuncular way, but just as unseemly,]]

    Warren Buffett has always been a ruthless operator, notwithstanding his folksy charm. Marketwatch described some of his ruthless operations not too long ago.
    Marketwatch story on Buffett

  8. Hubert


    that was not exactly what Buffett said. He said he is to some extent betting on Congress to pass something along the HP plan.
    In my view this is not in the Bill Gross league of manipulating markets to his own book.

    But the one question I would have liked to hear and being answered by WB would have been: “Why this complicated and easy-to-mismanage paper buy from the banks? Why not 700 bn high interest preferred with warrants attachend. If Goldman does such a deal with you, why not mate the hoi polloi banks with Treasury?

  9. schmidty


    You say Buffett is not talking his book and trying to manipulate the system. However, Buffett didn’t just make a bet. Bloomberg reports that Buffett called the Paulson plan “absolutely necessary”. He’s talking his book. Just like Gross.

  10. MrM

    The Treasury argument is that hold-to-maturity prices would be much higher than current mark-to-market. However, there are many investors out there with long term investment horizons and plenty of capital ready to be deployed (e.g., private equity). Yet they are not buying unless offered really steep discount, like in the case of Lone Star and Merrill.

    Is Treasury thinking that if it holds these assets much longer than private equity would, it will recover more value???

  11. Anonymous

    “Yet the press has treated the plan with vastly more deference than it deserves.”

    Rep. Marcy Kaptur (D-Ohio) directly alluded to this unwonted delicacy of the presstitutes in an incandescent rant in the House, which is available on video.

    What’s stunning is the turnabout in official tactics. In my view, they have been pimping the GDP statistics for years to a put a fake rosy glow on the economy (GDP deflator underestimated = growth overestimated).

    Now, when “they” need to raise cash, the opposite tactic is adopted: dire warnings, from the president himself, of a looming recession that will curl your toenails. This itself is a lie — we’re already in recession, once you discount the statistical lies mentioned above. Nevertheless, the overnight shift from Bubble-blowing to scare-mongering shows that something evil is afoot.

    Yves has convinced me that the government CANNOT estimate fictitious “hold to maturity” securities prices — any more than it can estimate the proper prices for medical procedures covered by government health insurance. It just does not have the expertise, or the strength of character to spurn rent-seekers. The only way in which the taxpayers could avoid getting burnt to a crisp would be by piggybacking on private transactions, either as a secured margin lender, or as an equity investor in the players.

    Buying equity securities on the taxpayers’ behalf at market prices as Social Security assets might be a good idea, but scarfing up distressed debt securities at non-market prices — with government as the only buyer — is a TERRIBLE idea.

    Plainly and simply, the BARF (Busted A-hole Recapitalization Fund) is a monumental looting operation, designed by and for the Pigmen. If this passes, you are likely to find me out on the street in a balaclava, heaving bricks through store windows and torching cars. Color me berserko …

    — Juan Falcone

  12. Thomas J.


    I think you are missing the larger picture.

    The purpose of the “bailout” plan is not to keep the competition alive vis a vis stealth capitalization. That is smoke and mirrors.

    The bailout plan is in fact a liquidation fund that will allow a few chosen Pig Men to put the final stake in the heart of their competition without collapsing the entire financial system.

    Sure some Friends of Hank will be allowed to offload bad debt at above FMV but most financial institutions will become roadkill. And any good stuff on their balance sheets will be transferred to the chosen members of the banking cartel for pennies on the dollar. The private equity firms and SWF are waiting in the wings preparing to feed on the carrion.

    You apparently have a blind spot regarding the true nature of the power grab underlying the three ring circus.

    The ultimate objective is to strengthen the value of the dollar resulting in a greater overall value for the remaining money monopoly franchise members.

  13. baychev

    then you have the risk of the borrower throwing the towel and asking for a mod on the loan or otherwise.
    and then again since this is government sponsored, the ignorant real estate agents and apprasers now without jobs that will work for the TARP will mod the loan, and the collected principal will be even lower….

  14. Erich Riesenberg

    Buffett basically called for a massive, low cost of capital, leveraged fund to buy these assets at or below market value.

    It would have been great to ask him why that is so different from what Paulson and Bernanke have suggested, but it was CNBC. He does speak very highly of Pauslon, which is also queer. Soros had a nice piece on Paulson yesterday.

    Read the transcripts at

  15. williamdb

    Why is it people still waffle about this. The aim of the excercise being to recapitalise banks then of course the taxpayer must overpay for those ‘assets’.

    A $700bn injection into the markets would never have been enough. Only $700bn in new bank capital, leveraged into $14,000bn credit or more by same banks does the trick.

    Shouldn’t the debate move on to the inflationary impact and appropriateness of handing a $700bn capital present on a plate to banks?

  16. Ben

    Just like to add my voice to the chorus praising this post (and the blog). Excellent work. I especially appreciated the breakdown of the housing and debt market. It has been difficult finding good documentation or forecasts of just what is weak and why. Wish I could find a similar analysis of UK and European debt.

  17. Anonymous

    joebhed said

    The perhaps ignorant one here.

    What are they worth?

    It’s mostly housing-related RMBS and CMBS.

    The average selling price of a house in a normally functioning economy is related to, if not established by, the average worker’s wages/salaries.

    That makes the house affordable.

    Index the average wage/average selling price at 2001, when MOST of this started, to the average wage today, and you can see that we have a Loooooooooong way to go before housing prices settle out and become any semblance of a driving factor in the economy.

    My guess is still dropping by 40 to 50 percent.

    That is what they are worth today, and project FROM THAT POINT out ten years the average wages driven by that economic reality, and you have what a long-term investment price should look like for taxpayers.

    It should be, to turn a phrase, very friggin CHEAP!

    VERY !

  18. Anonymous

    Does anyone ever know what goes on behind closed doors?

    The media has often been the voice to manipulate the people when the oligarchy can’t reach them, which is why we need you, Yves…

    So now should we expect the Americans to choke down the jagged little pill? Just because it’s been “explained” by some misinformed media puppet?

    Sorry, not this time. I’m still going to write my Senators today and say NO – people NO!

  19. Independent Accountant

    “Dreck”, I love it. As I have said since October 2007, the purpose of MLEC, the bailout, etc., is just what you say: to prevent price discovery. All the rest is smoke and mirrors.

  20. Laurent SJ

    I trully hope American people aren’t that stupid. They, and many foreign USD reserve holders, are about to get screwed BIG TIME ! don’t let these bastards get away with it ! SAY NO !

  21. tompain

    If everyone decides to sell US stocks at the same time, the stock market will drop dramatically. Will that mean that the aggregate value of the US economy has dropped the same amount? Of course not.

    There IS such a thing as a fire sale where assets trade hands at less than what they are worth to someone who is not in a hurry to sell.

    Right now you have a lot of banks who need to sell because of pressure on their balance sheets. It IS possible – even likely – that these assets in the aggregate are worth a lot more than their current trading value.

    Someone will ask, if that’s the case, why isn’t private capital stepping up to buy those assets. Probably it is, but you are not hearing about it because there is no one big enough to do it on a scale that would make a splash amongst the gigantic ocean of assets that the banks are holding on their balance sheets. Also, the reluctance of banks to sell is itself a manifestation of private capital holding these assets. Finally, it is difficult for private capital to move aggressively when there is so much uncertainty about what the government is going to do. Look at how FRE and FNM were turned away by private equity, not because the potential investors saw no fundamental value, but because those investors were frightened by Paulson’s bazooka.

  22. LJR


    Nice exposition!

    Additionally: the distribution of the money will be for the bad assets of Friends of Hank. Once GS et al are flush with taxpayer money they will proceed to pick the bones of all the smaller and less favored banks for the choice assets.

    By the time Paulson, Buffet and Gross are finished there will be far fewer regional banks. This is an unprecedented power grab on the part of the mighty.

    Very sad times.

  23. Let It Sink

    My favorite “expert commentary” on this subject I have heard several times, which is that the tax payers will likely make a profit on this deal. I don’t know if these experts are that gullible and dumb, or if they are just criminally complicit.

    My bet is that Wall Street is not going to admit the Bald Guy and his $700 Billion into their private reserve cellar of outstanding assets and offer him great prices out of gratitude. They are going to sell him truly valueless assets which have been hiding in footnoted partnerships, and they’re going to charge him billions. And as the administration’s latest manifestation of evil, he will write checks as fast as he can.

    Why doesn’t Paulson just buy an office stapler from Goldman for $140 billion and finish the charade. The stapler has more value than any of the great investments that the taxpayers are likely to end up with.

  24. squeezed

    Funny how all the individuals who speak highly of Hank stand to lose a lot of money if the financial system implodes.

  25. Lewis B. Sckolnick

    If this plan is a go then we still end up with a lot of junk paper which will only drive the problem and that is what is being missed. Write it off and we honor those who got us here and insure that they are well rewarded for their work.

    Warren Buffett and others who are successful in our civilization will always be in the crosshairs.

  26. Adam

    There are two sides to every debate, the other side of the Paulson plan is covered nicely by Kessler in today's WSJ.

    Buffett's book rests far more on those S&P puts he wrote than on a generous preferred investment and some warrants.

    "The second category of contracts involves various put options we have sold on four stock indices
    (the S&P 500 plus three foreign indices). These puts had original terms of either 15 or 20 years and were
    struck at the market. We have received premiums of $4.5 billion, and we recorded a liability at yearend of
    $4.6 billion. The puts in these contracts are exercisable only at their expiration dates, which occur between
    2019 and 2027, and Berkshire will then need to make a payment only if the index in question is quoted at a
    level below that existing on the day that the put was written. Again, I believe these contracts, in aggregate,
    will be profitable and that we will, in addition, receive substantial income from our investment of the
    premiums we hold during the 15- or 20-year period."

  27. RJMConsulting

    Mark to maturity is not, in theory, bunk. But eliminating the moral hazard may be so impossible as to have it in effect result in the “dreck” you so easily and obviously point out.

    A fair subset of these assets were completely customized. The use of “mark to market” is a terrible concept with highly individualized products, and shame on banks and accounting principles for failing to recognize the huge gap between “realizable capital” (for which mark to market is wholly appropriate) and “theoretical capital” which may be completely unreliable and therefore should be (have been) haircut drastically in ratio constructions.

    There is no question that some of these assets were pure yield pursuit, and woebetide the bankster now seeking to reach into taxpayer’s pocket to cover the aforementioned gap on those assets.

    But some of these assets were constructed for private utility: bespoke CDOs/CSOs may have offered hedging value to X’s portfolio that has next to no value to Y (or anyone else).

    In a stable environment (or so says the theory), the customized asset may perform with expected losses implying a price far above the price attainable in a “gun to the head, must sell to delever now” auction.

    For simple RMBS deals, I don’t disagree that if the loss expectations using 35% declines in housing prices means equity (and junior and mezz debt?) are gone, ‘dems da breaks. But if the seniors (still representing the vast majority of the RMBS’s capital structure) survive (even with some losses), buying those pieces at something like a mark to maturity may be one way to soften what is undeniably going to be a hard landing.

    I don’t think there is an expectation that purchased assets will return 100% (at maturity), but I think they might return [50-60?], and paying between 50 and 70 for a defined subset of them might help.

    In any case, pragmatism tells us that the ship has sailed (some “plan” is inevitable), better to spend effort on correcting the details and pushing on the rudder, rather than standing on the dock holding onto a line and pretending that you can bring it back.

  28. williambanzai7

    OHN McCAIN Meet Wall Street

    The following Vietnam War Fighter Pilot JARGON key is provided in order to expedite discussions and reduce confusion with John McCain concerning TARP

    Agent Orange: A toxic equity tranche
    Body Count: Number of bankers fired
    E&E: Escape and evasion tactics: Often applied by Wall Street CEOs and politicians
    Hootch: What investors smoke before they visit Bear Stearns and Lehman
    Gook: What you will find in Lehman and AIG's financial footnotes
    Level 3 Asset: Covert assets
    DC: Dick Cheney then, Dick Cheney now
    C Rations: Stale sandwiches from Kaplans deli.
    AWOL: Chairman Cox during the runup of the great meltdown.
    Delta neutral: A Wall Street hedging strategy not to be confused with Mekong Delta.
    Oversight: What Congress must do: Excuse us for the oversight.
    AAA: Anti Aircraft Artillery/ also Rating Agency Jargon
    AVRN: Already Very Rough Numbers
    Go juice: Prune juice
    HUD: Heads up display (Housing and Urban Development, where the subprime mess started)
    Ho Chi Minh Trail: AMTRACK
    Golden Parachute: Every pilot and CEO must have one
    Tailhook: The contingent liability payable under a CDS
    SAM: Securitised asset markdowns
    Bandits: Wall Street Bankers
    Jesus Bolt: The nut that holds everything together (Hank Paulson)
    Gigahertz and Nanoseconds ~ Highly technical, detailed, and hard to understand ("It's getting down to gigahertz and nanoseconds.")

    Lost the Bubble ~ Got confused or forgot what was happening. Alan Greenspan lost the bubble.

    Loud Handle ~ Lever or grip that fires ejection seat. Often used by Wall Street CEOs.

    LTCM: An early Wall Street ICBM

    Peter Pilot ("PP"): Affectionate name for inexperienced pilot newbie or Vice Presidential running mate.

    R&R: What Congress takes every 3 business days and what George Bush does for a living.
    Selling short: What the US government does to its Armed Forces
    Smoking Hole ~ A bottomless write off.
    TOP Gun: A derivative salesman
    Tunneling: What hedge fund managers do to opaque financial reports
    Up on the Governor ~ When someone is about to have a tantrum (term comes from the device that keeps the engine from overspeeding).
    Up to Speed, or Up to Snuff ~ To understand or to know what's going on.
    Swiftboating: There you go again ;-)
    Unknown Unknowns: The OTC derivatives market
    FWMD: Financial Weapons of Mass Destruction

  29. FR

    Hello Yves,

    “The banks are free to sell now at market price, but they aren’t willing to”

    I’m not sure it’s all that easy.

    In the current market many bids available are for a given and usually small size. You can for instance have a quote like 28/32 percent on a given bond, but this quote works for 10m. After the first seller hits the offer, the quote moves to, say, 26/30. As this goes on, you reach a level where noone wants to sell, as they feel like it’s absurdly low. What this is all about the market’s capacity to absorb these things being quite limited compared to the size of the holdings (which go into billions) as there are no natural buyers on the other side.

    If Paulson comes in and bids 35 for 500m, of this imaginary security, it will 1) put a floor 2) the willing sellers will be able to sell if they decide so 3) the market will be liquid and tradeable…

    You already know my view on this…

  30. aaron


    Let me know what you think of this small adjustment which I think would make the plan exponentially better.

    Only after the price of a troubled asset is declared will the government consider buying it at or above that price.

    Personally, I think this step might solve many of the plan’s problems at one fell swoop. Banks will try to value their assets low enough that they’re worth buying, but not too low–which would reduce the intensity of negotiation. The only problem is that it may reduce the effectiveness of the plan by limiting the effect of the program.

  31. Anonymous

    “I am not advocating that the government intentionally overpay,” Bernanke told the Joint Economic Committee today, in response to a question from U.S. Rep. Jim Saxton, a New Jersey Republican.

    Is Bernanke deluding himself or just plain lying when he made the above statement? The entire thrust of the program he and Paulson are advocating for is for the taxpayer to pay a higher price for the purchased assets than their present mark-to-market values, thus unclogging the system. So, unless someone does not believe that the FMV of these assets is adequately reflected in their current carrying values, the intention of the program IS to overpay for them.

  32. Lewis B. Sckolnick

    Why are we not going after the people who wrote the fraudulent paper in the first place. How long will it now take us to ask what have we wrought?

  33. Lewis B. Sckolnick

    Banks are holding paper for properties no one wants because of the crime rate. The Greater Cleveland area is one example with hundreds of houses sitting empty because of the danger.

    We let people burn down our cities in the 1960s and 1970s and that transformed the real estate market.

  34. donna

    There’s a reason many of us now get our actual news from reading blogs and not the media. When I send things out to my own political list, I usually try to quote media, but this week it’s been mostly posts from economic bloggers. The media coverage has been crap, except for what Krugman has been writing.

  35. Dan

    I understand that the explosion in the OIS spread is a reflection of the fear banks have for each others solvency. And it makes sense that it exploded right after the bankruptcy of LEH–it was not the bankruptcy per se, IMO, but the that $110b of senior LEH debt went from trading .95 to .12 in a matter of days that concentrated the market’s attention. If you include the less senior debt that is trading at essentially zero, LEH had $110b hole in its balance sheet. And just days before this, the market was being told and was believing that the $10b disposition of Neuberger was going to solve their funding problems.

    Now is there a precedent in this history of bankruptcy–excluding cases of accounting fraud–where bonds collapsed like this once a bankruptcy court opened up the books? I’m thinking the answer is ‘no.’ Which then makes you re-evaluate the premise that there wasn’t fraud at LEH in marking the value of their assets.

    Now extrapolate this reasoning across the entire banking system and, voila, you have the seizure of the interbank lending market.

    Now this leads me to the question: if the OIS spread represents eminently legitimate fears of inaccurate marks on banks books, how is a commitment from the treasury to buy hundreds of billions of distressed assets from the banks any assurance to a counterparty that that bank will not still become insolvent. Obviously it helps on the margin, but the staggering hole in LEH’s balance sheet that was revealed after bankruptcy creates profound fears about the true solvency of C or UBS. Until the market is convinced they are solvent–and TARP does not do this–the OIS spread will remain elevated and lending will remain frozen.

    Alright, take your shots–what is wrong with this reasoning?


  36. James Moore

    I’m an amateur around here. I’ve been reading too many econ blogs, but I’m not going to pretend to be a professional.

    But I still don’t understand, _at all_, why people can say that these things are hard to value and still keep a straight face.

    You start the bidding at a dollar. You see who will pay more than that. Repeat. Isn’t this the capitalism you learned back in third grade?

    All the whining in the world doesn’t change the fact that it’s trivial to determine a market price for something. You may despise that market price, you may have a huge raft of excuses why that market price is lower than some fantasy “real” price, but you need a giant helping of STFU. Pardon my French.

    None of the excuses even seem slightly relevant. Lack of transparency? Complicated by the number of mortgages and the way they’re split up? The porridge is too cold in the company cafeteria? NONE OF THIS MATTERS. AT ALL. Get bids. That’s your market price. Done.

    Go cry, sure, cause those factors mean that the real, market price on these things is something approximating what I’m planning on spending for lunch. At home. And it involves cold turkey.

  37. Anonymous

    > set a long-term value on
    > assets, holding them until
    > they mature or markets
    > improve.

    Isn't that a direct quote from the people pushing fake values on homes and telling homeowners they'll eventually be worth what the lender's trying to trap them into paying??

    Hell, why not just make a law that all real estate must be valued at what it will be worth say 30 years in the future?


  38. Matthew Dubuque

    Matthew Dubuque

    Yves, thanks so much for a truly outstanding article!

    I’m DELIGHTED you brought up the Merrill sale at 22 cents on the dollar. This is truly a price that has some rational relationship to the true state of the market. And conditions have materially worsened since that sale.

    Why does all the “informed commentary” REFUSE to mention this sale of Merrill?

    And Bill Gross this morning is talking on XM Radio about 66 cents on the dollar?

    My, my.

    ALSO, I have heard NO PERSON talk of the real possibility that Paulson will be BUYING THESE SECURITIES ON MARGIN. Recall he is doing precisely that now with FNM and FRE.

    There are obvious advantages to a free society. HOWEVER, EVERY member of Congress should be forced to read this great piece of yours prior to their vote.

    No exceptions.

    Matt Dubuque

  39. Anonymous

    I generally enjoy the blog, but this particular entry is a bit oversimplified and, as a result, (wrongfully) attributes some type of deceit or willful ignorance on the part of Bajaj.

    You note that the Government will be paying “above market,” which is obviously true in some sense. But it ignores the view of many that the market is currently beset by a dislocation caused by short-term illiquidity fears. The consequence is that current market prices are artificially low, akin to how monopoly prices are artificially high. If the theory is right, a well-heeled buyer (e.g., the Government … or Warren Buffett) can buy in now, wait out the storm, and sell at a profit later, even if they pay “above market” today. The debate in Washington over whether to pay “market” value, book value, or something in between (which Bajaj is accurately reporting on) is driven by differing assessments about how much we can afford to pay above market today, how much we might recover (if any) when the market returns to normal (if ever), and what the political winds will tolerate.

    This dissent aside, keep up the good work.

  40. ceremona

    I am always amazed how we can pull enormous amounts of money out of thin air for things like this but can seem to solve “complex” issue like national health care, etc.

    Why are we doing this bail out post-leverage at all?! That is the most expensive way to do a bailout that I can think of. It’s like paying the price of the defaulted homes * leverage (which is upwards of 30 in many cases). For a bargain price we could bail out these defaulted homes directly and have the tax payers get a cut in the upside on repayment and should the home value appreciate. This is what is in Nouriel Roubini’s plan as well:

    Is anyone in our government listening?!

  41. LightWait

    To DAN, September 25, 2008 1:06 PM

    Your reasoning is sound, but I am not expert enough to take a shot.

    However, I am humble enough to ask you a question that no one else seems to think is worth answering.

    Will PRICE DISCOVERY of toxic assets occur in the LEH bankruptcy proceedings?

    If YES, then why does Paulson et al need to have a reverse auction or any mechanism like that?

    If NO, then clearly I have even less understanding of Bankruptcy law than I thought.

    Looking forward to your reply.



    (to the melody of Puff the Magic Dragon, Peter, Paul & Mary)

    Adapted by WilliamBanzai7
    POOF!, the bailout dragon lived by the subprime sea

    And frolicked in the autumn mist near a land of Wall Street greed,

    Little Hanky Paulson loved that rascal POOF!,

    And brought him mortgage backed securities and other fancy finance stuff. oh
    POOF!, the bailout dragon lived by the subprime sea

    And frolicked in the autumn mist in a land of Wall Street greed,

    POOF!, the bailout dragon, savior of all deadbeats,

    And frolicked in the autumn mist in a land of Wall Street greed.
    Together they would travel on a workout boat with billowed sail

    Hanky kept a lookout perched on POOF!s gigantic tail,

    Finance kings and princes would bow wheneer they came,

    Pirate ships would lower their flag when POOF! roared out his name. oh!
    POOF!, the bailout dragon lived by the subprime sea

    And frolicked in the autumn mist in a land of Wall Street greed,

    POOF!, the bailout dragon, savior of all deadbeats

    And frolicked in the autumn mist in a land of Wall Street greed.
    Wall Street lives forever but not so little boys

    Without leverage and quantitative finance you can't make make fancy toys.

    One grey night it happened, Hanky Paulson came no more

    And POOF! that mighty dragon, he ceased his fearless roar.
    His head was bent in sorrow, greenbacks ceased to rain,

    POOF! no longer wanted to play financial legerdemain.

    Without his life-long friend, POOF! could not be brave,

    So POOF! that mighty dragon sadly slipped into his bailout cave. oh!
    POOF!, the bailout dragon lived by subprime sea

    And frolicked in the autumn mist in a land of Wall Street greed,

    POOF!, the bailout dragon, savior of all deadbeats

    And frolicked in the autumn mist in a land of Wall Street greed.

    sent from:

Comments are closed.