Couldn't The Taxpayer Make Money From the Bailout?
So, apparently the US government is going to authorize up to $700 billion taxpayer dollars to purchase distressed financial assets. I had an email today that said, to paraphrase, couldn't the government make money off these assets if they buy them for the right price?
My first thought was that this was theoretically possible, though my internal cynic found it unlikely in a pricing game run by elected officials between the taxpayer and powerful Wall Street interests that taxpayers would get the upper hand.
But then I realized there was no possible way this will end well for taxpayers. Because the government cannot exercise discretion in day to day financial decisions. It establishes rules and benchmarks and the typical bureaucrat is punished far worse for violating these processes and rules than he/she ever is for reaching a bad result. So the government will establish rules and benchmarks for what price at which they will buy assets (this will be all the more true given the great rush everyone seems to be in). And having set this in place, do you know what assets will be put to them? All the ones that the current holders think are worth less than the benchmark. This is the winners curse on steroids.
Update from Megan McArdle:
there's a gigantic asymmetrical information problem: the owners of
these securities know much more about them than the Fed. And there
isn't (obviously) a large liquid market for the Fed to check against.
So the Fed is likely to overpay, because there won't be a lot of
bidders in any one auction.
Megan, of course, reluctantly supports the bailout where I do not. But she has her eyes open about what she is buying into.
bill-tb:
And if they do, what will they spend it on? Isn't that the real problem?
September 25, 2008, 4:57 pmJohn Moore`:
Consider the following:
1) Cost of funds to the gov is less than to anyone else. That gives them an advantage in pricing.
2) If the gov is the buyer of last resort, it should be able to pay low. If the sellers don't like the low price, they are free to not sell and suffer the consequences.
Regardless of the above, the big numbers are thrown around as if they are the cost to the taxpayer, with zero return. That's just plain wrong, even if the government overpays.
You are against the bailout. What is the alternative? I would really like to see you post on that, because I suspect you have a pretty good answer.
Do you believe that if the gov stays out, the chips will settle where they should and we will cruise on to free market nirvana?
Do you think the credit markets will continue to function?
What if things just lock up?
What exactly is the scenario if the gov stays out?
September 25, 2008, 5:22 pmmorganovich:
an asset purchase could certainly make money if run properly. the original RTC did in the 90's. when they finally dumped all the $ back into the treasury it led to the surpluses of 2000 and 2001.
alas, this is not looking likely as far too much political interference has emerged.
most worrying is the idea from barney frank (one of the key freddy and fannie apologists and a key architect of this mess) that judges ought be able to arbitrarily alter the size of an outstanding loan, suspend the requirements of payments, and make the house unsiezeable as collateral. imagine what this will do the the cost of lending. mortgages will start to be priced like credit cards. it would also hammer an already complex and fragile CDO market. barney really is a fool. his populist instincts will dig the foundations right out from under any rescue.
were i paulson, i would walk away. the plan proposed by the house finance committee is too grievously flawed to even be worth consideration.
September 25, 2008, 6:48 pmDoug G.:
It doesn't seem likely the government could profit from these. If there was even a potential of profit to be made, I would expect private enterprises would already be buying them up.
September 25, 2008, 7:07 pmErikTheRed:
I liked this (NSFW!!!) take on it: http://www.sinfest.net/archive_page.php?comicID=2942
September 25, 2008, 7:26 pmKyle Bennett:
John,
You're right on, in both the fact that the "bailout" is not a donation, but a very risky investment that carries an almost certain return of some amount, and a very real possibility of profit - and in your identification of the important questions.
The talking heads on the right are describing this as something being done to protect the Wall Street bankers and wheeler-dealers. It may do that for some of them, but the problem it is trying to solve is that if the credit collapse is not short-ciruited, it could very well collapse to zero, and credit cards and checks basically cease to function. Might be OK so long as you have cash in your pocket to spend and the stores haven't run out of whatever inventory they had before the supply trucks stop coming, but come payday, that slip of paper in your pay envelope will be useful for rolling a doobie, and not much more.
I don't think the proposed solution is the best one to solve that problem, but it's important to at least properly identify what the problem is.
Doug,
The problem is that, regardless of the long-term potential returns on this paper, there is literally no-one on Earth anymore with enough money to buy it - or at least enough of it to keep the markets and banks running. It's the difference between liquidity and solvency. For instance, a very common cause of small business failure is liquidity, not solvency. It is like not being able to pay your bills, even though you have more assets than liabilities. Payment to your vendors is cash only, and your payables are all 60 days out - you're out of business even though you are solvent. Your vendors won't take payables for in exchange for their goods.
The US Treasury is the only entity for whom not having the money is no obstacle to spending it. They're going to become the creditor - like your vendors are - and take the payables to settle the bill, along with a stake in the business. And they're buying it all at the very bottom of the market, assuming the plan works and they don't all collapse to zero.
The question is whether those payables, the mortgages and other debt owed by all of us, will ever actually come in or not... aside from the more disturbing question of whether we want the government owning parts private companies in the first place, and having true dictatorial powers over the parts they don't own outright.
September 25, 2008, 8:12 pmCaptain Obviousness:
I think the libertarian misconception is that the market is still functioning right now. At this point the securities are irrationally being valued as nearly worthless. That means companies should buy them up, right? No, because no one will lend to companies with these on their balance sheet. They will go under because they won't be able to meet their immediate obligations. If no one wants to "be seen" holding these securities, they are worthless regardless of their actual underlying value which, granted, no one actually knows. The bottom line is these securities are tied to mortgages, to real physical homes. What percentage of people will default? 10% at the very most? Assuming that is the case, there is no rational reason to value the securities at 30 cents on the dollar. But if everyone thinks no one will buy them, they are effectively worthless. The government is the only one who can afford to buy them and hold them for 5-10 years until it is clear to everyone that people are in fact paying back their loans.
And even if they didn't, the alternative is I think a depression. No one will lend to anyone, and the economy will collapse. It is worth pinching our noses and bailing out the "fatcats" if it means averting a depression.
September 25, 2008, 10:16 pmQuincy:
Bingo. The market simply isn't functioning, and it isn't functioning due to massive distortion from Washington. Fannie and Freddie, along with various other regulations, have thrown the credit market into chaos, and it responded by locking up. The only answer I see is for Washington to vacuum up enough of the Washington-induced bad debt to allow the markets to function again. Think of it like dialysis for the US financial system instead of a simple "bailout" and it makes much more sense.
September 25, 2008, 10:46 pmjimk:
Actually, I would say that the "hard core" libertarians believe that the market is working. In fact libertarians do not believe that there are "market failures" only distortions of the price discovery mechanism, usually caused by government intervention. What we do know right now is that there is a significant bid-ask between the level financial institutions are willing to part with their bad mortgages and the level that private profit seeking investors are willing to pay.
In the mean time it is a rational response if you are a bank with excess reserves to hold onto those reserves, because you do not know if the financial institution you are lending to is solvent based upon current market prices or not.
The treasury bailout plan pre-supposes that the real value of the assets is higher than what private investors are willing to pay for them at present and proposes to pay an above market prices to "get things moving again". I have no idea if the treasury is right or not, what I do know is that this is exactly what libertarians decry -- government interference in the price discovery mechanism. So to say that the market is not functioning right now is a misconception. It is more correct to say that most people do not like what the market is telling them right now.
September 26, 2008, 7:11 ammorganovich:
if you want to take the true libertarian lesson away from this situation it is this: freddy and fannie were a bad idea. it was governmental interference in a market that horribly distorted it by extending credit where it ought not have been extended and by sucking all the the profit out of the private sectors lending by using a tacit government debt guarantee to get cheaper access to capital.
while not a financial services expert, i have been a fund manager for 15 years and i am here to tell you that absent freddy and fannie, this would never have happened. the next time you hear washington begin to demand "access to housing for the disadvantaged" remember that this is where it leads.
allowing the government to underwrite a massive drop in lending standards without a corresponding increase in interest rates is what got us here (and a housing bubble). now, they are going to have to reap what they sowed else watch the whole system lock up.
September 26, 2008, 8:12 amheretic:
So let's just say that by some miracle, the Feds are clever enough to price the assets to their advantage instead of just viewing this as yet another opportunity to "inject liquidity" (i.e. print money).
Then we will assume that the economy recovers, and in 5 years they are sitting on a gain.
What exactly do you think the feds will do with this windfall?
a) Close down the operation, and rebate the taxpayers their $2500 per capita plus profit,
b) Hold on to their new found power, and dispense the spoils based upon traditional political incentives.
Based upon what prior experience should we trust that a government will relenquish power once it has been seized?
Nationalizing the mortgage and banking industries may in fact be the end of capitalism.
Here you can see how hard they are trying to get the best deal for the taxpayer:
September 26, 2008, 10:08 amhttp://www.bloomberg.com/apps/news?pid=20601087&sid=aEyg9syOgmjE&refer=home
Payday Loan Advocate:
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