March 23, 2009

Déjà Vu About Vujà Dé

I once crafted a neologism, vujà dé, bouncing off of the psychological term déjà vu -- the false feeling that something you are now experiencing happened before. My new word vujà dé means -- the false feeling that something that actually happened before is really brand, spanking new!

I woke up this morning -- well, this afternoon -- and read the following new financial-rescue plan from Treasury Secretary Tim Geithner:

The Obama administration formally presented the latest step in its financial rescue package on Monday, an attempt to draw private investors into partnership with a new federal entity that could eventually buy up to $1 trillion in troubled assets that are weighing down banks and clogging up the credit markets....

Initially, a new Public-Private Investment Program will provide financing for $500 billion in purchasing power to buy those troubled or toxic assets -- which the government refers to more diplomatically as legacy assets -- with the potential of expanding later to as much as $1 trillion, according to a fact sheet issued by the Treasury Department.

At the core of the financing package will be $75 billion to $100 billion in capital from the existing financial bailout known as TARP, the Troubled Assets Relief Program, along with the share provided by private investors, which the government hopes will come to 5 percent or more. By leveraging this program through the Federal Deposit Insurance Corporation and the Federal Reserve, huge amounts of bad loans can be acquired.

The private investors would be subsidized but could stand to lose their investments, while the taxpayers could share in prospective profits as the assets are eventually sold, the Treasury said. The administration said that it expected participation from pension funds, insurance companies and other long-term investors.

This gave me an intense feeling of déjà vu (not vujà dé); didn't... we... see something like this sometime before? Not very long ago? Something... something... it's all coming back to me now....

Oh, wait. This may be it:

As proposed by Secretary of the Treasury Henry Paulson and Chairman of the Federal Reserve Ben Bernanke, the putative "$700 billion" "bailout" is actually neither: It will neither cost that much, nor will it bail out those financial institutions that wrote bad loans for people they knew were not likely to be able to pay them off.

As I understand it, here is the basic plan. Note that I'm drawing this from many sources, it's not yet written in stone -- or even in ink -- and I can't give you sources. If you want more information, you're on your own! But here is what I've been able to glean:

1. The Treasury is given authority to spend up to $700 billion (outstanding at any particular moment) to buy MBSs, CDOs, and related instruments that have become "illiquid." These "toxic assets" will be purchased from their current owners at a huge discount... meaning the banks and other investors who purchased these pigs in pokes will, in fact, take a significant financial hit... they're not being "bailed out."

So the Treasury can buy up these toxic assets; what do they do with them?

2. I believe the plan (which has not yet been formalized in legislation) is to create a Treasury owned and managed resolution corporation that will take ownership of these toxic assets. Analysts will then pore through each MBS, determining the status of all the underlying mortgages and making a report publicly available. This will make the opaque assets completely transparent. All the financial fundamentals will be visible, so analysts at private companies can examine all of the securities and decide how much they would pay for each.
3. The resolution corporation will then auction off each of the the now-transparent MBSs, selling it to the highest bidder; that very action allows the market to reset the value of the security.

That is why I characterize this rescue operation as "pressing the reset button."

Once some corporation has examined the fundamentals of the security and offered the winning bid for it, the MBS becomes (by definition) liquid; it is no longer a toxic asset. Its value has been reset... and it can go up or down after that point based upon subsequent, well-understood events (defaults, repayments, prepayments) in the underlying mortgages and reevaluations based upon other, market-based criteria. In other words, it becomes just like a mutual fund.

The crisis was the inability to value MBSs; the solution is to reset their values. The beauty of the Paulson-Bernanke plan is that this resetting is done by the free market, not by government decree.

Finally, note this point:

4. When the Treasury-owned resolution corporation auctions off the now-transparent MBSs, it can use that money as income. Since the asset is now much more valuable than before (having been scrubbed into transparency), if it becomes saleable, then it will certainly sell for more than the discounted rate at which the corporation bought it. In other words, the resolution corporation will make a profit on every security it resells -- so the program will not actually cost $700 billion... it may even end up completely in the black.

That's why the Paulson-Bernanke plan is neither a bailout -- the so-called beneficiaries in fact must pay dearly for their folly -- nor massively expensive, since it resells most of the securities it bought, and at a profit. It could still end up costing money, depending on how many of the MBSs end up still toxic even after the complete report (if too many of the underlying mortgages are in default, for example); but the losses won't be anywhere near $700 billion, and they may be less than the profits.

That was a Big Lizards post from September 22nd, 2008; the differences between the old plan, from almost exactly six months ago -- developed by George W. Bush's Treasury Secretary Hank Paulson and then Chairman of the Federal Reserve Ben Bernanke -- and the new plan just proposed today by Barack H. Obama's Treasury Secretary Tim Geithner and current Chairman of the Federal Reserve Ben Bernanke are... well, subtle:

• The Paulson-Bernanke plan wasn't quite as expensive as the Geither-Bernanke plan;
• It didn't have the patina of private investors coming along for the ride (heavily subsidized by the federal government and leveraged by the Federal Deposit Insurance Corporation, FDIC) that we see in today's version;
• In the original version, the government would buy the toxic assets from their current owners at a discount; Treasury (or a Treasury-owned resolution corporation) would investigate and "valuate" them (determine the actual value of the underlying mortgages that make up each mortgage-backed security, MBS, and related debt instrument); and then private investors would buy the formerly toxic, now liquid assets from the government at an auction. In the new version, the government will partner with private and corporate investors, leveraged by the FDIC, to buy the assets; then they would be auctioned to other private and corporate investors.

I don't know about you all, but the distinction between the two plans doesn't leap off the screen for me. The Times doesn't report whether the feds will undertake the intermediate step of investigating and reporting the details of these toxic assets, but I think it must be so; I can't see how else could they be turned from illiquid to liquid, except by injection of what I called in a later post, "timely, honest, accurate, and believable information," or THABI.

It seems I wasn't suffering from déjà vu after all. As the great sage Bert the one-man band, sidewalk chalk artist, and chimney sweep said, "Can't put me finger on what lies in store, but I feel what's to happen all happened before."

The current plan even includes the reset-by-auction of toxic assets that I gleaned from the original plan; from the Times story above:

An attractive feature of the program is that it will allow the marketplace to establish values for the assets -- based, of course, on the auction mechanism that will signal what someone is willing to pay for them -- and thus might ease the virtual paralysis that has surrounded those assets up to now.

For a relatively small equity exposure, the private investor thus stands to make a considerable return if prices recover. The government will make a gain as well. In the worst case, the bulk of the risk would fall on the government. The presumption, of course, is that the auction will lead to realistic purchase prices.

So where does vujà dé (not déjà vu) enter into it? Simply this: I haven't seen a single elite-media commenter point out that this is the very same plan we started with... lo these many months ago; the same plan that was quickly derided by congressional Democrats, railed against by presidential-candidate Barack Obama, dismissed as nonsense by voters (and by Wall Street), and derailed in favor of direct investments in -- that is, nationalization of -- banks, savings and loans, insurance companies like AIG, and so forth.

Everyone writes and speaks as though this is a brilliant innovation -- imagine, buying up toxic assets and using public auctions to establish a "realistic purchase price" for them! Who but Geithner could possibly have thought of such a corker of a solution? He's finally demonstrated the mental superiority with which he was hailed when he was nominated (so brilliant, we simply had to overlook that little kerfuffle about evading income taxes when he worked at the International Monetary Fund).

I still have a few questions:

• How long will the elite media continue to heap scorn upon that fool, Henry Paulson, and his ludicrous plan to buy up toxic assets -- while lavishing praise upon that genius, Tim Geithner, for his fantabulous plan to buy up toxic assets?
• And what about the hundreds of billions (or is it over a trillion? I can't remember) already spent or pledged by the federal government to buy "equity interests" in hundreds of financial corporations? Do we perpetuate the mass nationalization program even as Treasury crows that the wonderful thing about the new rescue plan is that it privatizes the bailout?
• Does the Obama White House suffer from Multiple Ideology Syndrome?

Everything old is new again, the wheel has come full circle, and what a long, strange trip it's been!

Hatched by Dafydd on this day, March 23, 2009, at the time of 3:30 PM

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