Big Lizards:Blog:Entry “Democrats Try to Hijack the So-Called "Bailout"”

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September 22, 2008

Democrats Try to Hijack the So-Called "Bailout"

Hatched by Dafydd

Republicans see the collapse of the mortgage market as a potential catastrophe that requires emergency measures... but an aberration caused by government intrusion into the market, not an indictment of capitalism and free markets.

Democrats see it as proof positive that capitalism has been proven to be a fad that will soon pass away, like pet rocks... and a golden opportunity to reintroduce failed liberal fascist economic policies straight out of the platforms of Woodrow Wilson, Franklin Roosevelt, and Jimmy Carter.

Which George W. Bush will show up... the veto-wielding Bush with a spine that we've seen in Democratic spending legislation after the 2006 elections -- or the wimpy, appeasing Bush that we've seen in legislation on racial preferences, Israeli-Palestinian "negotiations," and Republican spending prior to the 2006 elections? The choice will spell the difference between a small-footprint intervention or a massive repudiation of decades of progress on free-market economics.

But first, let's again talk about how we got into this mess.

Subprime mortgages, securitization, and toxic assets

This is the crux of the crisis: Back in the cretaceous period, when a bank or S&L issued a mortgage, it held that mortgage until the borrower paid it off. But in the contemporary era, what starts out as a mortgage is typically bundled with other mortgages into a "mortgage-backed security" (MBS) -- essentially bonds that can be traded on the open market. Bizarrely, in the process, bad debt automagically becomes good investment.

How are MBSs created? Let me quote from an excellent sumary in a newsletter by John Mauldin (free registration required):

Let's jump back 18 months. I spent several letters going over how subprime mortgages were sold and then securitized. Let's quickly review. Huge Investment Bank (HIB) would encourage mortgage banks all over the country to make home loans, often providing the capital, and then HIB would purchase these loans and package them into large securities called Residential Mortgage Backed Securities or RMBS. They would take loans from different mortgage banks and different regions. They generally grouped the loans together as to their initial quality as in prime mortgages, ALT-A and the now infamous subprime mortgages. They also grouped together second lien loans, which were the loans generally made to get 100% financing or cash-out financing as home owners borrowed against the equity in their homes.

Typically, a RMBS would be sliced into anywhere from 5 to 15 different pieces called tranches. They would go to the ratings agencies, who would give them a series of ratings on the various tranches, and who actually had a hand in saying what the size of each tranche could be. The top or senior level tranche had the rights to get paid back first in the event there was a problem with some of the underlying loans. That tranche was typically rated AAA. Then the next tranche would be rated AA and so on down to junk level. The lowest level was called the equity level, and this lowest level would take the first losses. For that risk, they also got any residual funds if everyone paid. The lower levels paid very high yields for the risk they took.

Then, since it was hard to sell some of the lower levels of these securities, HIB would take a lot of the lower level tranches and put them into another security called a Collateralized Debt Obligation or CDO. And yes, they sliced them up into tranches and went to the rating agencies and got them rated. The highest tranche was typically again AAA. Through the alchemy of finance, HIB took subprime mortgages and turned 96% (give or take a few points depending on the CDO) of them into AAA bonds. At the time, I compared it with taking nuclear waste and turning it into gold. Clever trick when you can do it, and everyone, from mortgage broker to investment bankers was paid handsomely to dance at the party.

So what started as mortgages -- ranging from very secure prime mortgages, which are doing fine, to lousy subprime mortgages for too much money to borrowers who really didn't have either the credit history or income to justify such loans, many of which are currently in default 60 days or more -- were, by the magic of "securitization," turned into bond-like securities; and in the process, many of the bad and even defaulted loans were transmaugrified into AAA-rated investments.

The banks and other financial institutions that securitized mortgages (and resecuritized already securitized MBSs) would make their nut by skimming some percent, typically fifty basis points (0.5%), off the loan rate; thus, if they began with a package of mortgages at 6.5% (they tried to bundle like with like), they would securitize them into an MBS that paid 6%, keeping the difference -- and hoping there would be few enough defaults that the mortgages would produce more than 6% net.

What happens when loans are defaulted is very complicated and not really germane to this post; they created different tiers, or "tranches," with different ratings -- AAA down to junk -- for different prices, that distributed the losses from worst tranch up to best. Not important here.

But defaults, of course, are where the whole pyramid scheme broke down. While housing prices continued to rise, everybody was happy and there were few defaults. But starting a couple of years ago, when the housing bubble burst and the mortgage default rate shot up, a bunch of banks found themselves holding very insecure securities, losing money hand over teakettle. The crash began among the lenders and spread to secondary markets (the MBSs and CDOs) and even tertiary markets (insurance underwriters like AIG). In short order, institutions all over the world found themselves holding pieces of paper whose value was impossible to determine -- which are referred to as toxic assets.

Toxic assets are illiquid, meaning they cannot be bought or sold because nobody knows how much to offer for them; they are frozen. If you hang onto them, they might regain some value later... or they could disappear completely. Worse, illiquid securities see their ratings drop; and current law forbids some types of funds from holding anything but AAAs... which means they may be forced by law to sell -- but unable to sell because of illiquidity!

Not only that, but current law also requires that such securities be "marked to market," meaning they must be valued at the last price offered by some institution that was desperate to sell -- because of the law in the previous paragraph. Thus, even institutions that didn't have to sell their toxic assets had to reprice them; this meant that a number of financial institutions suddenly did not have sufficient reserves for the amount of loans or leveraging they had out. That meant they needed to get hard cash and fast... which meant they would have to panic-sell a bunch of securities, precipitating a new round of re-rating and re-valuating.

Eventually, nobody had a clue what anything was worth anymore; and nearly every financial institution in the world, it seems, was involved up to the fourth cervical vertebra in this mess.

It was that uncertainty that caused the mortgage market to collapse. It's like trying to buy a car when all you can see is a grainy photo in a newspaper: You can't test-drive it, inspect it, or even kick the tires. You don't even know whether it contains an engine... how can you possibly make any kind of offer whatsoever?

Worse yet, the seller has never seen the car either, and he knows no more about it than you!

So what is to be done? Obviously, since the problem is the inability to set a value for these instruments, which makes them impossible to buy or sell (illiquid), the solution is to find a way to value them. Enter the Paulson-Bernanke emergency rescue plan.

Treasury presses the reset button

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:

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?

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.

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:

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.

Democrats: fingers in the pie, finger in your eye

But the loyal opposition is not content to use the Paulson-Bernanke emergency mortgage-market rescue plan to rescue the mortgage market from the current emergency; how dull that would be, especially in an election year. Rather, they see America's crisis as their opportunity to enact or re-enact by extortion every awful, failed, thoroughly discredited, socialist-populist scheme they have tried, or always wanted to try, over the past century. Senate Democrats demand:

Contingent stock in every, single company that sells its toxic assets to the resolution corporation; this would give the federal government a degree of ownership of virtually every bank, savings and loan, or other financial institution in the entire country. It is liberal fascism at its purest, and it would lead directly to much greater government control of private capital.

They demand that bankruptcy judges be allowed to rewrite the terms of the underlying mortgages, in order to "provide direct assistance to homeowners caught in the foreclosure crisis"... in other words, to allow people who took out loans much too big for houses they could not afford to nevertheless keep those houses, even though they cannot make the payments. All at the expense of financial institutions that are teetering at the brink as it is.

Democrats demand "limits on the pay of top executives whose firms seek help." That is, Congress would set the salaries and bonuses of executives working at companies that are in serious trouble because of the mortgage meltdown... and that's always worked out so well in the past!

They also have structural demands:

The 44-page Senate proposal, pulled together by Senator Christopher J. Dodd, Democrat of Connecticut and the chairman of the banking committee, would require the Treasury to run the rescue plan through a new "Office of Financial Stability" to be headed by an assistant treasury secretary. It would also establish an "Emergency Oversight Board" to monitor the bailout effort, made up of the Fed Chairman, the chairman of the Federal Deposit Insurance Corporation, the chairman of the Securities and Exchange Commission; and two non-government employees with "financial expertise" in the public and private sectors, one each appointed by the majority and minority leadership in Congress.

In addition, the Senate proposal would require monthly reports to Congress, rather than the biannual reports that would be required under the Bush administration’s proposal.

This sounds like an invitation to micromanagement -- and unless I miss my guess, the "Emergency Oversight Board" will somehow end up stuffed with former members of the Clinton administration and/or Barack H. Obama's campaign, like Franklin Delano Raines, James Johnson, and Jamie Gorelick... the same people who ran Fannie Mae and Freddie Mac into the ground and ran many of the very multinationals that offered subprime loans, hedge-funds and other derivatives, or that insured these toxic assets, thus creating the crisis in the first place.

While former Clintonista (and now Charlie "Tax Ducker" Rangel's lawyer) wants the Democrats to go even further:

Barack Obama has tried to run as a unifying centrist. Now it may be time for him to clear the fog and talk, walk and sound like a true FDR liberal -- reminding the American people that at times like this, the government is a friend, not an enemy, contrary to conservative theology. Indeed, now may be the time for him and the Democratic Congress -- urged on as recently as Thursday by Treasury Secretary Henry Paulson -- to take the next 30 days to enact something reminiscent of FDR's first 100 days. It should be more than just a $700 billion bailout. It should also include billions to help homeowners avoid foreclosure, to assist the auto industry, to upgrade the nation's infrastructure, and to spur development of alternative energy sources.

One can always trust Democrats to find a way, in any crisis, to throw gasoline at the bull.

President Bush (and the upcoming President John S. McCain) must remain stalwart and demand an up or down vote on a clean version of the Paulson-Bernanke rescue plan... no add-in spending, no wage and price controls or upgrading the nation's infrastructure, and specifically, no damned earmarks.

Anything less than this standard of rectitude and disinterested statesmanship would be an economic betrayal of America... and must lead to electoral ruin for any party which puts immediate self-gratification ahead of national economic survival.

Hatched by Dafydd on this day, September 22, 2008, at the time of 4:23 PM

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Comments

The following hissed in response by: Jaded

I am quite interested to see who shall blink first...we know Pelosi cannot blink; to much botox however in theory she may back off....I pray the President shows fortitude in this and sticks to the clean bill (I prefer no bill but).....he does not encourage great faith when he has worried more about he is viewed in history instead of sticking to conservative princples.

The above hissed in response by: Jaded at September 22, 2008 4:48 PM

The following hissed in response by: Jaded

Thank you kind lizard :-)

The above hissed in response by: Jaded at September 22, 2008 5:05 PM

The following hissed in response by: k2aggie07

Share and share alike Dafydd -- no help for hungry lizardites on the details of Paulson-Bernanke? Even a starter link?

The above hissed in response by: k2aggie07 at September 22, 2008 8:09 PM

The following hissed in response by: Dafydd ab Hugh

K2aggie07:

I'd say about 80% of my information on it came from oral interviews I heard on the radio or saw on the telly. I've heard perhaps eight people talking about it, and the bits I put here are those pieces on which they all more or less agreed.

The problem is that the proposal itself -- the written part -- is remarkably content-free; everything is oral right now between Treasury, the Fed, and Congress... I mean they're simply talking back and forth. Every once in a while, some spokesentity emerges and some information bubbles forth, such as the fact that the $700 billion is simply the permanent floating ceiling, not an actual expenditure, and that they will own securities that they'll auction off later.

You just have to keep your ear to the grindstone and separate the wheat from the boys.

Dafydd

The above hissed in response by: Dafydd ab Hugh at September 22, 2008 9:29 PM

The following hissed in response by: BlueNight

That was AMAZING! I have to print this out and give it to my co-workers!

The above hissed in response by: BlueNight at September 22, 2008 10:50 PM

The following hissed in response by: Navyvet

There was more than enough greed to go around in this debacle.

As a real estate agent in Florida, our agency has a substantial number of homeowners that are in foreclosure. Some of these individuals have multiple properties, and in reviewing their situation it is astounding they were ever granted loans.

In one case, a seller owns five homes, the one in which he resides plus four "investment" properties. Each property was obtained through an interest-only adjustable rate mortgage (ARM). No money down was required.

The plan was to hold onto the properties for a year or two, renting them out for enough to cover most or all of the monthly mortgage payment. During this time, Florida's 15-20% appreciation rate would be allowed to kick in. The properties would soon be "flipped" to a qualified buyer and the owner would pocket around $20,000 profit per property.

This scenario was repeated hundreds of times by people who saw an opportunity to get rich "quick".

Of course, when the bottom fell out of the market, all the property prices plummeted. Now the owners owe more on their mortgages than the homes are worth. The nifty little profit scheme has turned into a nightmare.

For all of us.

The above hissed in response by: Navyvet at September 23, 2008 6:33 AM

The following hissed in response by: Geoman

Remember all those late night ads on how to get rich in real estate? Yep. This is the result when too many people do the same thing.

The "bail-out" sounds like a pretty nifty idea. The problem isn't the securities per se, it's the valuation. No one knows what anything is worth, and the instruments being bought and sold are too opaque (by design) for anyone to figure it out.

I'd pass a law that securitization of home loans is fine, but the underlying data on each loan must be fully available to all buyers.

The above hissed in response by: Geoman at September 23, 2008 9:13 AM

The following hissed in response by: Geoman

Remember all those late night ads on how to get rich in real estate? Yep. This is the result when too many people do the same thing.

I'd pass a law that securitization of home loans is fine, but the underlying data on each loan must be fully available to all buyers.

The above hissed in response by: Geoman at September 23, 2008 9:13 AM

The following hissed in response by: BigLeeH

Dafydd,

I can prove that your explanation of Mortgage Backed Securities is wrong or incomplete. The proof goes like this: A) your explanation (and the bits of Maudlin you quoted) are clear and easy to read. B) Any reasonably intelligent read can follow it. But, if your explanation were also correct then C) any reasonably intelligent reader, by reading your post, could understand the Mortgage Backed Securities mess which is known to be impossible. Therefor you argument, while clear and persuasive, must be wrong... somehow.

The above hissed in response by: BigLeeH at September 23, 2008 9:28 AM

The following hissed in response by: David M

The Thunder Run has linked to this post in the - Web Reconnaissance for 09/23/2008 A short recon of what’s out there that might draw your attention, updated throughout the day...so check back often.

The above hissed in response by: David M at September 23, 2008 11:18 AM

The following hissed in response by: Stephen Macklin

It seems to me that if the government can open these things up, make them transparent and "reset" their value the companies owning should be able to do that also. In fact if I was holding some of this paper it is exactly what I would be trying to do.

The truth is there is probably no market for these securities without some express or implied federal guarantee.

The taxpayers are going to end up eating massive losses.

It's a bail-out.

The above hissed in response by: Stephen Macklin at September 23, 2008 4:54 PM

The following hissed in response by: Stephen Macklin

The truth is there is probably no market for these securities without some express or implied federal guarantee.

The taxpayers are going to end up eating massive losses.

It's a bail-out.

The above hissed in response by: Stephen Macklin at September 23, 2008 4:55 PM

The following hissed in response by: Stephen Macklin

Please Excuse the double post. Sorry.

The above hissed in response by: Stephen Macklin at September 23, 2008 5:04 PM

The following hissed in response by: wtanksleyjr

It seems to me that if the government can open these things up, make them transparent and "reset" their value the companies owning should be able to do that also. In fact if I was holding some of this paper it is exactly what I would be trying to do.

Agreed... But there might be laws getting in the way. I agree, though, that I would rather change those laws and allow everyone to see the result.

In fact, if my mortgage is currently being offered for 40% of its actual value... I'd like to join up with a bank and help them bid on it. That's a nice mortgage reduction.

I'm not totally happy with this bailout plan... The fact is that people will and MUST game the system. Worse, this will prime the pump for other bailouts -- the Dems can relax, they'll get their chance to bail everyone else out as well.

The above hissed in response by: wtanksleyjr at September 23, 2008 5:19 PM

The following hissed in response by: Stephen Macklin

If these "Toxic assets are illiquid, meaning they cannot be bought or sold because nobody knows how much to offer for them; they are frozen," how is the government going to buy them at a discount? Discounted from what?

The above hissed in response by: Stephen Macklin at September 24, 2008 10:10 AM

The following hissed in response by: Dafydd ab Hugh

Stephen Macklin:

From what their current owners paid for them.

Dafydd

The above hissed in response by: Dafydd ab Hugh at September 24, 2008 3:11 PM

The following hissed in response by: Stephen Macklin

But isn't half the problem that they are no longer worth anything close to what they purchased them for? Buying them at a discount from the original purchase price could very easily be buying them at a premium to what they are worth.

The above hissed in response by: Stephen Macklin at September 24, 2008 3:37 PM

The following hissed in response by: Dafydd ab Hugh

Stephen Macklin:

But isn't half the problem that they are no longer worth anything close to what they purchased them for?

No, the problem is primarily that nobody knows what they are worth, because so many mortgages and mortgage-baced securities have been securitized together, it's a complete mish-mosh.

The purpose of buying them isn't necessarily to make a profit for the Treasury but rather to sort out the mess, thereby allowing a value to be set by the auction.

Buying them at a discount from the original purchase price could very easily be buying them at a premium to what they are worth.

...But could still be at a discount compared to what they will be worth once all the fundamentals have been teased out of the complete chaos that exists now.

Dafydd

The above hissed in response by: Dafydd ab Hugh at September 24, 2008 7:07 PM

The following hissed in response by: nash

Wow, sounds amazingly like the Resolution Trust Corporation. If history is any guide, the current bailout will cost $2.1 trillion and result in a $375 billion dollar loss to the tax payers.

The above hissed in response by: nash at September 24, 2008 8:06 PM

The following hissed in response by: BlueNight

I've passed along this post to my co-workers, emailed Rush Limbaugh and Neil Boortz, and mentioned it twice on WizBang. This post is the single most important blog post that has been written about this credit crisis. If I were you, I'd look for a way to get it in newspapers. Perhaps through Charles Krauthammer...

The above hissed in response by: BlueNight at September 24, 2008 11:06 PM

The following hissed in response by: JenLArt

Dafydd, this is the best, most understandable explanation of the problem and the "bailout" proposal that I've seen anywhere--thank you so much for all your hard work!
You are one of the leading lights of the (Conservative) blogosphere and never fail to deliver with wise, cogent and reasoned analysis.

The above hissed in response by: JenLArt at September 25, 2008 1:43 AM

The following hissed in response by: Sinner

This gets me closer to understanding this mess, closer but still so very very far away...

My biggest question is sort of in line with Stephen Macklin's questions. If there is any, not even big, money to be made by grabbing up these "securities" and clearing up the actual backing assets, wouldn't someone (or a thousand someones) be doing this already? Americans are not known for passing up a chance to make a buck on the misfortune of others, so why hasn't someone taking this ball and run with it?

The above hissed in response by: Sinner at September 25, 2008 5:48 AM

The following hissed in response by: larry

Excellent explanation, the best I have seen. For a dry run at how bad loans would be handled by the government, here is a link.

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/09/25/BUBL134FO3.DTL&feed=rss.business

Larry

The above hissed in response by: larry at September 25, 2008 5:55 AM

The following hissed in response by: patrick neid

Great summary but sadly it goes off askew at number 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."

from yesterday....http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ajKCFjCBzU80

``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."

This is a bailout. The rational behind it is the price, to be determined, which will be less than the much talked about recession/depression that they trot out as the ultimate bogey man.

As some of you already know, I favor discarding the mark to market rule, put in place in 2002, and let the market work this out.

But that is not to be. We are getting a bailout and the national debt pile will be getting larger. No big deal I suppose by their logic.

The above hissed in response by: patrick neid at September 25, 2008 8:10 AM

The following hissed in response by: Weeha

My worry is as follows:

These financial people and institutions are not all that dumb...
Very likely the financial entities have SOME inkling of the "true value" of some if not many of these toxic mortgage backed securities is.

You can bet that if they are going to sell these 10's of millions of dollar assets at a loss they are going to look very closely at which ones to sell.

QUESTION:
What is to stop them from cherry picking only those securities they know to be the worst of the assets and only selling us the bottom of the pile?

If they cherry pick well then we get stuck with a HUGE bill.

The above hissed in response by: Weeha at September 25, 2008 12:30 PM

The following hissed in response by: Dafydd ab Hugh

Sinner:

My biggest question is sort of in line with Stephen Macklin's questions. If there is any, not even big, money to be made by grabbing up these "securities" and clearing up the actual backing assets, wouldn't someone (or a thousand someones) be doing this already?

I'm sure many people are. But the amounts necessary to affect this market are truly staggering... and one of the worst symptoms of the current crisis is the loss of liquidity: The big players are the only ones who have the capital to buy enough toxic assets to resolve the crisis; but the crisis is precisely that those players do not have the liquid assets to do such buying.

That said, I absolutely agree with some conservatives that even the original purchase of illiquid MBSs (in addition to the subsequent sale) should be open auctions, on which private capital should be allowed to bid as well as the government.

I don't think it would be a significant portion of the bidding, but it would be some... and every dollar of the rescue that comes from the private sector is more effective (and carries less threat) than a dollar from the government.

Patrick Neid:

I didn't say the toxic securities would be purchased at "fire-sale prices;" I said they would be purchased at a "huge discount." There is a distinction.

Nobody is claiming that this deal has the resolution corporation buying toxic assets at the same price that the current owners paid for them; it they did that, it would indeed be a bailout.

But it is not. It's buying them at a huge but not ruinous discount... and as the assets become more transparent, and as liquidity reenters the primary, secondary, and tertiary mortgage markets, many of these distressed securities will become significantly more valuable. Thus when the resolution corporation sells them to private bidders, it will make a big profit on those securities.

The question is how many will eventualy turn out to be worth much less than the discounted price, and how many worth nothing at all?

I doubt that number will be very high; these are real securities representing real mortgages that have (obviously) associated real property as collateral. And with some loan restructuring, even some of the defaulted underlying mortgages may still be collectable, yielding more money than would a foreclosure sale -- as Larry's link above indicates.

If so, then a great deal of this $700 billion will in fact be returned to the Treasury. Like the Savings and Loan bailout, the Chrysler bailout, and many others, historically, these things generally cost much less, not more, than the original appropriations guarantee.

Weeha:

What is to stop them from cherry picking only those securities they know to be the worst of the assets and only selling us the bottom of the pile?

If the financial entity knows which are the worst, then likely, so will the people at the resolution corporation... and their offer will be much lower than it would for a less toxic MBS.

The point is that the financials are desperate for liquid capital, and they're not going to get it by offering only the most rotten of all the rotten fruit. They're going to have to sell a lot of assets that are only illiquid because of uncertainty, but which can eventually be made much more valuable by making them properly transparent -- as they should have been in the first place, but weren't.

Dafydd

The above hissed in response by: Dafydd ab Hugh at September 25, 2008 2:48 PM

The following hissed in response by: Alec Rawls

If the AP report on the alternative being put forward by the rebel Republicans is correct, they are out of their minds:

Meanwhile a group of House GOP lawmakers circulated an alternative that would put much less focus on a government takeover of failing institutions' sour assets. This proposal would have the government provide insurance to companies that agree to hold frozen assets, rather than have the U.S. purchase the assets.

That would leave the frozen assets frozen, and the implicit guarantee of the government to bail out the whole mess when it does explode would become an explicit guarantee. As things stand now, the government can buy up the frozen assets at deeply discounted prices, but under an explicit insurance arrangement, We the People would have to make the investment banks whole. And since these banks are in no position to actually pay the value of such insurance (hundreds of billions of dollars) the plan can only be to give it to them for some token price.

If these legislators think this is a principled position they are out of their minds. My post here.

The above hissed in response by: Alec Rawls at September 26, 2008 12:48 AM

The following hissed in response by: Stephen Macklin

If all that is required to make these securities liquid gain is transparency, why not via regulation or the elimination of regulation make them transparent where they sit now?

I would think the people holing the things would welcome such regulatory change that increases their value.

All this bail out is going to do is artificially inflate the market price, probably beyond what the securities are worth, to magically improve banks' balance sheets. The crisis will appear to be over.

And everyone will admire the emperor's new robes.

The above hissed in response by: Stephen Macklin at September 27, 2008 9:50 AM

The following hissed in response by: Dafydd ab Hugh

Stephen Macklin:

I understand you hate the idea of any plan that doesn't result in the bankruptcy of hundreds of Wall Street firms, because you want to see them punished. And I also understand that you believe there is no real crisis, and everything can be resolved by just buckling down and redoubling our devotion to the free market. Believe me, I'm sympathetic to both ideas.

But we simply disagree that, with but a couple minor tweaks, everything will just magically work itself out. I wish that were the case -- but it's not.

Yes, Wall Street got into this mess by unparalleled mindless greed -- not enlightened self interest, but the sort of greed that in earlier eras led people to defend the "peculiar institution" of slavery or imperial conquest; but the mess caused to a large extent by statist intervention in the market is now so severe that, perversely enough, it really does require more statist intervention to fix.

So I think we must leave the back-and-forth at that impasse.

Dafydd

The above hissed in response by: Dafydd ab Hugh at September 27, 2008 11:14 AM

The following hissed in response by: Stephen Macklin

Wow.

Thanks for letting me know what I believe. I wasn't sure.

I don't believe Wall Street got into this mess solely though unparalleled mindless greed. I believe it was a combination of Wall Street greed, Washington regulation and the desire by the political left to use the housing market in general and Fannie and Freddie in particular as a vast welfare program.

I do prefer a solution that allows the market to sort itself out but I also believe that having created this mess, the government has a responsibility to help with that solution.

I don't think for a moment that a couple of minor tweaks is the answer. A complete regulatory renovation might be a good starting place though. I also don't think the government buying more bad paper than it already owns through the takeovers of the GSE's and AIG is the answer either.

Nowhere in the government's plans to buy up the MBS market have seen any talk of ending the social engineering experiment that got us in the mess in the first place.

This is just paint and spackle and it will last until the next storm unless it comes with some serious reform that eliminates the source of the problem.

And if a few more firms go belly-up as a result of their own poor business decisions I will not weep for them.

The above hissed in response by: Stephen Macklin at September 27, 2008 2:15 PM