Monday, September 22, 2008

Paulson Plan Part II

Advanced warning: there will probably be a lot of posts on this topic over the next few days. In addition, it will probably be awhile before I have a clear, comprehensive analysis/explanation. Events are coming fast and furious right now, so getting a complete thought in edge-wise is a bit difficult.

From the WSJ:

Valuing these assets will be one of the trickiest questions. For the plan to succeed, financial institutions must be able to get these assets off their books at a high enough price that their balance sheets aren't further pinched.

Treasury Secretary Henry Paulson pressed for Congress to act on the bailout plan, calling this a "humbling time" for the U.S.

The government is, in some respects, constrained in driving a hard bargain because the whole point of the program is to help banks get back on solid footing -- not to force them into deep write-downs, potentially exacerbating their pain. At the same time, the market turmoil has complicated efforts to determine the "real" value of the assets.

The mechanics of any sale are expected to be worked out between the asset managers and the Treasury. One option is a reverse auction. In that case, the Treasury could determine a type of asset it wants to buy (say, all AAA-rated mortgage-backed securities) and would then buy securities from financial institutions that offer to sell at the lowest price.

Congressional officials suggested the plan would create a rolling borrowing authority, with the $700 billion limit acting as a cap. That gives the bailout a potential value that's bigger than the entire annual Pentagon budget.

The proposal also calls for raising the public debt limit to $11.3 trillion. It would be the second time this year that ceiling has been lifted.

Treasury wants broad discretion in the program. If market conditions worsen, for instance, it wants flexibility to buy more or different assets.

Actually, valuing the assets isn't difficult. Everybody is saying in one way or another the market is valuing these assets improperly. The chaos is lowering the price, the uncertainty is lowering the price, the illiquidity is lowering the price etc.... Well, yes it is. All of those factors can effect the price. All of those factors are suppose to effect the price. Lack of trading in an asset makes it illiquid, and therefore less valuable. When the collateral backing a bond is experiencing increasing foreclosures, defaults and rising delinquencies the value of the bond goes down. Everyone is acting as though factors that correctly determine the value of assets in the market for some reason shouldn't apply to this situation. The bottom line is some of these assets (CDOs, CLOs, CMOSs etc...) are crap. The market should value them as crap. Simple.

It is not the government's responsibility to ensure none of these institutions fails. Some will. That's just part of the game right now. Institutions that own a ton of crap should pay for that decision. It's called responsibility.

I've written an awful lot about the national debt. There are several reasons for this, but the biggest is the debt issue indicates the US not willing to make hard choices. Over the course of the latest expansion, the US government was issuing over $500 billion dollars of net new debt per year since 2003. That indicates no one was saying, "we can't afford this." Instead, everyone was saying, "kick the problem down the road." This plan highlights how incredibly foolhardy that method of dealing with problems is. We're going to raise the debt ceiling again. What the hell -- what's a few more hundreds of billions of dollars.

This situation is approaching the unreal.