Treasury: Won't buy bad bank assets

http://news.yahoo.com/s/ap/20081113/ap_on_bi_ge/financial_meltdown

WTF is this? Wasn’t buying bad bank assets what was voted on and approved by Congress? Now the Treasury Dept. says no, we want to own a portion of the banks.

How could/should they have this kind of leeway? What if next week Paulson thinks that the best course would be to spend the money on liquor and lapdances? Is it still his to spend?

This is actually a very good thing.

Buying out the shitty mortgage-backed securities was a poor way to do the bailout, because one of the chief problems the financial sector has at this stage is pricing those assets. No one knows what they’re actually worth, so the market for them has completely frozen.

So if you force the Treasury to buy those assets, you’re forcing them to make up prices out of thin air. And that would be a beastly complicated task fraught with all manner of pitfalls. If you pay the investment banks too little for them, the banks will fail. If you pay the banks too much, then you cheat out the taxpayers while blindly benefitting the incompetent bankers who are responsible for the whole situation in the first place.

So instead Congress (at the last minute) changed the bailout bill to authorize the Treasury to purchase stock options. This is a much better idea. You avoid the mathematical rigmarole of making up prices on the spot, and as an added bonus, the government takes an ownership stake in the banks, which means that we taxpayers have a chance of getting our money back by selling this stock later after the economy recovers. As long as we get the economy on good footing again (which will happen eventually, even if it’s many years down the road), we’re just about guaranteed to get most of our money back. We might even see a positive return on this investment.

The problem right now, really, isn’t that the Treasury is buying up ownership. The problem is that they didn’t go far enough. We actually should’ve bought up voting shares so that we could force the banks to cooperate more fully with the attempt at economic recovery. The bailout as written did pull us back from the precipice, at least for the present, but now we have to continue to endure incompetent people in charge of many of these companies.

But the two main points you should get from this are: 1) Congress did authorize the Treasury to buy stock, and 2) it’s a damn good thing they did.

I’m looking for a cheap house. The agent told me that the banks had suddenly stopped listing their REO’s (foreclosed, bank-owned properties). My guess was that they were holding onto them in anticipation of the government paying more for the garbage mortgages than they expected to get from sellling the properties.
Now, maybe there will be a sudden inrush of REO’s on the market

I have no problem with buying stocks in the banks as a quicker and more straightforward means of freeing up capital … but pricing is still an issue. How much are we paying for this stock? What kind of stock?

I believe in contrarian investing and I do not mind the Feds doing it on all of our behalves. But the banking sector is so out of favor right now that we better be getting major portions of these companies for this money.

I think the treasury is trying to head off what is the next shoe to drop, that is consumer debt. The amount of credit card debt out there is huge. The lack of assets value to debt in the mortgage market must also be true of consumer debt… but more so.

The additional flexibility was added by Congress. The original Treasury plan called for purchases of assets.

If you add capital to a bank directly, it can support perhaps 7x that amount in new loans. Paulson, to his credit, recognized his mistake (made in a bill that they crafted in about 2 days) and corrected it.

OBTW: it’s an emergency. Yes, Paulson and the Fed have been granted an unusual amount of discretion. Similar processes are occurring abroad. Bernanke, Paulson and Frank understand what’s at stake and are determined to prevent a 2nd Great Depression. I wouldn’t say all of these guys are perfect (though Bernanke and the Fed have been pretty impressive) but they all are competent.

Isn’t this what other countries have been doing from day one? Pumping capital into banks?

I’m not convinced investing in banks is necessarily a good thing.

I tend to agree with Kendall Jackson that the inability to correctly price mortgages and mortgage derivatives are causing problems. But if this is the problem, I don’t see how investing in financial institutions will help resolve the matter. The financial companies cannot (or are unwilling to) price their assets properly either, so they must hoard their cash as a safeguard against future losses. And since there is no way to accurately price their assets, one cannot accurately value the company holding the assets either, so we are just putting a different face on the same problem. There’s just no way to tell if the senior preferred dividend of 5%/9% and the common stock warrants are a good deal for taxpayers or not. Stating a dividend yield for a company’s preferred stock implies a certain valuation of the company’s underlying assets (which are not known) along with the rest of the balance sheet, so declaring a particular dividend yield effectively is making up “prices out of thin air.”

Unless someone (the Treasury?) gets some of these mortgages out on the auction block and opens up the books to the scrutiny of analysts and investors, I think we’re just spinning our wheels with this program. In which case, the Treasury might as well just guess prices and buy up the distressed assets.

A few things: firstly, my understanding of the issue(s) is that the pressing matter is a seizing of the economy, not the troubled assets themselves. Though the assets may be the proximate cause of the trouble, time will allow the market to work itself out; it’s the immediate issue of the seized economy that needs to be addressed. The influx of cash to banks should (hopefully) do that in whatever form it’s made.

Secondly, let’s assume that – despite current conditions – most banks will not shut down. Some/many may be in a relatively precarious position, but on the whole a bank failure is pretty rare. Granted, more common nowadays, but still pretty rare.

Thirdly, there’s a difference between accurately pricing the security packages – for which no valuation is known in many cases (per my understanding) – and a bank’s trading price, for which we do have a market price (although it may be off, as you point out). The difference, in brief, is that the former really is “making prices up out of thin air”; the latter may be “effectively” doing the same, but that’s an explicit acknowledgment that it’s different in kind.

Finally, let’s take an abstract perspective, which essentially comes down to relative benefits (with a measure of “keep it simple, stupid”, aka KISS), thrown in. The choice presented is to (1) buy suspect assets or (2) obtain partial, temporary ownership of banks.

If the government buys the assets, the banks continue to operate as they have been, albeit with a more attractive balance sheet. The government, however, now has to manage the assets; not only isn’t that an area of expertise (so it’s likely to be done poorly if kept in-house), but it’s likely that it’ll simply be contracted out…to other financial institutions (at a tremendous cost). But the taxpayer likely gets hosed; besides the fact that the government would have to perform the due diligence on the packages (a costly venture, as I can say from having worked for such a company back in the '90s), they’d also have to hold onto them until property values rebounded. Figure a decade or longer; a shorter time period is likely to leave the assets undervalued and make the original purchases a simple gift to the current holders. But it’s unlikely that the assets will be held that long; I’d think wheels would be set in motion, and they’d be disposed of as quickly as possible. Furthermore, if a bank’s management is bad, there’s little reason to believe it’ll improve; rather, it’ll just perpetuate the status quo.

OTOH, if the government buys shares, the banks also continue to operate as they have been, again with a more attractive balance sheet – due to the influx of cash. The government does not have to manage the assets, but makes use of the already existing apparatus. The taxpayer’s fortunes are tied to the banks’ performance; if my first point is true, the most likely outcome is that taxpayer money is returned at or above the current value, with little net loss (and the possibility of gains). No costs involved in setting up auctions, doing due diligence, etc. Time isn’t a factor, really, as the system continues to function. And a bank’s management can continue as it would have if no crisis occurred; grossly incompetent management (to the point of a bank failing under non-crisis conditions) is really rare, and such management should be allowed to die (or be replaced).

Essentially, buying shares (as opposed to buying the assets) is a “let the market run it’s course” stance, but doing so by providing a rubber-band across the ditch into which the economy has fallen. (Aside: I’m pretty amused relating this to a Wile E. Coyote situation right now.)

No matter what happens, the books will be opened…eventually. The questions are: (1) whether the government purchases the assets without any idea of a proper valuation (likely losing substantial sums) and (2) whether the banks should be able to wash their hands of their own messes and be able to start fresh. Personally, I neither want the government owning these things (not their job), nor managing them (not their expertise), nor paying others to do so (not a good use of taxpayer money); I do want the banks to have to do their penance by cleaning up their own messes.

Did I present a convincing case?

I understand that it MAY be a good thing to do this instead of that, but is it consistent with our system of checks and balances to put these decision in the hands of the Treasury Secretary? If Congress had given President Bush, or even (say this is February) President Obama that authority, there would be outrage. But give it to an appointment full rein to spend $700 billion dollars as he sees fit, then that is okay?

Again, what if Paulson has another speech tomorrow where he cancels the bank purchases, but decides that in his reasoned opinion the best use of the money is to take it to Puerto Rico and gamble it on cockfights? Or to set piles of it on fire and dance naked around it? Or donate it to the United Way?

Is there any limit to Paulson’s power?

Sorry, I was just responding to Calazar, not the OP.

My understanding is that the original bailout was aimed at buying the troubled assets; after much hue and cry from economists, the modified plan was supposed to buy partial ownership of banks. I may be wrong though, as one of the truly bothersome things about the bailout was its lack of specificity – the first try was only three pages, after all.

Personally, I don’t like Paulson having so much control. I don’t like any individual (or small group, for that matter) to have that much unfettered control over taxpayer money. OTOH, perhaps it’s a good thing…avoid potential “design by committee” issues.

I don’t know…I guess I have to reserve judgment and see if the ends justify the means, but if I had my druthers, there’d be more oversight.

The bailout was sold on the idea we would get assets that eventually would pay us back. Paulson was on TV today and he said he made the decision for cash infusions on his own. He said it would be the fastest way to get the banks to start loaning. He also said it has not worked yet. People can not get loans for cars and homes yet. He says that they stopped the financial crash though.
I have trouble believing Paulson.

Er. The only way that the original program would work was if the Treasury paid more for the assets than the market was paying. Under such circumstances, if taxpayers got 100 cents on the dollar in the end, they would be lucky.

Under the current plan, the Treasury purchases preferred stock, returning 5% for the first 5 years and then 9% thereafter. They also get 15% of the value in warrants, which permit them to benefit from rises in the price of the financial stock.
http://caps.fool.com/Blogs/ViewPost.aspx?bpid=98418&t=01000991980945290868

The Treasury currently borrows at 2.4% for 5 years and 3.8% for 10 years. The latest version gives the taxpayer better odds than the original plan.

There are critics of course. IIRC, the British government infused capital by purchasing common shares outright from the financial institutions – this gave them some say in the management of the bailed out banks. But such a scheme resembles Paulson Mark II more than the original.

Basically every economist blogger gave a thumbs down to the original proposal. I’m glad that Paulson doesn’t have George W Bush’s faith in his first gut instinct. Mid-course corrections show a refreshing acknowledgment of human fallibility.

The assets would theoretically have some value. What the value was would be undetermined until sold somewhere down the line. Getting nothing removes any chance of relief for taxpayers. They take ,we give.

gonzomax: Yeah, the assets would have value, eventually. It would just total to less than $700 billion. Moreover, a direct capital injection can support over 7x the amount in new loans. The October purchases had strong justification.

In other news, U.S. Shifts Focus in Credit Bailout to the Consumer
From the New York Times:
Treasury officials said they hoped to invest about $50 billion from the bailout fund into the new loan facility, with the aim of helping companies that issue credit cards, make student loans and finance car purchases.

Credit cards??!?!?!??!?

Er, will there be a quid pro quo? Typically, junk mail solicitations constitute a large share of credit card costs. And nuisance fees are heading upwards. This is getting messy.

Stating the familiar and obvious, our financial architecture requires a full overhaul. The Obama administration and the Senate/House financial committees certainly have work to do.

Congress attached an independent oversight committee, as a check on Treasury discretion. What do they have to say?

Well actually, the panel has yet to be appointed. I-yi-yi.

Yes, TARP is history. The new plan is the Federal Underwriting Buyout And Recovery plan, or FUBAR.

Exactly. Since banks and corporations are levered, injecting equity gives you more bang for the buck than an outright purchase of assets.