Inside the Economic Rescue Plan: One Giant Bailout

The big news today was that the White House is pushing for a so-called “Rescue Package” for the economy. While details are still being fleshed out, the Treasury Department will apparently seek authority to spend “hundreds of billions” of taxpayer dollars to purchase illiquid assets from U.S. financial institutions.

These buybacks will be managed by a new entity that will run “reverse auctions” in which the federal government will buy securities from those that offer them up at the lowest price. As costly as this sounds, Treasury Secretary Henry Paulson is convinced that:

“…this bold approach will cost American families far less than the alternative — a continuing series of financial-institution failures and frozen credit markets unable to fund economic expansion.”

It won’t be simple, though. The Wall Street Journal asks:

Does [the government] pay more than fair-market value for hard-to-assess distressed assets, putting taxpayers on the hook for any losses? Or does it drive a hard bargain, buying for pennies on the dollar? The latter approach would further hurt financial institutions, since they would have to write down the losses and take additional hits to their balance sheets.

This line of thinking has led former Treasury official Douglas Elmendorf to argue that “This approach saddles taxpayers with significant downside risk but limited potential upside gain.”

In other news, the Treasury is temporarily insuring money market mutual funds to (hopefully) head off a stampede of withdrawals. Meanwhile, the SEC banned short-selling on 799 financial stocks for at least the next ten days. The Treasury, along with Fannie Mae and Freddie Mac, will apparently also step up efforts to buy mortgage-back securities to keep the housing market afloat.

Source: Wall Street Journal

17 Responses to “Inside the Economic Rescue Plan: One Giant Bailout”

  1. Anonymous

    The best bail out plan is to send every person over 18 years old $30,000.00 and forgive consumer debt by 50%.

    This puts spending money in our pockets and cut the amount of debts we have to pay.

    Most of the $30,000 will be deposited in banks and the 50%
    debt forgiveness will also end up in banks.

    This is a win win deal. No Depression!

  2. Anonymous

    How can people say that the government is trying to help us? They are just a bunch of power hungry people taking advantage of the bad market. They will buy off these financial places at a low rate and when the market goes back up they will sell for a higher rate. They will make MORE money this way. It’s government policy that was the problem in the first place. Look at The Great Depression… the government bail out back then made the USA go through a longer depression. It will be better this way without the bail out. Hopefully we will bounce back quicker than if the government stepped in to “help”.

  3. Anonymous

    @DAB, that would entail directing it towards homeowners who signed the dotted line on mortgages they couldn’t afford to from the start, too. Given the $300b homeowner bailout already, and political season, there isn’t a chance in hell that the poor homeowner (yes i’m being sarcastic) will be penalized. All of us who did the right things like saving and buying stuff we could afford will be though.

  4. Anonymous

    Is there no middle of the road approach between bail out or bust? What about bailout with costs being directed to those who created the irrational risk in the first place, they haven’t left the planet have they?

  5. Anonymous

    PG, thanks for detailed information, it is interesting to read to your perspective. All I know is what I read in the papers or hear on CNBC and most analysts there approve the plan and think it could actually make money.

    I also find it interesting that you think that these assets are overvalued whereas most analysts on CNBC – and it is well possible that they stand to gain from the bailout – say that they are priced as if over 50% of loans fail and there is no recovery whereas in reality only about 25% of sub-prime loans fail, and obviously there is some recovery in foreclosure. Do you look at the value of these assets in terms of what they can bring today or do you look at them in terms of what they can be worth in terms of holding? The perception of what is overvalued and what is undervalued on the stock market changes.

    For example, when the government bailed out Chrysler in 1980 and got options in Chrysler stock, I am sure most investors didn’t want these options as Chrysler stock was worthless. Yet, when Chrysler rebounded the government made money.

    I find it interesting, that Buffett’s opinion – both about the need for this plan and if the government ends up losing or gaining money on the deal seems to be different from yours:
    I heard him today on CNBC, and he said that if he had an opportunity to borrow at 3% and to buy these assets he would have. Do you think he was lying?

  6. Anonymous

    Kevin you make some good points but a few things I’d like to clarify. Not all of us hedge funds do the same thing, in fact the number of hedge funds engaged in trading MBS/ABS securities is a small fraction of all funds, as is the number of long/short, merger arb, or short-bias funds that were “allegedly” shorting LEH and others to drive them down. So when I say there is a lot of money on the sidelines I’m referring to both existing long-established distressed debt investors as well as new funds that have been launched specifically to take advantage of the new opportunities coming into the market. However right now the prices still aren’t right and the government is planning to pay a large premium to those prices. Also, while some argue that firms like LEH and BSC were brought down by short-sellers the evidence shows otherwise. At both of these firms and many others the problem was simple – they were way overleveraged on bad assets with tiny capital cushions. In fact if you look at LEH there was NO ‘bank run’ at all because LEH had the Fed’s discount window open to them. Every time a company goes under, whether it be in this environment or outside of it, the executives like to blame short-sellers but every time the case is the company was just no good. Its like the CEO of who has spent years railing against short-sellers while his company loses money hand over fist. I think a good metaphor was blaming short-sellers for the price of a stock is like blaming a thermometer for the temperature.

    To Kitty, I agree with you in some regards that “something” needs to be done. However this plan is ridiculous. Speaking as someone who works on Wall Street and will stand to gain quite a bit from this plan I hope you trust that I’m putting my personal interests aside. The problem with this plan is it so obviously benefits a relatively small group of Wall Street bankers, and investors over the American taxpayer. Sure everyone will benefit to some degree, everyone benefits if the economy runs smoothly, however the real beneficiaries of this are the banks – which means the bankers and traders who work on Wall Street and investors in the banks. If you are a private citizen with a big stock portfolio and you hold a number of financial stocks sure you will also benefit greatly. However 99.9% of the population doesn’t fit into those categories. This is a very blatant transfer of wealth from the vast majority to a select few – and that “select few” are already extremely wealthy. That is why I think this bailout plan is so perverse, it doesn’t make sense at all from any equitable angle.

  7. Anonymous

    Donna, could you provide a link that shows up to 90% devaluation of the dollar? I don’t see it.

    Also, are we talking “awful recession” or are we looking at maybe the next Great Depression? This crisis is huge and most banks are affected. What you are suggesting is doing exactly what powers-that-be did after 1929 crash. Shouldn’t they at least try to do something? Also, Chrysler bailout in 1980 ended up bringing taxpayers money. If done right, maybe this one wouldn’t end up costing as much? Not all mortgages in these “worthless assets” will foreclose, after foreclosures there is some recovery too. It all depends on the details.

    Also keep in mind, that when banks fail, FDIC has to pay to the depositors. When FDIC reserves fail, the government will still print more money. Either way we lose. Doing nothing was already tried in 1929.

    Incidentally, it took until the 50s for the market to reach the same value it was in 1929.

  8. Anonymous

    The alternative to this plan is an awful recession in which many people will suffer. Eventually (and probably slowly), there will be recovery. With any luck, we might learn our lesson about delaying smaller but inevitable recessions via bubbles in the market.

    Most of the economists who accurately predicted what would happen with this disaster are predicting a major devaluation of the US Dollar if we go ahead with this bailout. Some are predicting a devaluation of up to 90%. It would likely be permanent, or go on long enough for it to be permanent during most of our remaining lifespans. Flooding a market with worthless money when it already contains too much worthless money (in the form of debt) will make the economic and systemic problems worse by further encumbering the Government’s balance sheet.

    Our government requires $2 billion a day in foreign purchases of Treasuries. Without that, the government will be bankrupt. If we flood the market with more worthless currency as outlined in this bailout plan, why in the world would any foreign government buy our debt? They buy our debt because they think we are capable of paying it off. What do you think would happen if they stopped buying our debt? I’d call it the Mother of All Depressions.

    Many commentators have stated that the financial system is having a “heart attack”. Think of the credit markets as the circulatory system and money as blood. You can pump all the blood you want, but if you do not convert the heart from ventricular fibrillation to a normal sinus rhythm, the patient will still die.

  9. Anonymous

    Sure, we are all angry, but what was the alternative? With banks failing, millions of people end up unemployed. FDIC (i.e. taxpayers) pay for the deposit insurance. What happens when FDIC reserves run out ? More dollars and more government money… It would’ve cost us either way.

    Then there are companies that sell furniture, computers, software, etc. to banks, and their employees.

    It is so easy to say – let them fail. This is what they did in 1929. Did it work?

  10. Anonymous

    Nick, more regulation does NOT mean more government management. It only means more rules in place to manage the industry. I am afraid of any government management program of anything, but their regulation is paramount. Putting rules in place help keep an eye on fear and greed running rampant over ourselves.

    PG – lots of money on the sidelines…I bet that money was generated during the massive bubble. Good for anyone who took advantage of it, but I suspect there will be A LOT of people going to jail over this massive financial fallout. When traders (I’m singling out anyone here, not you) perpetuate the problem knowingly, then decide to shortsell like crazy the very same companies that bought what they were pushing prior (knowing that what they sold them to begin with was crap), bodies usually end up come missing.

    People ask me how Lehman could happen so fast. They know it could happen, but why so fast? I point to the massive shortselling by market movers who were “in the know” and had lots of money on the sidelines, shorting with margin. When the stock plummets, capital calls come in, borrowing becomes nearly impossible, then the rest is history. Then when the curtain is pulled back, everyone can see the assets are lousy.

    The WS traders and hedge funds who decided to package and hide risk through financial engineering CDO’s and burying it all in the different traunches (which no one really understands) is what caused this mess. Then those same traders took huge short positions on the companies they sold it to – people will end up going to jail on this…I can feel it.

  11. Anonymous

    Not only have the Feds been asleep at the wheel, they’ve been snoring so loud unethical investors have whizzed past laughing all the way to the bank. The Feds’ bus and its passengers were heading right towards a wall when the driver groggily woke up in time to swerve and avoid a head-on crash.
    Who’s responsible: the [Fed] driver, the passengers[us] or those whizzing by?

    Sorry for the stupid analogy 😉

  12. Anonymous

    I work for a hedge fund that invests in distressed debt, not distressed mortgage debt specifically but distressed corporate debt. I can tell you this – there is a ton of cash on the sidelines right now by distressed debt investors and they are not buying these assets for a reason – they are still too expensive! The government has essentially made the taxpayer the “dumbest guy in the room” – the only guy who will actually invest in the thing that no one else is willing to buy. Now in fairness, the government has a much longer time horizon than most investors. They can wait a decade in order to get their money back or make money, we typically want around a 1-2 year turnaround. However there is also a very good chance this ends up permanently costing taxpayers several hundred billion, and of course in the short-run there is no doubt it is costing us that.

    Nick, your statement on regulation is very simplistic. There is a lot of regulation of the financial industry however most of it is just antiquated and no longer applies, and what is on the books has largely not been enforced. So essentially the market was operating as if there was little to no regulation. A comprehensive regulatory framework needs to be designed that makes sense in the modern era. Otherwise this will happen again and again because short-term private profits through excess risk-taking is a natural part of unregulated markets. And the cost of the risk-taking ultimately falls on the taxpayer as it does now. Or everything can fail and it still costs the public through losses in even their safest investments and shut off of credit. Stop pulling a party line soundbite and think about these things.

  13. Anonymous

    The Federal Government will only make things worse. Govt. shouldn’t be the economic saviour. More regulation will NOT help. People who run these companies screwed up in their managing duties.

    ~No one will care more about your financial security more than you~


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