Paulson Shifts Course with Bailout
Wow.
The government has abandoned the original centerpiece of its $700 billion rescue effort for the financial system and will not use the money to purchase troubled bank assets.
Treasury Secretary Henry Paulson said Wednesday that the administration will continue to use $250 billion of the program to purchase stock in banks as a way to bolster their balance sheets and encourage them to resume more normal lending. He also announced that the administration was looking at a major expansion of the program into the markets that provide support for credit card debt, auto loans and student loans.
[...]
The administration decided that using billions of dollars to buy troubled assets of financial institutions at the current time was “not the most effective way” to use the $700 billion bailout package, he said.
The announcement marked a major shift for the administration which had talked only about purchasing troubled assets as it lobbied Congress to pass the massive bailout bill.
The bailout money also should be used to support efforts to keep mortgage borrowers from losing their homes because of soaring default levels, he said.
From a good government perspective, this decision underlines the complete abandonment of our system of checks and balances. The Congress ceded so much power to the Secretary of the Treasury that he can unilaterally decide how to spend hundreds of billions of taxpayer dollars. That much power in the hand of a single, unelected member of the Executive branch would have been unthinkable to our Founding Fathers.
From a policy standpoint, this is a better plan than the taxpayers buying up a bunch of bad debt. I still oppose the bailout, but if we’re going to do it, this is a better way. Of course, the devil is always in the details, which are few and far between right now.
I guess I should get off the fence and commit: I support the bailout—but with grave reservations.
And actually I heard about this provision weeks ago on NPR. It gave the secretary the ability to do the bailout this other way if he chose to. The way it was described, I think it’s a better way to go about it.
(My irony-o-meter twitches, however, when Owen writes about the dangers of putting too much power in the executive branch. It just had to be said.)
Posted by scott on November 12, 2008 at 1530 hrs
The bailout was and is a horrible idea based on a bad premise.
This change makes the situation worse from a taxpayer perspective. Now we are not even getting an overvalued asset for our money, we are getting mere pieces of paper that are in fact potentially worth nothing.
Posted by .(JavaScript must be enabled to view this email address) on November 12, 2008 at 1557 hrs
That’s not how I understood it. The old way was us specifically buying the garbage from these guys’ inventories and being left with…garbage. The new way is us buying a proportional share of all their assets, good and bad—on the premise that we might actually see some value down the road for some of this stuff.
Posted by scott on November 12, 2008 at 1601 hrs
It’s precisely the opposite, Scott. Had we bought the assets and they somehow appreciated, we would be holding something of greater value. The downside was limited only by how far the asset value could futher fall and the time we chose to hold the assets.
In the new case we get stock which has little chance of appreciating more than the companies underlying assets which we would have purchased anyways, and now also has a downside that is far greater because we don’t hold the assets. Further, in the event of liquidation of these companies stockholders rights come after the creditors, which means we would be completely SOL.
Posted by .(JavaScript must be enabled to view this email address) on November 12, 2008 at 1610 hrs
No, it’s preferred stock so to speak. If the company goes under, we get paid first.
And I’ll reiterate what I said above: under the old system we bought the junk assets for a made-up price and are left with, presumably, junk assets that aren’t worth much of anything. Under the new way, we purchase a portion of the company, good and bad assets, which poses a much better chance of actually providing some value, some return on that investment.
Posted by scott on November 12, 2008 at 1622 hrs
No,we don’t get paid first because even if we get preferred stock our claim is limited to a negotiated value which may be negligible, and is certainly less than the bank’s physical assets, and we are still lopped in with all the other secured creditors. We are left with far less then if we held the assets. The assets are the absolute maximum we could expect. Other than collateral comprised of physical property banks hold little of residual value. These assets are likely as good as they get from these banks.
Second, the stock we are getting and its’ par value is at least as made up as anything we would have paid for mortgage assets.
Finally,the whole point of not purchasing the assets is almost certainly so that the banks can continue to lend money against those assets. What are they going to lend money for? More crappy loans, based on the companion statement that we need to find more credit for the credit card, auto loan and student loan business.
Posted by .(JavaScript must be enabled to view this email address) on November 12, 2008 at 1644 hrs
Multiple choice question.
My company is failing and I want you to bail it out! Will you:
a) buy from me all the past-its-expiration-date milk I own and let me go on my way free of the burden of worthless inventory
b) screw you I’m not helping you
c) buy a 25% stake in my company along with a share of any future returns on investment
The original plan was option A. The new plan is option C. That’s at least how I understand it. I could be wrong.
Posted by scott on November 12, 2008 at 1649 hrs
Screw you was the preferred option, but option A is not the original plan.
The original option A would be we get the underperforming milk cows which are worth something and could in any event be sold for slaughter if worse came to worse. The new option C is we get stock in the company whose assets are the same underperforming milk cows and we give them money to but more underperforming milk cows, except we will no longer be able to sell the cows for slaughter and keep the money for ourselves if worse comes to worse.
Posted by .(JavaScript must be enabled to view this email address) on November 12, 2008 at 1659 hrs
Not all the cows are underperforming. Some of them have good value. I’d rather own some of the good assets than only owning the bad ones.
Posted by scott on November 12, 2008 at 1701 hrs
Except now we won’t have any assets, we will have stock. And if worse comes to worse we will go through a bankruptcy proceeding during which time the assets that do exist will be degraded further through a lack of maintenance, etc. And then when and if everything is liquidated we won’t get the value of the assets, we will get a negotiated value of the stock, except we will be in line with every other secured creditor which means we will not even get that but instead we will get a fraction of the pennies on the dollar the assets are sold for.
But it gets worse. Preferred stock doesn’t have the same appreciaition potential as common stock, so we don’t get the capital gain common stockholders do, the best we can do is get our money back with a minimal dividend.
But it gets worse still. If the deal is structured like most preferred stock deals the bank can buy the stock back for a fixed price, which means we may not even get the dividend, but only get our money back.
Essentially we have purchased a great deal more risk for little possible reward.
Posted by .(JavaScript must be enabled to view this email address) on November 12, 2008 at 1715 hrs
I disagree. It seems safer and smarter to own a portion of a viable company than merely own assets which, because we know nobody would buy them on the open market, by definition have a value of zero dollars.
Posted by scott on November 12, 2008 at 1837 hrs
Lots of people would buy the assets on the open market. They have actual value.
Second, if the companies were viable, they wouldn’t need the bailout, and the companies would certainly be more viable without the bad assets.
Further, you’re not owning anything. You’re merely hoping the companies will appreciate and you will not lose any money. That’s the best case scenario.
This whole thing is an exercise in attempting to artifically prop up housing while pretending that housing isn’t overpriced. If the government purchased the assets, then it would either have to liquidate them or hold them. Holding them would mean establishing some kind of federal mortgage bank to collect the payments and deal with the homeowners and foreclosures. Aside from the messiness, that just isn’t in the cards.
Selling the assets, which are presumed to be underperforming mortgages, is what treasury wants desperately to avoid. If the assets are sold their true value will be known. This means banks holding similar assets will have to write them down and in doing so limit their ability to lend. It also means that other home values will fall to their market levels limiting the ability of consumers to take out home equity loans and make purchases. Finally, if housing is allowed to reach its’ market levels people will get smart and begin to challenge the assessed values of their homes, squeezing the levels of government that depend on property taxes for their revenues. Treasury probably never had any intention of purchasing any assets.
Posted by .(JavaScript must be enabled to view this email address) on November 12, 2008 at 1903 hrs
Lots of people would buy the assets on the open market. They have actual value.
I heard that the 700 billion figure was literally “made up” due to the fact that a price cannot be determined for things which nobody wanted to buy. And the way I figure, things nobody will buy on the open market have a value of zero dollars.
Posted by scott on November 12, 2008 at 2001 hrs
They are things no one wanted to sell, not things that no one wanted to buy. They were never put up for sale on the open market and if they had been their actual value would have been determined immediately. People did not want to sell them because they knew they would take a loss, but without selling them, they could not acquire cash, thus the cries of “uncle”, and the nonsensical talk of a liquidity and credit crisis.
Posted by .(JavaScript must be enabled to view this email address) on November 12, 2008 at 2018 hrs
So, if the government is buying prefered stock, does that mean the government may pick and chose who are the companies board of directors? To me, that is scary.
Socialism in the United States has begun and it has started under Bush. Up until now I was one of the supporters of Bush, but in the last few months, I’ve changed my mind.Posted by .(JavaScript must be enabled to view this email address) on November 12, 2008 at 2152 hrs
I thought preferred stock traditionally meant non-voting stock. Am I wrong?
Posted by scott on November 12, 2008 at 2153 hrs
scott, you are right, they are non-voting.
However, that doesn’t mean the government cannot influence the company, basically hold it hostage.
For instance, if the government says to GM, for example, i don’t like the make up this board, so i will not buy your preferred stock, how much you want to bet, GM will change the board. It influence the board, policies, who gets hired etc. To me that is very scary.Posted by .(JavaScript must be enabled to view this email address) on November 12, 2008 at 2349 hrs
Let me offer some thoughts on the banking system and why this new plan was better.
a) Banks have an ability to leverage capital. i.e. you can start a bank with a million dollars in capital and that allows you to borrow another $8 or $9 million from depositors. Much of that money can then be lent out. You’ve turned a $1mm investment into a machine that can put out to lend $8 or $9 million.
b) The banking problem was not “bad assets”. They were a symptom of the problem. The problem is capital. If we buy the assets at crappy prices, the bank takes the loss immediately then, must write down its capital, and then must contract in size (reduce leverage) to safely operate under government guidelines as it has less capital. Less capital means a weaker bank and one with less lending capacity.
c) What Paulson is doing is sticking capital into the banks. That’s what they really need. They can leverage this up 8 or 9 times to lend to people to get the economy going. Note that the government gets a 5% return on their money for the first five years on this preferred stock. It jumps to 9% after that. The government also gets warrants to buy up to 15% of the capital advanced in the form of common stock for further profit down the road.
d) One of the major problems in this credit crisis was that banks stopped doing business with each other. But putting capital into the banks, the US government is picking the winners. And giving confidence for banks to deal with winner banks. It has made a big difference the last few weeks. They put National City, Wachovia, and Washington Mutual out of business (via forced mergers). But they’ve also declared local places like M&I;winners that they’ll back with this money.
Owen, I know you are troubled by the “power” granted, but this is one situation where it worked out better that Paulson had options. Also, given our inflationary mess, $700 billion isn’t that much money anymore these days.
Posted by .(JavaScript must be enabled to view this email address) on November 12, 2008 at 2351 hrs
We agree in the assessment of why we are not purchasing the assets, Steve Austin, but the problem most assuredly IS bad assets. If the assets were good the banks would have no problem lending against them or selling them to achieve liquidity.
Posted by .(JavaScript must be enabled to view this email address) on November 13, 2008 at 0854 hrs
The whole thing is idiotic… thanks Paul Ryan. And no Owen, this is not a better way to spend the money.
There is no need to bolster credit card debt in order to protect consumers, because credit card debt is fully erased during bankruptcy. There is no need to protect credit card companies, because their high interest rates are there to account for the lack of backing of that debt.
Car loans don’t need protection because they are a fixed debt. Housing prices haven’t made your car loan more expensive. Your car payment is the same today as it was a year ago.
Student loans are an even stupider thing to back, because they are already largely forgivable, and already backed by the government. Giving tax dollars to back a loan that is already backed by the government is practically a zero sum game. The government is giving money to… well… the government. So who does that help?
This just goes to show that what Paul Ryan did makes him deserving of losing his seat in Congress. He encouraged Congress to pass a bill, that clearly does not have the oversight he said it has. NOBODY THOUGHT ABOUT THIS! Nobody knew what they were going to do. They just decided to quickly right a blank check, and figure it out later, with no oversight. Congress is supposed to be a deliberative branch of government. Paul Ryan and his bailout cohorts ignored that, and should suffer the consequences. He should be ashamed of himself.
Posted by Nick on November 13, 2008 at 0925 hrs
Student loans are an even stupider thing to back, because they are already
largely forgivable,When did that happen?! Wait till I tell my wife!
Posted by scott on November 13, 2008 at 0927 hrs
If you have money Scott, then no, you can’t just ask to stop paying. But if you lose your job, its actually fairly easy to get a deferrment for a good period of time, if you take the time to talk to your loan administrator. If you are going through credit counseling, or bankruptcy, then forgiving student loans is a common part of this.
Posted by Nick on November 13, 2008 at 0946 hrs
If even half of my student loan debt was forgivable under bankruptcy law, I’d be filing tomorrow.
Posted by scott on November 13, 2008 at 0951 hrs
If even half of my student loan debt was forgivable under bankruptcy law, I’d be filing tomorrow.
nice
Posted by .(JavaScript must be enabled to view this email address) on November 14, 2008 at 0944 hrs
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