If banks and financial institutions find it difficult to recapitalize (i.e., issue new equity) it is because the private sector is uncertain about the value of the assets they have in their portfolio and does not want to overpay. Would the government be better in valuing those assets? No. In a negotiation between a government official and banker with a bonus at risk, who will have more clout in determining the price? The Paulson RTC will buy toxic assets at inflated prices thereby creating a charitable institution that provides welfare to the rich—at the taxpayers’ expense. If this subsidy is large enough, it will succeed in stopping the crisis. But, again, at what price? The answer: Billions of dollars in taxpayer money and, even worse, the violation of the fundamental capitalist principle that she who reaps the gains also bears the losses.From Calculated Risk: Does the federal government pay above market prices for the bad mortgages it is offering to buy and thus assist the banks to recapitalize (and donate taxpayer-financed profit to those banks), or does the government punish the banks by driving a hard bargain and paying only market price for those bad mortgages thus making it harder for them to stay in business? How will the prices be set?
Bloomberg has posted the text of the
U.S. Treasury Proposal to Buy Mortgage-Related Assets.It essentially authorizes the Secretary of the Treasury to organize the bail-out of Wall Street bankers, without saying much of anything about how it will be done. Sort of a typical Bush Administration "give me a blank check" proposal. The proposal authorizes Henry Paulson, Secretary of the Treasury, to spend $700 billion in taxpayer money to buy bad mortgages. He'll only be spending that $700 billion on bad mortgages because the private investors are already happy to buy good mortgages.
Kevin Drum discusses the mistaken idea that the problem requiring the bail-out is simply that the banking institutions are not sufficiently liquid. That really is not the basic problem. The basic problem is that the banks generally made a whole lot of bad loans that are never going to be paid back. Throwing more money into the system ("increasing the liquidity of the banking system") is not going to somehow magically convert those bad loans into good loans that the borrowers will repay. Whoever ends up with those bad loans on their books is going to have to write them off. That's the essence of the government bail-out. The government is going to buy those bad loan, the banks are going to use the money they receive for them to recapitalize, and the government is going to write them off. The money the banks get by selling the bad mortgages to the government - Paulson is asking for $700 billion - will come directly from taxpayers.
Calculated Risk also explains how the sale of the bad loans to the treasury is supposed to work.
However buying the assets isn't enough. These asset sales will lead to substantial write-downs, and that will reduce the regulatory capital at the banks.The theory is that by getting rid of the toxic loans the investors will decide they can trust the bank with new investments for future business. Of course, the current stockholders will take a bath (as they should) because the executives have misused their prior investment to gamble in the great Wall Street casino and lost their stake.
So how do the banks recapitalize?
The hope is that by making the assets transparent, and selling off the toxic waste, that will rebuild confidence with investors. Maybe. But the U.S. Government might also have to help recapitalize the banks to keep them lending (like the Reconstruction Finance Corporation (RFC) did during the Depression). Either way, it appears the current shareholders face massive dilution.
Also - as an aside - when the banks make their assets transparent (should be a requirement for participation), we will discover if any executives misrepresented their assets and filed false reports with the SEC. That could be prosecuted under Sarbanes-Oxley, and perhaps a few executives spending time in jail might help with the moral hazard issues.
Will it work???? Everyone has their fingers crossed. But it's all between bankers and the government. The taxpayers are going to be hosed. That's a given. [My opinion - Editor WTF-o.]
Bill Moyers on Bill Moyers' Journal last night interviewed several experts on the Wall Street financial crisis. The transcript is available here. You can find the video here. The best part of the entire hour-long interview was the interview with Kevin Phillips about his recent book Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism. That book is considered the best explanation of the current mortgage crisis and credit crisis that has destroyed Wall Street and is being blamed for requiring the taxpayers to bail Wall Street out.
How come these "genius" financial experts on Wall Street get to collect multimillion dollar bonuses during good years and then just walk away with most of their loot when the ponzi schemes they have been selling collapses? Especially, why do the taxpayers receive the bill? The government should go back ten years for anyone who received a Wall Street Bonus in excess of a million dollars in any of those years and confiscate whatever they own to pay for this crisis they created. Call it the Wall Street Bankers Tax for the bail-out. It won't cover the $700 billion, but at least the bankers will share the pain along with the American middle class.
Addendum 2:40 pm CDT
I overlooked this clause of the treasury proposal submitted to Congress today.
Let's translate that. By passing this Congress hands $700 billion in taxpayer money to Henry Paulson to pass off to his Wall Street banker friends as he wishes, and neither the courts nor any administrative regulator has any right to question his decisions!Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
That is flat stupid! That clause should never be accepted.
Addendum September 21, 2008 12:17 am CDT
Krugman weighs in. His conclusion? No Deal as written.
Here’s the thing: historically, financial system rescues have involved seizing the troubled institutions and guaranteeing their debts; only after that did the government try to repackage and sell their assets. The feds took over S&Ls first, protecting their depositors, then transferred their bad assets to the RTC. The Swedes took over troubled banks, again protecting their depositors, before transferring their assets to their equivalent institutions.Yep. This is just a rip off of the taxpayers by the very investment bankers who created the bad loans in the first place.
The Treasury plan, by contrast, looks like an attempt to restore confidence in the financial system — that is, convince creditors of troubled institutions that everything’s OK — simply by buying assets off these institutions. This will only work if the prices Treasury pays are much higher than current market prices; that, in turn, can only be true either if this is mainly a liquidity problem — which seems doubtful — or if Treasury is going to be paying a huge premium, in effect throwing taxpayers’ money at the financial world.
And there’s no quid pro quo here — nothing that gives taxpayers a stake in the upside, nothing that ensures that the money is used to stabilize the system rather than reward the undeserving.