Arthur Dent wrote:Hungary Jack wrote:The Paulson plan is a fire sale. The types of toxic securities that Paulson proposes to buy will likely be bought for cents on the dollar. For example, about 6 months ago Merrill Lynch sold a bunch of securities to a private investor for about 21 cents on the dollar. Today's prices may likely be lower, and the Treasury is not proposing to buy all securities--only enough so that some sort of market is established for these things so that some reliable valuation may be attached to them.
The mechanism for purchasing these securities is a reverse auction. Outside of collusion among the firms trying to sell these securities, I don't see how the Paulson plan will "overpay" for bad loans.
The companies that bought these things have been punished pretty severely already by the stock market, and this bailout is not going to infuse them with tons of capital so that there stock price recovers. In theory, it will get the crap off the Balance Sheet so that the Balance Sheet actually makes some sense.
Finally, I am not sure who these "rich bankers" are. The guys who ran the small investment operations that put an entire firm's capital at risk have mostly been fired. Most of the CEO's on whose watch this occurred have been fired.
The original Paulson plan says nothing about a reverse auction. It says Paulson gets $700 billion to use as he pleases and that there will be no oversight or review ever permitted.
If the treasury doesn't overpay, there is very little point to the bailout. The point is that these assets are worth much less than originally supposed, so much less that banks holding them can no longer cover their liabilities. Selling them at the market rate changes nothing. The plan only helps if the government overpays and gives the mortgage holders free money. Taxpayers ought not to give money to people implicated in creating this mess in return for nothing.
Banks are undercapitalized and having trouble raising capital to make loans. A big part of the problem is that the securities they hold cannot be reliably valued because no one will buy them. The market is frozen. There is no doubt that the assets are far, far below book value. But until banks can bring some clarity to their balance sheets, they cannot raise additional capital and they are afraid to make loans.
The Paulson plan aims to liquidate some of these securities to provide some capital to banks that sell, but more importantly to establish prices that can help banks value the securities and state their assets and liabilities with some certainty. Then they might be in a position to raise more capital through equity or borrowing from other investors.
The government purchase is not necessarily a write-off. The Paulson will have the government buying illiquid, distressed securities. If economic conditions improve and the market recovers, these securities may regain their value in 2, 5, 10 years. No one really knows how it will play out. But time has shown that equity valuations and junk bond valuations can swing wildly as economic conditions change.
In short, the primary aim of the plan is not to have the government recapitalize banks by buying toxic securities at a huge loss to the taxpayer. The capital infusion will certainly help, but the bigger aim is to bring liquidity to a market for securities that no one will go near at this point in time.