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Commentary

Rescue Plan, for whom?

The rescue plan is out and so are thoughts on it. The plan says, in a way I could glean:

  • We’re going to buy mortgages because no one’s buying them.
  • At any one point we’ll have upto $700 billion worth mortgages outstanding. We may buy, then sell them or have them go into foreclosure or whatever, and then buy even more just to make up the mark. So we have an unlimited license to buy crap. Okay?
  • And we aren’t going to tell you what “outstanding” means – is it the amount we paid? Or the mark-to-market value? or the face value on the loans? We’ll tell you later, or not at all.
  • We can give banks or financial institutions any amount of money for services rendered as “agents”, whatever that means.
  • And you can’t sue us.
  • We will tell you every three or six months how we are doing. So the first time we tell you anything there’ll be a new president in town, by which time we probably won’t have our jobs, so just do this already.

Some thoughts (via Calculated Risk).

There are private investors willing to buy these troubled assets right now, but the banks do not want to sell at those prices. Why? Some banks believe the assets are worth more than the current bids (it all depends on future house prices, and different banks and investors have different projections). And many banks are unwilling to accept the current bids because the banks would then be insolvent.

Essentially what it seems to be is that prices the treasury will pay will be higher, maybe dramatically higher, than current bids. This means the taxpayer is getting stiffed, so maybe the price will be higher with some oversight present.

Now this still means writedowns, so capital infusion is going to be needed. So the treasury may go back to Congress with a recapitalisation plan where they’ll buy capital of these banks. The USSR is back.

Like CR asks:

If an investment from the Government is required anyway, why bother buying the impaired assets?

Very important question. And it is rare to do something like this before a failure. Even in the 1990s S&L crisis the FDIC took over banks after they failed. The impact is better defined. If the banks go under they can be taken over and capitalised – that would be a socialist rescue attempt from Marx’s books and very well understood. Government owns it. Shareholders are screwed. That’s how it’s supposed to be.

We now have a situation where the government first buys bad assets. That only adds to profits (or reduces losses) of the banks – the government and taxpayer see no upside.

Then, the banks threaten to go bust anyway because let’s face it, they don’t know the meaning of conserving capital and will find out how to lose it in other ways. Plus, conserving capital doesn’t pay them their big ticket salaries.

So the government says here’s some money for capital, now we own a chunk of you. But it might as well have ditched the concept of buying impaired assets anyhow! Why bother, when you are guaranteed to have to add capital?

My view: The only solution is to let them fail. Let the entire system come under and then use the $700 billion to capitalize the biggest banks that are left. You are a socialist republic anyhow, might as well take the whole thing. You will have a depression – but a much milder one than the full blown madness you are going to see.

If this plan is accepted as is, then I fear we are building up for another gargantuan fall, all over the world.

Note: In India we can’t say we wouldn’t do this. What else is the drama of oil price subsidies? The government doesn’t take all the hit – it palms off the losses to PSU oil marketing companies – which are publicly traded. Some losses are taken off by issuing oil bonds – which is a debt of the taxpayer. So the taxpayer has been effectively paying for a part of the profits of a (partially) privately owned company.

And then, we had a 70K cr. write off of loans given to farmers. The government is issuing bonds – read: to be paid off by us taxpayers – to the banks, not all at once, but over time. This is again keeping private shareholders happy at the cost of the taxpayer.

The two above add up to 150,000 cr., about 4% of our GDP. And the US economy is what, $13 trillion? 700 billion is about 5% of it. So we’re not too far behind, in India. And the impact of the above two, plus some fertilizer subsidies (another 3% of GDP) and other random stuff will show in the next few years. I think this increases the chances that we will recess, and recess severely. The world factors are only likely to help us along.

  • Max Dama says:

    >Deepak,

    My interpretation of the Fed’s plan is: take all the toxic assets onto the US gov’s books and hope/pray the additional deficit does not cause China, US taxpayers, etc to finally stop funding the debt. All the money the gov owes bondholders (China, US citizens) steadily decreases in value as a result of inflation. As long as China doesn’t catch on or as long as they perceive the consequences of cutting off credit as being too internationally devastating, the plan can keep working. Obviously they encourage moral hazard just like Bernanke feared he would encourage by bailing out LEH.
    So there are basically two outcomes:
    1) Inflation rises as the US prints money to buy junk mortgages and the world economy continues to run relatively smoothly.
    2) The gov’s credit line is cut off and who knows what happens after the dollar bubble pops.

    I don’t really know how this crisis is affecting India except that my shares of VWO have been down.

    Regards,
    Max

  • Siddharth says:

    >Remember mayor of Lousiana said, this is Mother-of -all-Hurricanes, when Gustav headed towards the city. Al people packed their bags and fled to safety, his statement had the effect they wanted.

    Now only Hank should say like this is Mother -of-all-Economic-storms, just to get his own way.
    God save us from this Sh*t!!

  • Anonymous says:

    >On India – Don’t dream teams fail to perform ??

    PLEASE Dont talk about the pain, talk about the medicine to avert it …find solutions and give new investment ideas !

    keep up the good work

  • Anonymous says:

    >I don’t see your point as to how markets will tank if Paulson Plan is accepted.

    Since the plan is inflationary in essence, it will crush the Dollar and increase the prices of Commodities and will be bad for Indian Economy. But stock market will march higher.

    Take the case of Zimbabwe, the Stock market has given fantastic return and protected investors from crushing currency.

    If the plan is rejected then it will be depression.

  • Anonymous says:

    >Awesome writeup. Keep up the good work.

  • Anonymous says:

    >Don’t miss the fantastic summary of the current crisis by Nouriel Roubini today at Financial Times London.

    http://preview.tinyurl.com/3jp3p6

    Interesting times.

  • Anonymous says:

    >This is like the cat trying to catch his tail. Well eventually things will crumble.
    Govt funds junk with tax payers money. Means you as a tax payer invest 20% in junk and say 80% in stagnant money.
    Then you are taxed some more and finally all the money goes down the drain.