Well before we get to the $62 trillion in CDS most people have never dealt with and probably don't know about maybe it is good to bear in mind the maybe smaller but more close to home $7 trillion in money markets that have started to see the effects with one breaking the buck. It's one thing for investment banks to lose money on exotic instruments like derivatives and stock market participants to lose money in stocks since people know them as risky assets that one can expect to lose money on in tough times. But money markets? The entire psychology is different. Money market funds are supposed to be safe. If money market funds can lose value it undermines the entire system of trust with ordinary people. You are going to see runs and that is disastrous. Better to put an end to such apprehensions immediately than tempt fate and wade into unknown waters. Recent IMF study puts the damage in past financial crises at around 16% of GDP. Current proposal is far less than that so far. Containment action might still mitigate damage. The situation calls for action. The only question is what form it takes.
The Treasury plan to buy illiquid financial assets has been widely criticized as being unfair to taxpayers, who will have to bear losses ahead of shareholders of the institutions that will be bailed out. [The Public Deserves a Better Deal] Corbis There is a better alternative to stabilize the markets: Invest the $700 billion of taxpayer money in senior preferred stock of the troubled financial institutions that pose systemic risks. Let's call this the "Preferred plan." In fact, it is the Fannie Mae and Freddie Mac model -- which the Treasury Department has already endorsed and used in practice. It is also the approach Warren Buffett used for his investment in Goldman Sachs. There are major problems with the Treasury plan. First, by buying banks' worst assets at above-market prices, taxpayers take an immediate economic loss -- while transferring wealth to shareholders and executives of the very institutions that brought on the financial crisis. Second, this plan puts too much discretionary power in the hands of Treasury officials. Who determines what financial assets are purchased and at what prices? Who determines which bank gets to benefit from these taxpayer subsidies? Will bank shareholders continue to receive dividends, and executives continue to get paid huge bonuses? When financial institutions borrow massive amounts of money to invest in assets that are now found to be illiquid and poorly performing, it is not the responsibility of taxpayers to bear the resulting losses. These losses should be borne by the shareholders. If taxpayers have to step in and provide capital to keep operating enterprises that the government decides are key to the functioning of the economy as a whole, taxpayers must receive protection. Treasury Secretary Henry Paulson said at the Senate Banking Committee hearing this week, "[the] Fannie Mae and Freddie Mac [interventions] worked the way they were supposed to." These enterprises continued to function, maintaining homeowner access to and lowering the cost of mortgage financing. However, managements of these companies had to leave and forfeit the compensation packages they had negotiated. Shareholders had their dividends blocked and remain first in line to bear losses, as they should have been. Taxpayers came both first and last -- first to get paid back, as the new preferred stock is senior to all shareholders; and last in realizing losses, as common and other preferred equity would be extinguished before the taxpayers would be at risk. This mechanism -- purchases of senior preferred stock with warrants in troubled institutions -- addresses the problems with the Treasury plan. The financial market is stabilized, companies get recapitalized, failures are avoided, debt securities are supported, and time is gained for illiquid assets to mature. The institutions continue to function, their cost of funding will decline as equity capital increases, and innocent third parties like bank depositors, broker/dealer clients and insurance-policy holders are all protected. The only difference is that potential losses are kept with the shareholders where they belong. The Treasury plan would also entail larger outlays than the Preferred plan. By allowing all banks to sell their worst assets to Treasury at inflated prices, taxpayers would be subsidizing healthy banks which have access to private capital (Goldman Sachs, J.P. Morgan, Wells Fargo, and Bank of America, for example) as well as banks that don't have a private alternative. But under a Preferred plan, only banks that don't have a private alternative will be given federal assistance. This would reduce the outlay otherwise required to solve the crisis. Few people familiar with the issues deny that Treasury action is needed to stabilize the financial markets. However, the question is who should bear the cost? Under the Treasury plan the taxpayer pays the price. Under a Preferred plan, the shareholders of the firms who created the problems bear the first loss. Who do you think should pay? Before committing $700 billion of our money, we should encourage Congress to take a few extra days to get this legislation right. Mr. Paulson is president and portfolio manager of Paulson & Co. Inc., a New York-based investment management firm.
Exactly. Excellent point. The government intent is to overpay, since if they pay the a "firesale price" it will bankrupt the institution. Then the "hope" is that they can then hold the asset long enough that it will rise in value, and they can get out whole. So the bottomline here is that the taxpaper is in the tank right out of the chute. Next problem. Underlying all the mortgages is a house. As the homeowners default, there is a need to foreclose, your lose money as you dump the house, etc etc etc. In other words, there are costs and other market risks. OldTrader
Thanks for the link. I heard the same figure before too, but not the 50:1 gearing to an underlying $1.1T debt. The government should be focused on getting this crap under control before even thinking about the bailout.
If you want to soften the blow, we have no choice but to spend money that we don't have. I put the credit impact ratio at the end. We can do it thru tax rate cut (1:1), forming banks (10:1) and government spending (1:1) etc.... The current bailout plan is (10:1). The spending has to benefit people that weren't in this mess too. That will be my point. Don't expect the spending to increase GDP again. Just soften the blow.
This is a better plan. Taxpayer needs to be in front of shareholder and bond holder of that company. Which means, if these companies are in default today and those CDO don't change in the future, the government will end up owning these companies. I will still argue that don't rescue these guys. Inject credit else where, but I will settle for a combination of both.
JP Morgan Chase buys WaMu. Bank of America buys Countrywide and Merrill Lynch. Evidently there are some who are now in preliminary discussions with Wachovia. Buffett puts $5 billion into Goldman. Theres a price that everything will clear at. yeah, it may wipe out the shareholders. It might wipe out the bondholders. But there will be people/institutions who did not take the risks, who will step forward at a price, even if it's on the courthouse steps or the bankruptcy court. To repeat. This country is based on capitalism....the free market. If you're from another country (which it sounds like you are), then you need to acquaint yourself with the way free markets work. We don't believe in socialism here. And let's call it the way it is, this particular bailout plan is a massive governmental intervention...the latest in a series of steps down the socialistic road. OldTrader