Sunday, October 19, 2008

The Dirty Little Secret You Read About First At EPJ

A Brian Carney interview with Anna Schwartz, published this weekend by WSJ, hints at how dangerously clueless Treasury Secretary Hank Paulson is. 

In September, I wrote, of Paulson's initial plan to buy up mortgages:
Treasury Secretary Paulson's "bailout" plan has little to do with bailing out banks in trouble. In fact, if his plan is approved by Congress, it is likely the number of banks that will be in trouble will hardly decrease...You see, Paulson wants to buy the mortgages on the cheap, at their "real" value. But the bad stuff, the sub-primes, and the like, are worth at best 50 cents on the dollar. For banks that are insolvent because they own this paper, a Treasury purchase of 50 cents or less on the dollar isn't going to help things, indeed, it may make it clear to even more that these banks' liabilities far exceed their assets. 
Carney, a member of WSJ's editorial board, confirms that the reasoning in my analysis was exactly why Paulson ditched the first plan:
The problem with that idea was, and is, how to price "toxic" assets that nobody wants. And lurking beneath that problem is another, stickier problem: If they are priced at current market levels, selling them would be a recipe for instant insolvency at many institutions. The fears that are locking up the credit markets would be realized, and a number of banks would probably fail.

Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week.

Of course, whatever Plan Paulson developed, it would include getting cash into the pockets of his crony buddies. Paulson's first plan would have just sunk the rest of the entire banking system while Goldman Sach's wallet, and the lke got fatter.

1 comment:

  1. Not only would pricing of these “assets” at market prices hurt the banks which had large amounts of these bad assets (though helping the prudent banks since their accounts would look good in comparison) since they could no longer pretend that their accounts were good, it also had massive political problems.

    Lowering the price of these mortgage back securities would also lower the price of the RE they are based on. However politicians would hate that since it would mean telling their homeowning constituents that they were not as well off as they thought and it would also mean that State and local politicians would lose a lot of money that they were expecting to get from RE taxes.

    But economics says that RE prices must fall to levels that people can actually afford before sales can really pick up. The politicians are tying to have two things which can’t be done at the same time over the long term, high RE prices and high RE sales volume. Trying to do both is just going to hurt RE sales and raise the cost of the bailouts and in the long run cause stagflation.

    P.S. From what I have seen, Paulson’s special subsidies to Goldman Sachs is reason enough to call for his resignation and an investigation by the FBI. The “Investment Banks” have proven in the market to have been a bad economic model, way too much debt and leverage and too much dependence on short term borrowing to cover long term debts. They should have been allowed to collapse and the loses taken by the stockowners and lenders, not supported by the taxpayer or dollar holders. Rewarding failure just gets you more failure.