Interest Rate Roundup

Monday, September 22, 2008

Belated thoughts on the latest multi-billion dollar bailout scheme

Greetings everyone. There's a very simple reason I haven't been posting: I was away on vacation for a few days. And wouldn't you know it? The trip just happened to coincide with some of the most tumultuous times in financial market history. Rest assured I was keeping up with the news (I was in Boston, not Botswana, after all), just not taking extra time away from family and friends to blog about it.

So what are my thoughts on this gazillion dollar bailout of the financial system?

Well, if unfettered American capitalism wasn't already on its deathbed due to the earlier bailout efforts, it's lying on a cold slab somewhere now. For better or for worse, the government is now intimately involved in everything from the pricing of mortgage backed securities (via Treasury's plan to manipulate MBS yields by sopping up MBS in the open market) ... to the insurance business (via its bailout of AIG) ... to the pricing of certain financial stocks (via the ridiculous move by the SEC to ban shortselling -- but only for companies the government has deemed don't deserve to go down).

So much about this bailout package is unknown at this point, too. Will it truly end up costing U.S. taxpayers $700 billion? Or will they make out much better eventually if the government buys assets on the cheap, holds them for a long time, and then sells them at a profit once the crisis has passed? Speaking of buying on the cheap, how exactly will the government determine the price it pays? There are hazards in paying too little and in paying too much, as the New York Times notes today:

"Perhaps the biggest question about the Treasury’s acquisition plan is how the government will decide how much it is willing to pay for the loans and securities it acquires. Will the government drive a hard bargain and acquire assets for the lowest possible price to protect taxpayers against losses? Or will the Treasury Department, in the interest of jumpstarting the credit market, try to bolster large financial institutions like Citigroup and Washington Mutual by paying a slight premium to the markets’ valuation of these troubled assets? Over the weekend, Treasury said it might use “reverse” auctions in which financial institutions rather than the Treasury — as buyer — would submit bids."

What else might get tacked onto any bailout legislation? That's up in the air as well. Democrats are mulling several possible additions, including a provision that would allow bankruptcy judges to cram down mortgage loans and one that would restrict CEO pay. There is also talk of requiring banks that participate in the program to grant warrants or shares to the government. That would allow taxpayers to later recoup some of the cost of bailing the companies out now.

Finally, there's the biggest question of all to consider: How the heck is the government going to pay for all this? It's not like we're a surplus nation or anything. We're already running a large budget deficit. We've already committed vast resources to bailing out Fannie Mae, Freddie Mac, AIG, and Bear Stearns. And now, we're talking about adding as much as $700 billion more in bailout costs to the mix? No wonder Treasuries have gotten trashed in the past couple of days, and the dollar has fallen out of bed.

Bottom line: There are no easy answers at this stage, only a lot of unanswered questions.


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