Congress Reaches a Bailout Deal: 90% of the Suck You Were Expecting
So, yeah, according to the NYTimes a bailout deal has indeed be reached. Details are a bit sparse and we’ll have to wait till tomorrow to really know exactly what is going on. On top of that, although leaders are all agreed, it’s not yet clear that they have the backbench votes to push this thing through. Features that seem to be in the bill are:
700 Billion, but Staggered: It looks like Paulson gets 350 billion to play with, the rest will be released later, presumably in January. Mechanism for release is unclear. I would have preferred just giving him a 150 billion, and the rest to follow after a better bill in the new year, since he said he could make do with 150, but it’s still better than giving it all to him, since it would have all been gone, pretty much, by the time the new President was sworn in. Now at least Obama (probably) will get to have his Treasury secretary spend the bulk of it. (update: the release is at the President’s discretion, unless Congress votes 2/3 against it. Expect the money to be mostly gone by January).
Full Value of the Bailout Concealed: Looks like they will claim some part of the value of the securities purchased, possibly maturity value, as an asset, so the cost booked will not be 700 billion. Since, in fact, no one knows what the maturity value or default risk of most of this stuff is, this is a fiction (aka. BS.) The practical effect will be that if the 700 billion, or 250 billion is still a "at any time" value, then the Treasury secretary will be able to rotate a ton of money through without raising the debt ceiling that much.
No Change In Bankruptcy Laws: Yes, banks will be helped not to go bankrupt, but if you go bankrupt judges won’t be able to allow you to keep your house.
Treasury to help people avoid foreclosures if it owns their mortgages: Not sure what this means and the details are vague. Might be very good, might not. This will depend very much both on the specific language, and on the Treasury Secretary in charge.
According to the NYT, only in some cases do taxpayers get an equity stake. Other sources aren’t clear on this. I suspect the original idea that if it was a reverse mortgage the government doesn’t get a stake, but if the government directly intervenes it does get a stake is what happened. The reverse auction is needed because no normal investor will pay what the banks need to sell this waste for to survive. So, in all cases, in my opinion, if the government buys the banks crap, the government should get equity. Warren Buffet showed the way, and the government should insist on nothing less than the 10% guaranteed dividend convertible shares he got and they should get an amount equal to the maturity value of whatever securities they buy. If banks don’t like it, well, they obviously don’t really need the help, do they? (Update: this is incorrect, in all cases the government has to get some sort of stake, in either preffered shares or debt, but non-voting. Price and return are up to the secretary.)
Treasury has the authority to issue insurance. I’m not sure if this is required, or if it’s an option Paulson has been given. If required I don’t really see how it can work—if the government charges a fair price, it’ll bankrupt a bunch of companies. If it doesn’t, it will cause a huge run as people cash in their insurance. Not to mention that it puts the government on the hook for the entire financial industry. I suppose you could charge healthy companies more and weak companies less, but I suspect that will go over very badly. And I’m not sure how many companies really are healthy.
If it doesn’t pay back in 5 years, Treasury to levy fees on the financial industry to get the money back. Not in itself a bad idea, though the question of interest and inflation is something I’m curious about. (Paying back in money 5 years from now is a great deal if there’s no interest). I also wonder if in 5 years an administration will have the guts to do this. And what if both the assets and the financial industry haven’t recovered enough to get the money back? If the value hasn’t recovered, then that may mean that the plan itself hasn’t worked and the financial sector is still filled with walking dead (the Japanese banks, 5 years after their meltdown sure were). This is also a case of spending now and pushing into the future. Congress is trying to give itself every way possible to pretend this isn’t costing very much and that it’ll all be paid back. We’ll see. (Update: looks like this is probably optional. Secretary"can", so it depends on who the Secretary and President are.)
The heart remains the Paulson plan. Buy distressed debt, hold on to it, try and sell it later. You either pay too much, in which case you’re not setting a market price, or you pay the right price in which case it’s not clear that many institutions can survive. The former will be done, since that’s the point of the bailout, and what will happen is simple enough—it will calm the roiling waters for some months, and then it will turn out that 700 billion, or a trillion, or whatever, is not enough. Then Congress and the President will have to decide how much money they are willing to pour into an endless hole.
Concluding Remarks: This is a plan that assumes that the government can buy enough bad debt at above market prices to bail out the banking system. Since as long as the government is willing to spend above market prices (and by market I mean "what other banks would pay for this crap") banks won’t sell it to each other, the government has taken on an open ended obligation. If the pile isn’t that large, then a trillion or so may be enough. But if the pile is much larger than that, and it is, then the government will have to keep ponying up money over and over again. It won’t be limited to the original 700 billion, or trillion, or whatever. It will be an ongoing program that the market will become dependent on. Since the fundamental problems of securitization, over-leverage and declining housing prices haven’t been fixed, there’s little reason to believe that the government could get to the bottom of the pile, since, in fact, it will still be growing. (Especially as the economy gets worse and housing prices continue to drop. And they will, since this provides no floor price for real estate.)
In short, while this plan is an improvement on the original Paulson plan, which is saying, well, almost nothing. It’s still a plan that, at the end of the day, won’t work. That doesn’t mean we won’t see some short term benefits. Throw 700 billion bucks at the economy and the financial sector and it will do something. That’s still a ton of money. But it won’t fix the problem permanently, it will only patch it for a time and even during that time, things will continue to get worse. (For example, expect this to cause oil inflation.)
It’s a bad plan that won’t fix the economy or the financial sector. So we’ll be revisiting this issue in 6 to 9 months or so when it becomes clear that the problem hasn’t been solved, and that not solving it is costing a hell of a lot of money which could have been used to actually fix things.