The Paulson Plan: Filling in the Blanks

exactly. this is so reminiscent of the Bush administration taking advantage of fear after 9/11 to get tha aumf and the patriot act, or better yet, Bush administration officials scaring and intimidating members of Congress to sign off on the warrantless wiretap program. Step 1) scare members of congress with disaster scenarios; Step 2) call for legislation passed ASAP, legislation that gives executive branch broad, undefined, unreviewable powers...paint any questions or opposition as traitorous

in other words, trust us and just delegate all power to us Republican high priests, or the world will end/terrorists will attack/the financial system will implode

I find the aspects you point out very troubling, perhaps the most troubling in a way because if (by some miracle) this worked then it would still sow even more seeds towards consolidated power.

But really that's not my main focus because I think it's foolish to focus so much on them when the basic economics are a big enough threat. This post reflects all my concerns but the greatest is what she mentions at the end: I think there is a huge risk of selling off government bonds and the dollar collapsing. I personally think that the system is so rotten that we'd have to create so much debt that we'll default, but even if we don't, the mere fear that will happen will kill all the appetite for more bond buying by foreigners. In a way it doesn't matter what the real reality is because our creditors might not stick around.

Also that Huffington Post piece is disgustingly unhelpful because it polarizes and vilifies when we should be discussing what the actual consequences are. This is hardly a carefully orchestrated conspiracy..unless you think it's been happening the last 25+ years across all administrations. It falsely suggests that if someone else were in power then things might be OK, or that the populace was mere pawns that were victimized and controlled instead of the truth: which is that the political and social culture created the foundation for the problem and Wall Street and politicians merely manipulated the underlying feelings to their advantage and turned it much worse. (The book Hitler's Willing Executioners points out that this was the same for Germany as well. He wasn't a demon that corrupted an innocent country as much as he seized on a pervasive feeling and manipulated it into a monster).

A couple of things are bothering me here:

Why the assumption that the "mortgage assets" will be purchased at a premium price?

The argument seems to be that if a discount price is paid, then some of these lenders will fail; ergo, the plan MUST be to pay the premium. But I don't think the point is to keep every institution from failing. The point is to unlock the flow of money. In the course of this, I still expect quite a number of financial institutions to fail.

Also -- people seem to view these assets as inert, but that's also incorrect. They are generating a monthly income stream, and will continue to do so. Even if some percentage of mortgages within a bundle fails, the entire batch won't suddenly become worthless.

Nothing I've read anywhere denies that one of the fundamental questions remains unanswered. If these bundles of paper actually had a future which involved producing a profit, or even breaking even, why are they currently threatening to sink the institution holding them? Why seek to unload them? As was pointed out in one of the linked articles, we're not talking about buying individual mortgages here. They are sets of shares in much larger group interests... a small piece each in a bundled package that includes a lot of highly dubious loans which are far beyond the risk threshold for potential profit. It's a forrest of losing bets, and in many of these cases, the Government may not be able to sell them off even if they want to. They own parts of an investment which has a lot of other holders who have to agree to the sale. Stagnation results.

As to "why the assumption" about the premium price, ask the army of economists who have already stated this. Much of this paper is nearly worthless and if the banks sell them for their *real* value (pennies on the dollar) they take as much of a beating as they would if they held on to them. For the cash infusion to make a substantive difference, they'll need to sell them at an inflated price. Again, it's already been noted by plenty of professionals weighing in that even determining the "real value" of these bundles is a task which the banks themselves can't manage. The government is certainly not up to the task and very likely to walk into a bear trap. Oh yes... and doing it with your money.

Polimom there is a very logical reason that things will be paid for at a premium (it's not just mortgages it's everything) and that is that all the major players would be insolvent if the real price was paid. And by "real" I don't necessarily mean "current" either, but the price that things will be at the bottom.

The Alt-A loans haven't really started to reset yet. There are WAY more of these than subprime, and the average reset increase will be 60%. There are going to be huge failures. And then even prime loans are seeing increasing defaults. A severe recession is a certainty and these will only get worse. In 2-3 years then even the best stuff will be worth a lot less.

Also it is correct that a relatively small percentage of loans in a bundle going bad make it worthless from an investor standpoint, and these are supposed to be from an investor standpoint. It doesn't take very many loans to put the expected return below zero and so no one would buy it. If you are talking about the government buying tons of loans and holding them to maturity, then yes you need to start talking about expected losses on the loan over the life time. But that's not what they are talking about (it'd require trillions more to do that anyway). They are talking about buying investment securities and then selling those securities later. Well most of those securities are worth very little because the expected return rate is going to not be much better than say, government bonds, if it's positive at all.

Mikkel and Jazz --

I'm seeing conflicting opinion all over the place on what the Treasury would (or would not) pay. I'm also seeing conflicting opinion on whether, or for how long, the mortgage assets would be held.

No doubt all this conflict is because the plan as submitted by Paulson does not contain these details. As far as I'm concerned, that makes the plan a non-starter at this point.

Mikkel, you're absolutely right. This is going to be rolling forward for quite some time. Along those lines, though... I doubt that any intervention, no matter how radical, will save many of these institutions from failure. But it's likely to be the Alt-A (and more recent) -related assets that go into the auction, which makes them doubly volatile. There's no telling how this group will fare.

The reason I'm questioning so much of the CV just now is because the details we're missing aren't just devils. They are the difference between total disaster and a possible way out (in the distant future).

What bothers me is the insistence that this package go through as is without any real debate. That's a prescription for disaster. If the public doesn't get a sense of how the pricing mechanism will work, there could major unrest over this.

We're talking about adding nearly $1 trillion to the debt overnight. This will hamstring everything the government does. I'm not opposed to a bailout in principle. But I think talk of "poison pills" is very counterproductive.

I haven't read the plan yet (thanks, Jazz for the link- I'll read it shortly), but I do want to make a couple comments that can be made without reading the plan....

About the premium... good comments by Jazz, mikkel and Polimom (thanks!). I'd like to add my two cents... the securities that are being sold are illiquid and impossible to price. mikkel raised the excellent point about the securities deteriorating in quality if the economy continues to go down. The are "worthless" now because no bank wants to buy them....

Even though the securities in question may be worth something "now" if the economy continues to go down, then those securities become worth less than what they are now. So they're "worthless" now because no bank wants to take on potentially worthless securities.

The easiest analogy would be buying stock. This is pretty basic, but I think it's something we all know and the same is true with the securities held by the financial institutions.... I buy stock expecting the value to remain steady (and a good dividend to make that stock worth my time) or I buy stock if I think the value of the stock will increase. If I see a stock selling at $100/share right now, but the company is having difficulties then I'm not going to buy that stock if I think the company (and the price of the stock) will continue to decline over time. So while these securities are pretty good now, banks are afraid those securities will decline in value. Because the market for these securities is so illiquid banks don't want to be caught holding the bag if those securities do end up being worthless. So it's like a self-fulfilling prophecy...

I personally feel that if there's going to be a bailout of Wall Street then Main Street should be helped too. Many of the problems are caused by higher mortgages paid when the rates reset (and people can not afford to make those higher house payments)... so I think that the banks and government should not allow these higher resets. The banks are already earning interest and I think our goal with the bailout should be to keep as many people in their homes as possible at the lowest cost possible. We are going to lose money.... so let's lose it responsibly. :) I think raising the monthly house payment which then forces the family out of their home is a higher cost (both financially and socially) than forgoing rate resets (and some extra profit) to keep that family in their home.

Also, if people are forced form their homes, then those homes often sit vacant (depending on the local economic conditions) and that in turn brings down the value of the surrounding property. Lastly I think if people ARE making their payments then banks should NEVER foreclose on the property (part of the problem as that as housing prices decline the value of house may be worth less than the outstanding loan so banks foreclose, even if people are current on their payments). Even if people do not agree on my thoughts of not resetting the mortgages to a higher amount, I think most of us would agree that as long as a family remains current on their mortgage payments, then they should not be kicked out of the house because of the market fluctuations in the value of their house. I'd like to see these two provisions in any plan put forth by the GOP.

The government should not pay a premium on these securities. It is not the role of the government to guarantee a good return to shareholders for poorly run companies whose leaders/management made poor decisions. The government owes its responsibility to the citizens and taxpayers, not corporations (and certainly not to corporations at the expense of tax payers) Given that the purpose of the bailout is to save many of these companies and give them cash on these illiquid assets, I don't think the government should buy at fire sale prices either.... I have a feeling that the government will pay the companies an amount pretty close to what those companies want. However the government should look at the different classes of securities, come up with a good fair price and tell the companies that they can take the price or leave it. It is the government here with the upper negotiating hand.

Again I want to stress I don't think the shareholders should benefit at the expense of the tax payers for poor decisions those financial institutions made. If the shareholders are unhappy with a company's management then the shareholders can sell their stock. Or vote for a new board that will demand accountability and performance by management. If the companies complain about the price the government is willing to pay for those securities, then those companies are free to sell them at a higher price (if they can find a higher price). :)

Oh, one last comment.... Given that this plan is rushed and there are concerns with certain provisions I think it is important to work out some of those major concerns. But I also think this needs to be passed quickly which means that we will end up with a less than perfect plan. I hope the Republicans do not demand that the Democratic Congress pass the legislation immediately and I hope that the Dems do not try to hold up the legislation by wanting to negotiate a perfect plan. I do expect to see both of these themes played out in the next few days (hopefully it will be kept to a minimum) but it will be interesting to see if one side really does try to make a political statement more than the other side. It would be really easy for the Republicans to demand immediate action when I don't think our financial system is going to fail in the next few days (and I hope no one says that our financial system is going to fail if the plan isn't passed now). The plan is to give financial institutions cash for these securities... most of these financial institutions are not in any imminent danger of failing... and there may be two big financial institutions (WaMu and Morgan) which there are concerns about but neither of these will bring down the entire financial sector and both are in merger talks with various entities. So while the rescue plan does need to be passed, we can take a few days and make sure the plan is "more right" than "more wrong".

"part of the problem as that as housing prices decline the value of house may be worth less than the outstanding loan so banks foreclose, even if people are current on their payments"

??

Stockboy, I must have missed something. Can you give a link to an example of this happening to somebody?

I think Stockboy is confused. The "mortgage reset" refers to the interest rate. The house is not reappraised and its value reset. (The banks don't need to do this to reset the rate, and no doubt they don't want to know the current market value of their collateral.)

Um yeah, I've never heard about anyone being kicked out because their house value declined. I've heard of people refusing to pay because of it but I don't think they can foreclose if you're current.

Also it's easy to talk about the rate resetting thing not going into effect but it's not that simple. Many Alt-A's are interest only the first few years and actually have negative amortization. Obviously these have to reset to include principal payments as well and many people can't afford that. Hence the massive jump in payments. The actual interest reset is only a couple percentage points which hurts but I'm not sure how many people it kills by itself.

Mortgage reset v. house value.... Two completely different things.

Yes, the mortgage reset does refer to the interest rate reset.

Re: banks foreclosing on homes even if the payments are current.... If the house declines in value to the point where it is worth less than the underlying loan (house value is $200k, but the outstanding loan is $300k) then the mortgage is considered in default (because the value of the collateral, the house, does not cover the outstanding loan). In a rising economy this doesn't really occur because home values typically rise, too. In a falling economy (even if it is local) this can happen.... though given the current crises it will be interesting to see how the banks will approach this.