Saturday, September 20, 2008

NY Times Makes a Funny

by Bill McBride on 9/20/2008 08:23:00 PM

From David Herszenhorn at the NY Times: $700 Billion Is Sought for Wall Street in Massive Bailout

The ultimate price tag of the bailout is virtually impossible to know, in part because of the possibility that taxpayers could profit from the effort, especially if the market stabilizes and real estate prices rise.
emphasis added
I hope you laughed. I did. A little gallows humor.

And, yes the cost is still unknown, but there is no way that the taxpayers will profit. My initial estimate is that the direct costs of the Paulson plan will be $700 billion to taxpayers. That is about double the cost of the S&L crisis (compared to GDP).

Why $700 billion?

The plan only limits the Treasury to "$700,000,000,000 outstanding at any one time", so the total purchases can exceed $700 billion. In fact, every time the Treasury sells some securities, they will probably plow the net proceeds back into more troubled assets until the entire $700 billion is gone.

Think of a drunk gambler at a slot machine. He starts with $100 and slowly loses. Every now and then he wins some money, but he keeps putting the coins back into the slot until he has lost everything. That is how this plan will work.

Unless there is a dramatic changes, there will be no upside participation in the financial companies for taxpayers, and the taxpayers will recapitalize the banks by, in Krugman's words, "having taxpayers pay premium prices for lousy assets".

Note: I believe a Reverse Dutch Auction is inappropriate for these assets (it won't lower the price much). This is because these auctions only work when the sellers have very similar goods to sell. In this case, if the asset class is defined broadly, then the characteristics will vary too widely been assets, and the Treasury will just end up buying the worst available assets.

And, if the asset class is defined narrowly, there won't be enough sellers for a reverse Dutch Auction to work.