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Thursday, September 25, 2008

The Cost of the Bailout

by Calculated Risk on 9/25/2008 03:53:00 PM

When I read the intial proposal (admittedly very vague), it appeared the Treasury could churn the $700 billion, and therefore could possibly end up losing all of it (like a gambler at a slot machine "reinvesting" all their winnings).

Although we still haven't seen the proposal, Bernanke noted yesterday (if I heard him correctly) that the plan didn't intend to reinvest any proceeds after a sale. So if Treasury bought MBS for $70 million and sold it for $50 million, the loss would be $20 million - but they wouldn't reinvest the $50 million and lose even more. Those proceeds would be returned to the Treasury.

As far as total losses, here are the some comments from PIMCO's Bill Gross in an interview with Mathew Padilla at Mortgage Insider: Taxpayers can gain from $700 billion rescue

Gross said the government must find the right price between the market value of the assets they are buying and the value they have on paper at the banks holding them.
It’s certainly possible if done right for the Treasury to make money for the tax payer,” Gross said.
emphasis added
And on CNBC, Warren Buffett said (hat tip Bernie):
[T]hey shouldn't buy these debt instruments at what the institutions paid. They shouldn't buy them at what they're carrying, what the carrying value is, necessarily. They should buy them at the kind of prices that are available in the market. People who are buying these instruments in the market are expecting to make 15 to 20 percent on those instruments. If the government makes anything over its cost of borrowing, this deal will come out with a profit. And I would bet it will come out with a profit, actually.
Unfortunately the plan is to buy the assets at a premium to market prices and probably at prices close to, or even above, the carrying value.

The WSJ Real Time Economics blog has more: Running Numbers on Treasury Bailout Plan
In a research note Thursday, Goldman Sachs estimated that there are probably about $1.15 trillion in distressed assets in the market.
That number is higher than the figure proposed by the Treasury, but it represents the face value of the mortgages. Since the discussion focuses on delinquent or foreclosed loans, the government should be getting a discount. Paying as high as 70 cents on the dollar would translate into $1 trillion in buying power for $700 billion.
The Goldman research note included calculations for losses also (ranging from none to $200 billion), although these were more examples than projections.

Price is still the key. Since Treasury doesn't plan on churning the $700 billion, the losses will be a portion of the amount invested - and the losses depend on how much Treasury pays (or overpays!) for the assets. The losses are unknowable at this point, but probably in the zero to $300 billion range. My guess - until we know more on pricing - would be towards the high side of that range.