by Calculated Risk on 9/22/2008 11:11:00 AM

Since the administration is trying to railroad the plan through Congress - with no changes or additions - here are a few questions to ask:

How does buying troubled assets help recapitalize the financial institutions unless the Treasury pays a premium for the assets?

Why aren't taxpayers receiving some sort of contingent shares in the companies based on the losses to the taxpayers? If there are no taxpayer losses (as some are projecting), then the shares would not be issued - if there are substantial losses, then the taxpayers would own a sizable portion of that institution.

Note: Senator Dodd proposed something along these lines this morning. From the WSJ: Dodd Bailout Draft Could Give Government Shares of Companies

Sen. Dodd's plan would not allow the Treasury Department to purchase any assets "unless the Secretary receives contingent shares in the financial institution from which such assets are to be purchased equal in value to the purchase price of the assets to be purchased."

Why isn't the entire process transparent? There are no national security issues, so Treasury could provide an online site that listed each transaction purchased by the government. This could be updated daily and list the details of the asset, the PAR value, the selling institution, the underlying characteristics, the originators of the loans, the price the government paid (and eventually sold the asset for) and any other relevant detail. This transparency would help with pricing and oversight.

by Calculated Risk on 9/22/2008 09:29:00 AM

From the NYSE:

The SEC has delegated to each national securities exchange the authority to identify additional listed companies that qualify for inclusion in the list of companies covered by the revised prohibition.
...
According to the SEC, companies that were on the original list attached to Friday’s Order, or that fall into one of the categories expected to be covered by the new order, may opt out of the application of the revised short sale prohibition by informing the NYSE of that determination.

I'm still waiting for a company to opt out!

Here are the added companies:

GLG GLG Partners
GE General Electric Co.
OCN Ocwen Financial Corp.
KBW KBW Inc.
GFG Guaranty Financial Group Inc.
MFG Mizuho Financial Group, Inc.
FMR First Mercury Financial Corp.
STC Stewart Information Services Corp.
FCF First Commonwealth Financial Corp.
MTB M&T Bank Corp.
DFS Discover Financial Services
BMO Bank of Montreal
TD Toronto Dominion Bank
CM Canadian Imperial Bank of Commerce
FMD First Marblehead Corp.
BBV Banco Bilbao Vizcaya SA
CIB BanColombia SA
LM Legg Mason, Inc.
NFP National Financial Partners Corp.
AXP American Express Company
CIT CIT Group Inc.
GM General Motors Corp.
HIG The Hartford Financial Services Group
ADS Alliance Data Systems Corp.
ALD Allied Capital Corp.
RAS RAIT Financial Trust
DRL Doral Financial Corp.
FSR Flagstone Reinsurance Holdings
MCO Moody's Corp.
COF Capital One Financial Corp.

by Calculated Risk on 9/22/2008 12:06:00 AM

Professor Krugman writes in the NY Times: Cash for Trash. A few excerpts:

How does this resolve the crisis?

Well, it might — might — break the vicious circle of deleveraging ... Even that isn’t clear ... And even if the vicious circle is limited, the financial system will still be crippled by inadequate capital.

Or rather, it will be crippled by inadequate capital unless the federal government hugely overpays for the assets it buys, giving financial firms — and their stockholders and executives — a giant windfall at taxpayer expense. Did I mention that I’m not happy with this plan?
emphasis added

I believe this is exactly the plan - to buy assets at premium prices and thereby recapitalize the banks. As I noted earlier, this will probably be successful in getting the banks to lend again, but that "success" would come at an astronomical cost to taxpayers. And there would probably be other unintended consequences.

The logic of the crisis seems to call for an intervention ... but ... the financial system needs more capital. And if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.

The current plan is vague, opaque, has almost no oversight, puts the taxpayers at extreme risk and encourages future moral hazard.

A better plan would be transparent (all deals would be publicized), involve a share in ownership for the taxpayers, and have substantial oversight. We can do better.

by Calculated Risk on 9/21/2008 11:43:00 PM

From the WSJ: WaMu, Under U.S. Pressure, Scrambles for Deal or Capital

Washington Mutual Inc. pushed Sunday to decide its fate, continuing talks with potential buyers amid mounting pressure from federal regulators.

...some people close to the discussions hope a deal could be struck within days ...

A spokesman from the Office of Thrift Supervision ... said "we are aware of the situation and following closely"

I'm not sure if or how the Paulson plan will impact the negotiations.

A likely scenario is that a deal will be struck between a buyer and the FDIC, and then WaMu will be closed with certain assets going to the buyer, and the FDIC taking the toxic waste.

by Calculated Risk on 9/21/2008 10:11:00 PM

From the Fed:

The Federal Reserve Board on Sunday approved, pending a statutory five-day antitrust waiting period, the applications of Goldman Sachs and Morgan Stanley to become bank holding companies.

To provide increased liquidity support to these firms as they transition to managing their funding within a bank holding company structure, the Federal Reserve Board authorized the Federal Reserve Bank of New York to extend credit to the U.S. broker-dealer subsidiaries of Goldman Sachs and Morgan Stanley against all types of collateral that may be pledged at the Federal Reserve's primary credit facility for depository institutions or at the existing Primary Dealer Credit Facility (PDCF); the Federal Reserve has also made these collateral arrangements available to the broker-dealer subsidiary of Merrill Lynch. In addition, the Board also authorized the Federal Reserve Bank of New York to extend credit to the London-based broker-dealer subsidiaries of Goldman Sachs, Morgan Stanley, and Merrill Lynch against collateral that would be eligible to be pledged at the PDCF.

This means more oversight and a changing business model.

by Calculated Risk on 9/21/2008 06:45:00 PM

From the WSJ: Australia Suspends All Short Sales

The Australian Securities and Investments Commission banned short selling on all listed shares in Australia, following moves by other countries to prevent short sales of financial stocks.

Also from Bloomberg: SEC Pushes Hedge Fund Oath in Manipulation Probe

Udpate: Dutch ban 'naked' short selling for 3 months

And in Taiwan: Taiwan reimposes short-selling ban on 150 stocks

These seem like stories from long ago, in those early days of finance when people didn't really understand markets and government officials went on misguided witch hunts.

by Calculated Risk on 9/21/2008 04:38:00 PM

The primary goal of the Paulson Plan is to get the banks to lend again - or "unclog the system" as Secretary Paulson put it. Secondary goals are to "protect the taxpayer" and hopefully minimize moral hazard.

Will the plan achieve the primary goal? I think the answer is yes. By removing these troubled assets from the balance sheets of the financial institutions, the banks will able to lend again without lingering doubts about their solvency and viability. At first glance, the size of the plan seems sufficient.

UPDATE: This assumes some sort of recapitalization of the banks while they deleverage too. Something that isn't in the plan ...

It is almost guaranteed that there will be unintended and unanticipated consequences, but the plan will probably achieve the primary goal. And making sure the banks continue to lend will minimize the impact of the credit crisis on the general economy.

Unfortunately the Plan fails to address the secondary goals.

By definition the Government will pay more for these troubled assets than private investors (or the banks would just sell the assets to investors). The question is: will the government pay more than the intrinsic value of these assets? (intrinsic value in this sense would be the amount the government eventually receives for these assets).

This intrinsic value is unknown right now because we don't know how far house prices will decline (and the value of MBS is related to house prices), and we don't know how much the Government will pay for these assets.

Under an optimistic scenario perhaps the government might pay close to the intrinsic value for the MBS, and the taxpayers would lose little or nothing. A more pessimistic scenario would suggest that the government would lose something on every transaction - and because of the structure of the plan, this might cost the taxpayers $700 billion.

Note: This doesn't imply each asset is worthless. Imagine you start with $100. You buy an asset for $100, and sell it for 30% less - you lost $30. Now you invest the $70 and lose 30% again, and on and on. Even though you only lost 30% on each transaction, you eventually lose the entire $100 - this is possible with the structure of this plan.

So the plan does nothing to protect taxpayers or minimize moral hazard. This is fixable by adding some sort of options or warrants for preferred shares and / or senior debt that could be tied to the losses for each institution. If the government loses money buying MBS from a particular institution, then - after several years - that institution could reimburse the taxpayers or the shareholders suffer significant dilution.

And a final suggestion: In an effort for transparency, I'd like to see a website that listed each transaction purchased by the government. This could list the details of the asset, the PAR value, the selling institution, the underlying characteristics, the originators of the loans, the price the government paid (and eventual sold the asset for) and any other relevant detail.

by Anonymous on 9/21/2008 02:58:00 PM

This is purported to be from a member of Congress, regarding the TARP authorization. I cannot independently verify that, but like Fox Mulder I want to believe:

Paulsen and congressional Republicans, or the few that will actually vote for this (most will be unwilling to take responsibility for the consequences of their policies), have said that there can't be any "add ons," or addition provisions. [Frank expletive]. I don't really want to trigger a world wide depression (that's not hyperbole, that's a distinct possibility), but I'm not voting for a blank check for $700 billion for those [serious obscenity].

Nancy said she wanted to include the second "stimulus" package that the Bush Administration and congressional Republicans have blocked. I don't want to trade a $700 billion dollar giveaway to the most unsympathetic human beings on the planet for a few [adjectival exuberance] bridges. I want reforms of the industry, and I want it to be as punitive as possible.

Henry Waxman has suggested corporate government reforms, including CEO compensation, as the price for this. Some members have publicly suggested allowing modification of mortgages in bankruptcy, and the House Judiciary Committee staff is also very interested in that. That's a real possibility.

We may strip out all the gives to industry in the predatory mortgage lending bill that the House passed last November, which hasn't budged in the Senate, and include that in the bill. There are other ideas on the table but they are going to be tough to work out before next week.

I also find myself drawn to provisions that would serve no useful purpose except to insult the industry, like requiring the CEOs, CFOs and the chair of the board of any entity that sells mortgage related securities to the Treasury Department to certify that they have completed an approved course in credit counseling. That is now required of consumers filing bankruptcy to make sure they feel properly humiliated for being head over heels in debt, although most lost control of their finances because of a serious illness in the family. That would just be petty and childish, and completely in character for me.

I'm open to other ideas, and I am looking for volunteers who want to hold the [colorful noun] so I can beat the crap out of them.

I've been an advocate of bankruptcy cram-downs for ages, so no argument there. What I really really like is the idea of subjecting CEOs to the same petty humiliation everyone else gets treated to. I suggest that for every separate asset these CEOs sell to the government, they be required to write a Hardship Letter over a 1010 warning (that's a reference to the statute forbidding lying in order to get a loan) explaining why they acquired or originated this asset to begin with, what's really wrong with it in detail, what they have learned from this experience, and what steps they are taking to make sure it never happens again. Furthermore, the Treasury Department will empanel a committee of the oldest, most traditional, and bitterest mortgage loan underwriters--preferably those downsized to make way for automated underwriting systems--to review these letters and opine on their acceptability.

I'm sure you all will have other suggestions.

by Calculated Risk on 9/21/2008 10:33:00 AM

Here is a paragraph from the Treasury Fact Sheet released last night:

Asset and Institutional Eligibility for the Program. To qualify for the program, assets must have been originated or issued on or before September 17, 2008. Participating financial institutions must have significant operations in the U.S., unless the Secretary makes a determination, in consultation with the Chairman of the Federal Reserve, that broader eligibility is necessary to effectively stabilize financial markets.

So this bailout covers any securities issued on or before last week! Why would we be bailing out activity from this year? Or even after Feb 2007 when the subprime crisis woke everyone up? I'd argue for an even earlier date ...

But the second sentence is even more surprising: eligibility has been changed from "financial institution having its headquarters in the United States" to "significant operations in the U.S." - and even "broader eligibility" if Paulson so decides.

According to this fact sheet, under the Paulson Plan, U.S. taxpayers may bailout foreign financial institutions and even foreign governments.

Update: Paulson confirms on TV, via Reuters: Paulson: Foreign banks can use U.S. rescue plan

Treasury Secretary Henry Paulson said Sunday that foreign banks will be able to unload bad financial assets under a $700 billion U.S. proposal aimed at restoring order during a devastating financial crisis.

"Yes, and they should. Because ... if a financial institution has business operations in the United States, hires people in the United States, if they are clogged with illiquid assets, they have the same impact on the American people as any other institution," Paulson said on ABC television's "This Week with George Stephanopolous."

by Calculated Risk 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.