BIG NEWS ON ASSET PRICING QUESTION: Bernanke wants government to pay significant premium over current “firesale” price for troubled assets. Specifically, he wants to pay close to the “hold-to-maturity” price, which he argues is much higher than the mark-to-market firesale price. Bernanke and Paulson believes this is necessary to get banks to participate.
This is a huge boon to banks and will likely hose taxpayers. Why? Because the government will not have time to figure out what the true “hold to maturity” value of these assets is. Instead, it will have to take the word of banks who have every incentive to dump their crap on taxpayers.
The justification for this is that banks won’t participate in the bailout unless you give them big incentive to do so. To which we say: Tough beans. Make the program expensive, as it should be. Give the banks a specified period of time to accept the help or forever forego it. Then work with the banks that jump at the offer.
Neither Bernanke nor Paulson mentioned the government taking equity stakes in the companies it helps, which taxpayers deserve. In our opinion, both men are too worried about persuading banks to play ball and not worried enough about the impact on taxpayers and bank shareholders and managers. Senators are hammering on this issue in Q&A (see below).
Instead of buying assets, the government should be following Sweden’s playbook: Force banks to write down their assets to current market values and then recapitalize the banks with equity injections (preferred stock). This will make the banks deal with their own bad assets, instead of forcing the government to hire outside managers to do it (creating yet another conflict of interest). If the assets really do have a higher hold-to-maturity value than firesale value, it will also allow the banks and taxpayers to generate value from this. We still don’t understand why Paulson and Bernanke favour an outright asset purchase plan.
Hank Paulson and Ben Bernanke hit the hill. Paraphrased notes below:
PAULSON: emphasises that economy practically seized up last week. This is threat to American people, not just Wall Street.
10:57: I hear you on exec comp. I think they’re paid like pigs, too. And we hosed them in the Fannie/Freddie case. But…
10:59: Housing is the real problem. We must address. We have proposed to remove troubled assets from system. All types of institutions. Unclog credit, capital markets. Must be properly designed for immediate implementation. Must also protect taxpayer to biggest extent possible.
When we all met Thursday, you said to us, don’t give us fait accompli. We gave you simple outline. I thought would have been presumptuous for us to give you oversight plan. We need protection, oversight, transparency. I want it, we all want it.
Market turmoil we are experiencing poses great risk to US taxpayers. Job creation, savings, etc. threatened. This system has to work. I am convinced this approach will cost far less than the alternative.
Let’s work together to get it done…
BERNANKE: Explains why our markets sucking wind. These assets have fire-sale price and hold-to-maturity price. No market for them right now, so fire-sale price much lower. This is leading to big writedowns and reductions in capital. This sets firesale price even lower, etc. Private investors reluctant to come in.
One option: eliminate mark-to-market, use internal estimates. Trouble with that is no one trusts banks.
The government’s auction plan will provide good market price. If Treasury bids at close to hold-to-maturity price, this should help whole market. This will allow banks to revalue own assets, attract other investors. Eventually, taxpayers should come out OK [if actually buy at discount to hold-to-maturity value]
**THIS IS HUGE: BASICALLY SAYING TREASURY WILL PAY WAY MORE THAN ASSETS CURRENTLY WORTH**
So goal of program is to establish reasonable hold-to-maturity prices. THIS IS WHERE THE PROBLEM IS: MUCH EASIER SAID THAN DONE.
After a bunch of irrelevant speeches, Bernanke back. emphasises that, if valuation process done properly, taxpayers will get a good deal. This ignores two things:
- No one knows what these assets are worth (least of all banks who want to ditch them)
- No information on how exactly this evaluation process is going to work
QUESTION: Why did you choose this plan of all the possibilities? [KEY]
PAULSON: Root cause housing. Until we fix, won’t solve. Some said “equity injections.” That’s what do when have failures. We’ve done that with failures. But here right way is not to use guarantees but to use market mechanisms. Some of questions/frustration on compensation, I share. We both agree key is housing. Can’t have stable system without housing fix. So we worked on asset prices.
BERNANKE: Japan, etc. all situations with failed institutions. Takeovers work in that context. Our situation is completely new. The firms we’re dealing with now are not failing…they’re just pulling back. So in order to address illiquidity of market and complex securities, methods used to solve failed institutions are not appropriate. We’re better off addressing cause of problem.
This is most persuasive answer so far. Unfortunately, it’s just not that persuasive. Basically, it boils down to: “We need to pay banks to help us, otherwise they won’t.” That’s just not good enough. Because the moment the banks understand that this is the game, they’ll play it for all it’s worth.
Paulson defends paying foreign banks to fix problem, too: All about keeping system moving.
Sorry, have to disagree here, too.
How do you justify bailing out banks that caused this problem?
Paulson: I share your frustration, so I hate to be on this side of the table. I’m angry. But greatest protection for American taxpayer is having this program and work and be effective. Because consequences worse.
Q: But what if it doesn’t work?
Our plan gets to root cause, frees up balance sheet, leads to price discovery/private capital coming in [debatable].
Q: What does it do for homeowner?
Regrettably, won’t save all homeowners. This plan will make financing available. There’s nothing more important. If no capital available, homeowners won’t be able to stay in homes.
Q: What punitive actions are being taken against companies and CEOs?
Plan addresses system [ie, not companies]. When do one-offs, can punish companies. Here, need to save system. [Blames regulatory system.] Compensation issue: Can’t do it quickly enough to get system up and running again. May make you angry–makes me angry–about taxpayers being on hook. Guess what: They’re already on the hook. Need to stabilise system so small farmers in your state can get loans.
Paulson now getting pressed on price-determination mechanism. This is the real weak point in the plan.
emphasises very complex. Will be different approaches in different situations. Want broad-based authority to use different approaches.
Senator notes that this is the whole problem… If Treasury ends up paying too little–screwed. If end up paying too much, no upside potential. Details about how find right balance, all of us need to understand better.
Paulson: You’re right. Problem easier to define than to solve. We believe we will get right group of experts and come up with solution. Will be different for each group of assets. But…banks have to want to participate.
Paulson very strong, completely dominating Bernanke and the room. Continually emphasising need to save the system now or taxpayers will pay for it anyway. Unfortunately, the design of the bailout just isn’t that persuasive. Even if clean up bank balance sheets, can’t force them to lend. And banks simply have to pay for their mistakes. And the valuation is critical.
The government and taxpayers should be there to save system, but current plan goes way beyond that: It’s trying to accelerate the process by paying the banks to play. The banks will surely play…because it’s a great deal for them. But it’s just not a great deal for taxpayers. And it’s also not clear that it will quickly restore aggressive lending, which has been curtailed not just because banks are short on capital but because consumers and businesses are under pressure.
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