As we’ve noted since Hank Paulson and Ben Bernanke first described their bailout plan, the devil is in the details. Specifically, the devil is in the amount the government ends up paying for the crap assets it buys from banks.
There are two basic possibilities:
- The government pays “market prices”–the amount a willing private-market buyer would pay for the assets today. This is the right thing to do, and the best option for taxpayers. It is also the pricing strategy that Warren Buffett has continued to emphasise in interview after interview. Warren’s emphasis on this is no accident. In a brief phone call with CNBC yesterday, he mentioned the need to pay market prices more than half a dozen times. On Charlie Rose in the evening, he mentioned it twice.
- The government pays some theoretical “hold to maturity” price that is higher than the market price. This price has to be calculated on an asset-by-asset basis via a complex discounted cash flow analysis. It also assumes that the “market price” is artificially low. This flies in the face of most market theory. It also assumes that the government knows better than the market what the assets are worth.
Why does Warren Buffett keep repeating the importance of paying market prices? Because the government is not planning to pay market prices. It is planning to pay the theoretical “hold to maturity” price. We are not the only ones we take this to mean that the government will therefore be intentionally overpaying for the banks’ crap assets. And we aren’t the only ones frustrated by this.
Paulson and Bernanke have a motive here: They want the banks to play ball, and they want to buy up the crap assets without forcing the banks to raise new capital (because the market prices are almost certainly lower than the prices at which the banks are carrying the assets on their books). In more general terms, Paulson and Bernanke want to save the country, not earn a compelling rate of return. Nevertheless, the difference between the Hanke-Panke plan and the Buffett plan is profound.
Warren is now freely giving interviews to emphasise the need for Congress to approve the bailout. In these interviews, on the surface, he appears to be saying that the bailout will also make money for taxpayers–and that, if he could, he would happily take 1% of the plan’s profits. Note, however, that when he says this, he then without fail emphasises the need to pay market prices. He even suggests that Paulson and Bernanke determine the market prices by first having the bank sell $100 million of crap assets to a private-market buyer.
Paulson and Bernanke, of course, have no intention of doing this. Instead, they plan to invite the banks to sell them the assets at a price that makes sense for the banks. Warren refers to this price as an “artificial” or “phony” price. And it’s reasonable to conclude that, if this were the deal on offer, Berkshire Hathaway wouldn’t want to take 1% of that trade.
NOW WATCH: Money & Markets videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.