At the Congressional Bailout Hearings today, we finally learned what Hank Paulson and Ben Bernanke are thinking. Specifically, we learned what prices they plan to pay for the crap assets they’re buying (more than they’re worth). And we learned why they picked this asset-purchase bailout plan instead of one more like Sweden’s in the early 1990s (which included direct equity injections).
Detailed answers to these questions below and here. But here’s the bottom line:
The big difference between this bailout and the ones that have come before is that the banks aren’t yet on death’s door. Thus, in Paulson and Bernanke’s opinion, these banks must be persuaded to participate–by making the plan a boon to them (and probably a liability for taxpayers).
What Paulson and Bernanke are trying to do, in other words, is fast-forward the movie a few months or years instead of waiting until the banks realise that they are hosed and come begging for help. The trouble with this plan is twofold:
- First, until the banks are on death’s door, they’ll use any government largesse for their own gain: Specifically, they’ll only sell assets they think the government is overpaying for (otherwise, why would they sell them)? And the banks know far better than the government will what their own assets are worth.
- Just cleaning up the banks’ mistakes will not make them start aggressively lending again. Yes, it’s the first part of the process, but contrary to Paulson’s assertions this morning, cleaning up bank balance sheets will not quickly fix the housing market. The trouble in the housing market, remember, is that millions of houses were bought by people who couldn’t afford them. These folks still can’t afford the houses, with or without loans (and especially now that the economy is cratering). So merely making the banks able to lend again won’t suddenly soak up all the excess housing inventory.
It may be that what Paulson and Bernanke are trying to do is essentially impossible: Save companies before they know they are screwed. This doesn’t mean it’s not worth trying. But it does mean it’s unlikely to succeed without the taxpayers getting burned.
The government has already headed off the immediate crisis by announcing that it intends to help (since last week, the credit markets have settled down). Now, perhaps it can use that assurance to play more of a backstop-of-last-resort sort of a role, where it only helps companies that are truly in trouble and gets a significant equity stake for doing so. Anything less, we fear, will come right out of the hide of the taxpayer.
Price. The Treasury intends to buy the crap assets at “close to hold-to-maturity” prices instead of the “firesale” prices that banks are currently carrying them at. This is a huge boon to banks. It also presumes that “hold-to-maturity” prices are really much higher than the “firesale” carrying values, which many experts would argue with.
Asset purchase instead of equity stakes. Bernanke and Paulson believe taking equity stakes is appropriate when dealing with failed companies. Here, most of the banks the bailout will help are still operating (and, probably, still in denial). Bernanke and Paulson believe these banks must be persuaded to participate in the plan and that, if the government tried to demand equity stakes, they wouldn’t do it. Thus, the happy plan (for the banks), whereby the government buys all their mistakes at a gain vs. current carrying values and dumps all the wreckage off on the taxpayers.
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