Bailout Evaluations

Rebecca Christie and Jody Shenn reporting on new developments in the mortgage backed securities bailout at Bloomberg.

Essentially, Bernanke and Paulson plan on paying greater than "market" rates (currently at "firesale" prices because there is no private market) for the securities.

From the article:

The government can help restore liquidity to the banking system by buying depreciated assets at "a price close to the hold-to-maturity price,'' rather than the price they would fetch in the market today, Bernanke said. He also warned the economy will contract "if the credit markets are not functioning.''

Seidman [Note-William Seidman worked extensively on the S&L bailout], who also served as Federal Deposit Insurance Corp. chairman, said a 1990s attempt by Japan to halt that nation's banking crisis failed because the government offered prices that would have drained companies' capital.

The Upshot: Valuation will be for above market rates.

Sirota on "Bailout Bill"

David Sirota (channeling Naomi Klein and Tom Frank) raises five questions about the propriety of the Bailout Bill over at InTheseTimes.

He primarily raises the issue of lack of oversight/writing an effectively blank check which is hot on some of my listserves. With action imminent, we will see where everything falls when the dust settles.

For my two cents, the major questions beyond oversight are: (1) how will the paper be valued and (2) who are the counter parties who are the actual beneficiaries?

On this last point, take the example of AIG. Apparently it has large losing positions in a large number of credit default swaps. The government is taking an 80% stake in AIG, thus "bailing it out." But who holds the winning end of these swaps???? To me, it seems that these are the people who are being "bailed out" (along with anyone who has retirement money in AIG) as the alternative would be for AIG to go into bankruptcy and let the counter parties try get their money from the bankruptcy trustee. Instead, AIG gets the money it needs to settle the swaps.

The upshot: Who are the beneficial counter parties???

Mortgage Backed Securities Bailout

David Stout in the NYTimes today, "Paulson Explains Need for Plan to Buy Mortgages"

Paulson reasoning that this needs to be done, and is far more than a rescue of Wall Street, but is needed to protect ordinary people:

“Their retirement savings, their home values, their ability to borrow for college” and their chance to find and keep good jobs depend on it, he said.

The plan seems to be for Fannie and Freddie to purchase toxic Mortgage Backed Securities, and thus create a market where there really isn't one.

This may actually be a brilliant plan for intervention. It helps address one of the underlying problems of the credit market turbulence--large institutions were unable to liquidate their holdings--at all (partly because there is really no way to accurately value the paper). In steps the government (through Fannie and Freddie), and suddenly there is a market for this paper, and the institutions can liquidate their positions--instant liquidity!!! This is great, as credit has tightened, and everyone needs cash to operate.

Where the rubber hits the road is the valuation of these assets. This is also where it will be determined if this is a bail out of irresponsible firms or a measure to protect macro-stability. If the government pays too high a price, it will in effect be providing free insurance to the firms who made the bad bets in first place. This issue is extremely problematic because one of the reasons there is no private market for this paper is there have been few people willing or able to value the paper. So, if no one in the private market has been able to, how will the government undertake this task????

The upshot: It's a great idea for the government to buy this paper, but what is the appropriate discount???

McCain's Financial Regulation

As reported in the NYTimes, the McCain campaign has laid out a four point financial regulation plan:

1. All financial institutions must have a "safety and soundness regulator,"
2. Greater consumer protection, e.g. easy-to-read mortgages,
   
3. Improved corporate governance, e.g. putting executive compensation to a shareholder vote, and
4. "the last piece is sort of the systems stability issues."

Not much substance, especially on the "systems stability" issue. It would be interesting to see how the specific example in No. 3 would be implemented--what happens if shareholders vote "no" on the compensation package?

No. 1 is primarily aimed at setting up a regulated derivatives clearing house, with the idea that:

You can’t possibly assess the safety and soundness of an institution if you can’t get clarity each day with where they stand in their net positions versus the people they’re trading with.

No word on what accounting method other than mark-to-market would be used to net daily positions, or what the actual role of the "safety and soundness regulator" would be.

Would the bailiwick of the CFTC be enlarged? Create a new agency? Go DHS and merge the SEC and CFTC under the Fed?

As with all election proposals, everyone wants to see more.

UPDATE Freddie/Fannie CDS

Follow up article by Ms. van Duyn at the FT.

The more things change.....

.....the more they stay the same.

Two stories highlighting this principle.

First, Russian strategic bombers land in Venezuela. Apparently payback for the missile bases in Eastern Europe, Russia comes and plays in the U.S's backyard a la Cuban Missile Crisis.

Second, forget free trade and non-discrimination. The Pentagon has re-opened bidding on the lucrative refueling project which had been awarded to a Northrop Grumman/EADS (Airbus) consortium. The Pentagon has decided to reopen it to Boeing, a U.S. corp. EADS is the European competitor of Boeing in the most profitable export industry in the world. The back and forth in aviation industry trade disputes is legendary (including European claims that U.S. military contracts were disguised subsidies), and looks to continue despite all rhetoric.

CDS triggered by US action on Fannie, Freddie

Aline van Duyn at the FT has a piece of reporting on the effect of US intervention at Fannie and Freddie.

Apparently the act of being placed in "conservatorship" is equivalent to bankruptcy, and triggers many of these "insurance" contracts. The International Swaps and Derivatives Association (ISDA) is working on a protocol to address the situation.

This protocol will likely allow adherents to amend the documentation of their contracts, most likely (if past practice rules) to take advantage of some auction pricing mechanism.

Depending on the specific documentation (I haven't seen any) there could also be disputes over whether the "conservatorship" was actually a triggering event. Whether something actually constitutes a triggering event can be a notoriously tricky question.