The Wall Street Bailout: We Must Have Oversight And Equity

By Big Tent Democrat, Section Legislation
Posted on Tue Sep 23, 2008 at 11:43:00 AM EST
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Krugman:

The premise of the Paulson plan– though never stated bluntly — is that these assets are hugely underpriced, so that Uncle Sam can buy them at prices that help the financial industry a lot, without big losses for taxpayers. Are you prepared to bet $700 billion on that premise? But how can we help the financial situation without making that bet? By taking an equity stake. That way, if it turns out that the feds are pumping money in at above-fair prices, at least they get ownership, just as a private white knight would have.

There is no, repeat no justification for refusing to grant equity warrants that provide some taxpayer protection. This is, for me, an absolute deal or no-deal point.

(Emphasis mine.) Why is Paulson resistent on this point? It makes perfect sense.

By Big Tent Democrat, speaking for me only

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The Wall Street Bailout: We Must Have Oversight And Equity | 26 comments (26 topical)

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It's the only upside (5.00 / 1) (#1)
by Stellaaa on Tue Sep 23, 2008 at 11:39:53 AM EST

the only way that the "taxpayer" will get anything from this. Krugman as always is a leader in this issue.

Have we not learned already (5.00 / 2) (#2)
by ruffian on Tue Sep 23, 2008 at 11:45:52 AM EST

not to trust premises that are implied vaguely but never stated bluntly?

Krugman is calling Paulson's bluff here. Good for him. My guess is that Paulson knows that in fact these assets not underpriced at all, and in fact may well be overpriced. The majority of the adjustable rate mortgage resets will happen in the next two years. We are not at the bottom of the housing market yet.

I agree that equity warrants should be a deal breaker. But they won't be.

No one knows if they are overpriced (none / 0) (#9)
by litigatormom on Tue Sep 23, 2008 at 12:37:49 PM EST

or underpriced. If Wall Street knew how to value them, they wouldn't be in this pickle. As it is, they can't figure out how much they need to write down, or how much more capital they need to have.

So we won't know whether Paulson is overpaying or underpaying for the securities. We have to trust his "judgment" and his negotiating skills. The problem is, the financial institutions will be telling him what they "need" to avoid having to pump too much more capital onto their balance sheets, so Paulson does not have a motivation not drive the hardest bargain he can. He's not really dealing with these companies at arms' length, because the whole point is to put a lower limit on how much more capital the financial institutions need.

Which means he is not motivated to negotiate the best deal -- the lowest purchase price -- for taxpayers. The main benefit to taxpayers is the supposed loosening up of the credit market.

I haven't heard an explanation of why an equity stake is inappropriate. It can't be speed, because he negotiated that very quickly with AIG. I did read on a NYT live blog of the hearings that when Paulson said "This is all about the American taxpayer," the audience in the hearing room burst into laughter.

The basic philosophy is the same as it ever was: if Wall Street does well, the benefits will trickle down to the little people.


: Excuse the double negative (none / 0) (#10)
by litigatormom on Tue Sep 23, 2008 at 12:39:46 PM EST

This:

so Paulson does not have a motivation not drive the hardest bargain he can.
should be this:

so Paulson does not have a motivation to drive the hardest bargain he can

: Bayh Brought Equity Stakes Up... (none / 0) (#13)
by santarita on Tue Sep 23, 2008 at 12:57:09 PM EST

The response to equity stakes and executive compensation restrictions is the same - they believe that punitive measures will limit the number of bidders, which will negatively affect the upside of the pricing.
I am not saying I buy the premise but that is there thinking.
I think that there is going to be overpricing by the Fed at least initially.

: My own 1% doctrine (none / 0) (#24)
by ruffian on Tue Sep 23, 2008 at 05:01:38 PM EST

about Bush administration perfidy is as follows:
If there is as much as a 1% chance that what they want to say is true, they will state it as a fact, more often than not a bald faced lie.
Therefore, since they really really want to reassure us and say that the securities are underpriced, but will not state it as a fact, I believe they know for a fact (with less than 1% doubt) that the securities are actually overpriced.
A year ago it made sense that know one knew how much these things were worth - how many defaults and foreclosures there would be, etc. But with the data they a have collected to date, I believe the banks and funds have told the administration that they expect massive foreclosures in the next couple of years as more ARMs reset. Hence the crisis.
But hey, it is up to our creditors in China and Japan if they want to finance this risk. Has anyone asked them yet ?

I can't agree with this (5.00 / 3) (#5)
by Steve M on Tue Sep 23, 2008 at 12:10:46 PM EST

I just bought an insurance company last week. I have way too much on my plate right now to take on responsibility for running any more corporations.

: Ha - especially when the de facto CEO (none / 0) (#6)
by ruffian on Tue Sep 23, 2008 at 12:14:22 PM EST

of my newly acquired company admits it is too complicated for him to figure out without hiring hordes of 'experts'.

Oversight, equity..... (5.00 / 1) (#7)
by kdog on Tue Sep 23, 2008 at 12:31:44 PM EST

How about a little responsibility?

Companies gambled in the housing market, companies lost. As they say in free market capitalism, tough sh*t.

The world needs ditchdiggers too, Danny.

The so-called Democratic response proposed ... (5.00 / 1) (#11)
by alexei on Tue Sep 23, 2008 at 12:49:00 PM EST

by Dodd etal is nothing but give the ones who made this mess all the rewards and throw a few tiny chicken bones to the taxpayer, homeowner and wage earner.

This is the time to come out with the bold, comprehensive plan that will bring real change and reform to broken social, political and economic systems. Why do Democrats work at the margins of a horrendous, pork barrel of all pork barrel proposals , which is exactly what the Paulson plan is. Why can't the Democrats counter with real legislation for working families, relief from bankruptcy and foreclosures and save the financial and economic interests. Why can't the framework of that plan be what Hillary Clinton has proposed: freeze foreclosures, institute the HOLC, and add some other measures such as get rid of the bankruptcy bill, stop usurious rates for any credit (why is anything above 10% allowed and may be that is too high). What about instituting universal health care (pass Conyer's bill now). Why are Democrats caving into a President who has a 24% approval rating and is a lame duck?

The real problem is that wages have gone down, the housing bubble is collapsing due to many reasons, credit is illiquid due to many reasons and thus the middle class is shrinking to nonexistence. The trickle down economics of the Republicans and its Dem enablers is an abject failure. Give these billions and trillions to the people who are footing the bill.

: Putting lipstick on a pig (none / 0) (#16)
by Andreas on Tue Sep 23, 2008 at 01:19:01 PM EST

I like your formulation "pork barrel of all pork barrel proposals." Maybe it is even better than "putting lipstick on a pig."
The Democrats support the "bailout" because they represent the same interests as the Republicans. Does Hillary Clinton oppose the "bailout" ?

I watched a bit of the hearings: (5.00 / 1) (#25)
by coigue on Tue Sep 23, 2008 at 06:16:27 PM EST

The part where Shumer was talking about Congress releasing the money in "trunches" then Paulson having to come back to them, report on it and ask for more if he needed more.

Paulson kept saying he HATES having to come before ccongress, he HATES haveing to be accountable to the American people.

As I watched him say this over and over, a vision formed in my head:

Paulson to Bernanke: However this goes down, we need enough money so we don't have to go before congress again.

Paulson hates being held accountable to the taxpayers, but he needs to be. This power grab is crap and he should not have tried it. He is the distilled essence of Wall Steet hubris, and his comments betray that.

Our standards have dropped so low. (none / 0) (#3)
by lizpolaris on Tue Sep 23, 2008 at 12:06:01 PM EST

How is this reasonable?

if it turns out that the feds are pumping money in at above-fair prices, at least they get ownership

Could I please sell my used car that way? Write me out a blank check, I'll fill in the amount. If I fill in too much, well, no problem. At least the buyer gets ownership of the car - whatever shape it's in. And I get a nice fat profit!

Getting ownership should be the MINIMUM expectation. We the taxpayers should expect NOT to bail out these companies by overpaying for the assets we buy.

I'm with Krugman in this one. (none / 0) (#4)
by sarcastic unnamed one on Tue Sep 23, 2008 at 12:08:40 PM EST

But I can't even figure out where the heck the 700B number came from.

According to this article there are about 1,000,000 loans in foreclosure, which, at about 250,000/loan is about 250B, not 700B.

Also, shouldn't the bail out be for the unusual problem that we're facing now?

iow, of that 1 million foreclosed loans, about 400,000 are prime, fixed-rate, non-ARM, non-"predatory," standard run-of-the-mill loans like the ones your parents got for their homes all those decades ago.

And their default rate today is not out of whack compared to how such loans have performed in the past, so I can't imagine why they'd be included in any unprecedented "bail-out." They're SOP for the mortgage industry.

Anyway, subtracting those "normal-part-of-doing-business" loans, that leaves about 150B of "toxic" new-fangled adjustable-rate loans in foreclosure.

Just a tad less than the 700B Paulson is proposing.

Part of the Problem May Be That The ... (none / 0) (#14)
by santarita on Tue Sep 23, 2008 at 01:01:28 PM EST

securities are backed by both good and bad mortgages. Therefore, it is hard to point to just ARM mortgages or just subprime or Alt-A.


Well, if that's the case, (none / 0) (#17)
by sarcastic unnamed one on Tue Sep 23, 2008 at 01:30:57 PM EST

then if of the 50 million mortgages in the US there are 600,000 sub prime defaults, and if the value of the defaulted mortgages were assumed to be zero (which they are obviously not - the properties securing the mortgages are worth, what, 60?% 70%? more? of the outstanding mortgage. ie, they're worth much more than zero) then the value of the blended securities (securities with both good/prime and bad/sub prime mortgages) should be calculable.

For example, a blended security with ~80% prime and ~20% sub prime mortgages would be bought by the gov as thought he subprime mortgages had no value, ie., at ~80% of face value, or, said another way, bought at a price equal to the value of only the prime mortgages the security holds.

But, now I see, using my numbers, that if the 80/20 blend percentage is approximately valid, then 150B/20% = 750B.

iow, it'll take ~700B to buy all or most of these blended securities.

So I've answered my own question of where the 700B number comes from...


: And, coincidentally enough, (none / 0) (#20)
by sarcastic unnamed one on Tue Sep 23, 2008 at 02:37:01 PM EST

the suggested stock/bailout $ by Dodd is 1.25 shares for every bailout $ - which is another way of saying the gov/people will want $1 in shares for every $0.80 we give you in bailout $. ie, 80/20...

Equity Positions in Which Financial Institutions? (none / 0) (#8)
by santarita on Tue Sep 23, 2008 at 12:32:39 PM EST

I think their premise is that there are some institutions that are well-capitalized but hold some measure of illiquid assets while there are others that may not be well-capitalized especially if some of their assets are valued at fire-sale prices. Part of their assumptions as well is that some of those assets are worth more than fire-sale prices if held to maturity.

So they are trying to establish a more than fire-sale price for securities. I don't think that this bailout precludes the possibility that some institutions will fail and go into receivership.

Well, as I wrote up thread, (none / 0) (#12)
by sarcastic unnamed one on Tue Sep 23, 2008 at 12:51:32 PM EST

it seems the 700B will moooore than cover the so-called "toxic" adjustable rate mortgages in default, and these mortgages are the source of the "unusual" problems in the mortgage industry.

So, once the "toxic" ARMs are taken off the institution's balance sheets, isn't the chance that these institutions fail and go into receivership

not due to the so-called "toxic" mortgages and
a natural, major, and critically important part of out free-market capitalistic system?

Or have we decided that our financial institutions are a gvt entity and no longer a part of the free market? iow, the gvt will not allow them to fail?


Their response to this is... (none / 0) (#15)
by santarita on Tue Sep 23, 2008 at 01:03:43 PM EST

that they have already allowed some to fail or to take other steps (such as forced liquidation or forced merger).

I am not necessarily agreeing with them just trying to explain what I think they are saying.


Fair enough. (none / 0) (#18)
by sarcastic unnamed one on Tue Sep 23, 2008 at 01:35:35 PM EST

I think the gvt is letting institutions "fail" if they think that failure won't topple us over the proverbial brink. And if a potential failure will do so, in their opinion, then they step in.


: I think that you are right. n/t (none / 0) (#19)
by santarita on Tue Sep 23, 2008 at 02:03:58 PM EST

Call me a cynic ... (none / 0) (#21)
by Robot Porter on Tue Sep 23, 2008 at 02:58:59 PM EST

but I can only assume that someone is going to profit from the Paulson plan, and it isn't going to be the American taxpayer.

It reminds one of those billions of dollars in cash that went missing in Iraq.

I saw some business writer from Wapo on Charlie Rose last night, and he said in a rather matter of fact manner something to the effect of "some people will benefit from this plan who probably shouldn't."

To me that isn't a minor point.

: Ben Stein writes (none / 0) (#26)
by coigue on Tue Sep 23, 2008 at 06:49:01 PM EST

http://finance.yahoo.com/expert/article/yourlife/109609;_ylt=AihYXGa_2tf9PJDeCl.2G0S7YWsA

The crisis occurred (to greatly oversimplify) because the financial system allowed entities to place bets on whether or not those mortgages would ever be paid. You didn't have to own a mortgage to make the bets. These bets, called Credit Default Swaps, are complex. But in a nutshell, they allow someone to profit immensely - staggeringly - if large numbers of subprime mortgages are not paid off and go into default.
The profit can be wildly out of proportion to the real amount of defaults, because speculators can push down the price of instruments tied to the subprime mortgages far beyond what the real rates of loss have been. As I said, the profits here can be beyond imagining. (In fact, they can be so large that one might well wonder if the whole subprime fiasco was not set up just to allow speculators to profit wildly on its collapse...)
These Credit Default Swaps have been written (as insurance is written) as private contracts. There is nil government regulation of them. Who writes these policies? Banks. Investment banks. Insurance companies. They now owe the buyers of these Credit Default Swaps on junk mortgage debt trillions of dollars. It is this liability that is the bottomless pit of liability for the financial institutions of America.

Don't we have to get ripped off? (none / 0) (#22)
by roy on Tue Sep 23, 2008 at 03:02:13 PM EST

The idea is to strengthen the current debt holders, but they already have something worth about as much as the debts: the debts. So if we pay them exactly what the debts are worth, they are no better off. If we get a fair deal -- or worse yet a favorable one -- we won't accomplish the goal.

The same logic, such as it is, applies whether we're buying debts or debts plus equity.

: I think you are right, (none / 0) (#23)
by sarcastic unnamed one on Tue Sep 23, 2008 at 03:10:56 PM EST

although I think the idea is that the gvt, supposedly, can hold onto the good/bad debts much longer before liquidating them than the institutions can.
iow, in order to restore liquidity and confidence to the financial sector the financial institutions need to liquidate the "toxic" securities right now, but the gvt can liquidate them at its leisure.
At least I think that's what they're saying...