"How Much Will It Cost and Will It Come Soon Enough?"

Here's Jamie Galbraith's view of the bailout plan (the Senate may try to revive the plan tomorrow):

How Much Will It Cost and Will It Come Soon Enough?, by James K. Galbraith, TNR: There is no question that the current bailout bill represents an enormous improvement over the original Treasury proposal. ...

The question now is could the purposes of this bill be met with a smaller appropriation. In my view, the best way to answer that question is to ask: What problem does $700 billion solve? The answer to that is, we do not really know. On the face of it, the exposure to bad mortgage-backed securities is considerably larger; the purchase plan in the bill would inevitably bail out some inessential as well as essential investors and institutions, thus wasting a fraction of the resources; and we do not know the full extent to which banks need new capitalization in order to remain solvent. The reasonable presumption, therefore, is that TARP would buy time; one hears estimates that the authority would be used at a rate of $50 billion a month, though the basis for that estimate is not clear. A smaller appropriation would buy less time.

How much time is needed? There is in my view very little prospect that economic recovery will restore housing prices and personal incomes within a reasonable time -- that is, before the $700 billion runs out. Therefore, it seems to me unlikely that this issue will finish here; more will be needed at a later date. However, on the assumption that one can trust and monitor the actions of the Treasury to assure that it carries out its mandate in good faith, there is an argument for appropriating the full sum now: It will help ensure that the system will hold into next year. A smaller appropriation increases the risk of a major crisis in the relatively near term. By how much and when? No one can say. ...

Many are concerned with the fiscal implications of this bill, so let me turn to that question.

Despite the common use of language, the capital cost of this bill does not involve "taxpayer dollars." It authorizes a financial transaction, exchanging good debt (U.S. Treasury bills and bonds) for bad debt (the "troubled assets"). Many of those troubled assets will continue to earn income for some time, perhaps a long time. The U.S. Treasury commits itself to paying the interest on the debts it issues. The net fiscal cost -- which is also the net fiscal stimulus -- of this bill is the difference between those two revenue streams. Given the very low rate of interest presently prevailing on Treasury bills, this is likely to be somewhere between $20 billion per year..., even if the Treasury were to issue all $700 billion in new debt at once. It is a mistake, in short, to count the capital cost as a "cost to the taxpayer." ...

In the longer run, of course the Treasury will incur capital losses on the assets it acquires. The entire purpose of the bill is to overpay for bad assets, so as to give financial institutions a chance to recapitalize themselves. The proposal to recoup that capital at a later date through a fee on the same institutions strikes me as being somewhat defeating of the very purpose of the bill. If it is desirable to raise tax revenues to cover the running cost, a turnover tax in the stock market is an attractive alternative -- if it could be passed. ...

Whatever happens, if my analysis is correct, even if the bill is passed the issues will not go away. The $700 billion will permit parts of the banking system to be reorganized. I doubt it will cure an underlying problem of illiquid securities many times larger than that. ...

A larger issue concerns the relationship of this bill to the overlying economic situation. Will this bill "unblock the channels of credit" and restore the economy to normal? I would answer in two parts. First, if it is the case that runs on money market funds are threatening the liquidity of the corporate financial system, urgent measures including the Treasury's insurance facility should be put in place to prevent that. Here the TARP plays a somewhat tangential role. Think of it as a slush fund with which Treasury can recapitalize banks as needed, for a time. But even though it is tangential, it may be a useful and perhaps necessary part of a program to prevent, or defer, a disaster.

Second,... this program ... will [not] prove sufficient to restore economic growth and high employment. For that purpose, resolution of the underlying housing problem, of the revenue problem of state and local governments, and of the wealth and income problems of retirees and other asset-dependent parts of the population are all essential. Those measures lie ahead; they will not be part of this bill. ...

In short, as I said at the beginning, the bill is a vast improvement over the original Treasury proposal. Given the choice between approving or defeating the bill as it stands, I would urge supporting the bill. I do so without illusions. There need be no pretense that it will solve our underlying financial and economic problems. It will not. The purpose, in my view, is to get the financial system and the economy through the year, and into the hands of the next administration. That is a limited purpose, but a legitimate purpose. And it may be the most that can be accomplished for the time being.

Comments

[Bubble]

"There is in my view very little prospect that economic recovery will restore housing prices..."

That's his goal? It was wasting our limited credit line on bubble prices that caused the problem in the first place. Foreign lenders will not loan us enough to support constantly rising bubble prices, period. We have to funnel the limited credit the rest of the world is willing to extend into the most important areas, such as starting new businesses. Without credit for business, incomes are toast.

[ken melvin]

Bubble, you and I agree. There was no real growth to begin with, no wealth created. In a sense, all that's left to do is give the money back. The much vaunted economic growth never happened.

[Bruce Wilder]

Galbraith: "How much time is needed?"

Look at the calendar. 4 months to inauguration.

Galbraith: " I would urge supporting the bill. I do so without illusions. There need be no pretense that it will solve our underlying financial and economic problems. It will not. The purpose, in my view, is to get the financial system and the economy through the year, and into the hands of the next administration. That is a limited purpose, but a legitimate purpose. And it may be the most that can be accomplished for the time being."

Oh, he did look at the calendar, after all.

$700 billion to buy time! Has everyone gone mad!

[Lafayette]

Lending to the confusion

Galbraith: How much time is needed?

Obviously a good question, but one that begs another. Needed to do what?

I suggest it is needed to restore confidence, which is a lot lesser of a requirement than taking the Toxic Waste Debt (TWD) off the books. The time necessary to absorb all the TWD is going to be very long, so long it isn't even worth thinking about. Why? Because it involves reselling the TWD properties to credit-worthy home buyers, such that they become productive and therefore saleable once again to investors. That will require the economy to mend itself significantly.

What is unfortunate in this sad tale is the plight of the people who were originally snookered into buying properties with balloon payments that they could not inevitably meet and property values that diminished as well, leading to foreclosure. What has become of them? They've not evaporated in thin air because Wall Street is in crisis.

It would be only fair to recycle as much as possible of the presently TW to that group, by means of a mortgaging GSE, but with different payment schemes based upon lower face values of the property, thus making them more affordable. Thirty percent less should do the trick. Forty percent off would surely move the stock of unsold houses.

But this would mean other property values -- of housing owned by people who had nothing to do with the sub-prime mess -- would see their values affected negatively.

The challenge to my mind is determining the fair value for the TWD, which means, perhaps, sampling the original transaction values geographically -- then applying a discount to those averaged values. What discount? I'd propose a discount that made the properties 10-15% less expensive than current market values.

Once a commission starts actually buying the TWD from banks, the market will regain confidence that "something is being done". This sentiment inevitably leads to a level of confidence where banks start lending to one another, provided they have the capital to do so.

Therefore, recapitalization is also a prime requirement to the recovery, and the Fed will likely know how to manage that act. Fifty billion dollars a month of TWD assumed by the Treasury is unlikely to go unnoticed in the market place. It will start the return-of-confidence so necessary to unblocking the Credit Mechanism.

Like most complex problems that baffle us, the hardest step is usually the very first one. Everybody is afraid it is the wrong one. Usually, in-process corrections reorientate the aim. The important part, therefore, is not to pre-strategize the process but to learn-by-doing within the process. Meaning: Get it off and running.

We are still engulfed in the strategy phase with ideas – both pro and con - flying all about the place. This only lends to the confusion and immobility. That's the hurdle Congress has to get over ... and quickly.

[Bruce Wilder]

Someone points out to me that Galbraith claims the "cost" of the buying time is much, much less than $700 billion.

this is likely to be somewhere between $20 billion per year..., even if the Treasury were to issue all $700 billion in new debt at once. It is a mistake, in short, to count the capital cost as a "cost to the taxpayer." ...

In the longer run, of course the Treasury will incur capital losses on the assets it acquires. The entire purpose of the bill is to overpay for bad assets, so as to give financial institutions a chance to recapitalize themselves. The proposal to recoup that capital at a later date through a fee on the same institutions strikes me as being somewhat defeating of the very purpose of the bill. If it is desirable to raise tax revenues to cover the running cost, a turnover tax in the stock market is an attractive alternative -- if it could be passed. ...

Whatever happens, if my analysis is correct, even if the bill is passed the issues will not go away. The $700 billion will permit parts of the banking system to be reorganized. I doubt it will cure an underlying problem of illiquid securities many times larger than that. ...

A little algebra in place of misplaced wishful thinking might have saved Galbraith. If the bill succeeds in recapitalizing financial institutions, it will do so by incurring large capital losses to the Treasury. Hello!?

The program allows the Treasury to both buy and sell. Buy AND SELL. The $700 billion is a limit on the Treasury's capital losses. Can no one else read?

[Betsy L. Angert]

Dearest Mark . . .

I greatly appreciate this article and the discussion. While I believe action must be taken, I think we must be measured in our investigation and assessment of the information. I understand the fierce urgency of now and at the same time I know in my own life haste makes waste.

I am extremely concerned as I peruse The New York Times article, Big Financiers Start Lobbying for Wider Aid.
http://www.nytimes.com/2008/09/22/business/22lobby.html?_r=1&oref=slogin

I am thankful for the thoughts presented in "How Much Will It Cost and Will It Come Soon Enough?" One of many that advance awareness . . .
The problem here is, in turn, two-fold: it would appear to permit the Treasury to buy assets indirectly, in effect, from any entity in the world, so long as an eligible entity acted as a middleman. To put it mildly, it may not be the intent of Congress to extend the provisions of this bill to foreign investors, hedge funds and banks, but there appears to be no obstacle to that in the language. And, it would appear to allow other eligible entities to circumvent other provisions, such as the golden parachute restrictions, simply by lining up behind a middleman rather than participating directly in the program.
Today, a friend shared another perspective that might be worth discussion. The plan, I think, deserves serious consideration.
http://www.ips-dc.org/articles/736
10 Ways to Bail Out Wall Street (and Main Street) Without Soaking Taxpayers in Debt
By Chuck Collins and Dedrick Muhammad.
Institute for Policy Studies
Published September 25, 2008 12:00AM

I believe instead of the drum beat too often heard among the citizenry, "No Bailout," or the blast the White House bellows, "Bailout Now," Americans must consider the practical. Avarice will not disappear from the human race any time soon. Regulations are required if we are to realize economic health, or so I believe.

I invite your review and reflections on any of the essays offered above and below . . .
Bailouts Blaze; Exuberance Explodes
Let the Bailouts Begin

Betsy L. Angert
BeThink.org

[Lafayette]

Abracadabra!

BW: The program allows the Treasury to both buy and sell. Buy AND SELL. The $700 billion is a limit on the Treasury's capital losses.

Yes, which is why the offer price is so sensitive to the debt-holding companies.

The Treasury is being asked to buy presently non-productive SIVs that will be productive if the underlying real estate is resold at lower cost. So, do the maths.

The cost to the Treasury is its purchase price minus the resale price of the properties. The Treasury is buying not only the SIVs but title to the properties, for ultimate resale. When the properties are sold, their mortgages become productive and so do the SIVs.

But, the resale can only happen if the toxic properties are sold at a significant discount of their original transaction values at the height of the real estate boom. Today, the people foreclosed upon cannot repurchase those properties, even if they pass bona fide credit-worthiness criteria, unless the payments are significantly lower.

So, the purchase prices of the toxic waste SIVs must be sufficiently low. But, that means also, that their resale value may not reflate (read recapitalize) sufficiently the banks selling the SIVs.

How much should it take to recapitalize markets, such that the Credit Mechanism unblocks and starts to function once again? Damn fine question. I haven't a clue as regards an exact answer.

Or, maybe just one. If the Treasury starts reflating at $50B per month, then the markets themselves will show us the answer. I suspect (meaning guess) that this can have effect long before the Treasury reaches $700B. Many of these banks/companies (AIG comes to mind) had/have revenue streams that were in fairly good health -- just not enough to pay the debt generated by their derivatives manipulations.

Also, as the Credit Mechanism begins to crank out credit once again, people will get back into the housing market. Abracadabra! The Toxic Waste SIVs become productive once again. The banks stop selling them to the Treasury at discount prices and start selling them onward to investors once again. Or, they keep them on the books as revenue producing assets.

Does that happen overnight? Of course not. It will take a good many years to get it all straight once again.

The sooner we get started, the sooner it's done.

[Bruce Wilder]

Lafayette, I have noticed the rumors that the Treasury has been telling the politicians, $50 bn a month, and the industry, that the tranches mean nothing, and purchases will be much more rapid and massive and "friendly".

I'm keeping my tinfoil hats, in an assortment of fashion colors.

[paine]

other "asset-dependent parts of the population"
besides retirees???

lace curtain widows and orphans ???

" Given the choice between approving or defeating the bill as it stands, I would urge supporting the bill "

jaimie you you...you ... three hankee type

"bail em ...be damned"

the people rise in anger
ready to take the full consequences

i mean really
are they in for anything else anyway ???

[paine]

bw
jaimie must figure like this
700 bills in t debt at what 5%

35 bills per annum
the 700 buys crud but the crud yields somethin eh ???
cash flow wise

okay so we got
the reserves uncle sets up
agin the loses down the thirty year road
but shit man
they're just paper work

[Lafayette]

Helter-skelter

BW: I have noticed the rumors that the Treasury has been telling the politicians, $50 bn a month, and the industry, that the tranches mean nothing, and purchases will be much more rapid and massive and "friendly".

I think that (massiveness) is a load of BS. Paulson wrote his plan over dinner on the back of three envelopes.

There is no way in hell they can assess the discount values of the SIVs in order to move "rapidly". This is really, truly the work of a go-go pyromaniac who has been put in charge of the fire brigade.

They have had months, since Bear Stearns, to get into the nitty-gritty of the sub-prime muck, down to a discrete mortgage level. But, to be fair, they would have to do an sample analysis that is nationwide, in order to have a good handle on local price variations. (As I mentioned, if these properties are resold at too deep a discount, some local realty markets will find themselves depressed greatly. The wailing and crying will be heard all the way to the steps of Capitol Hill. But, of course, this present nest of nerds will have been long gone.)

It's all doable, but without the massiveness that they may claim, unless of course they go at it helter-skelter. Which wouldn't surprise anyone, since it is precisely the way they got into this mess.

Keep your tin-hat on ... this Plan has all the indications of a walk through La-la Land. It is nonetheless better than doing nothing. I think. Only on Thursdays. Afternoons.

En passant

Remember when this administration "swore" that Saddam had WMDs? This mess has the very same acrid smell to it. Nincompoops, all of them.

[ken melvin]

Suspect the value of the SIVs is closely related to the economic growth of the past few. One could get very close to the SIVs' current value by dividing their total by the increase in housing prices. Looks like about 20 cents on the dollar.

[Lafayette]

KM: One could get very close to the SIVs' current value by dividing their total by the increase in housing prices. Looks like about 20 cents on the dollar.

This figure is VERY low and bears further explanation.

At the heart of an SIV is the Original Transaction Price of residential property. Let's assume those properties no longer are worth their original values, given the present market correction and resulting value depreciations. They are therefore worth twenty percent? No, I can't see that.

It must be somewhere between 50 and 70%. If you dump a property back onto the local market at 20% of its original value, it will depress realty prices for a good many years -- given the stock that must be sold. That would be grossly unfair to present owners who have been paying their mortgages in an orderly fashion for a great many years. Some of whom might wish to resell and move on.

The challenge is to understand how best to both recapitalize the national Credit Mechanism whilst avoiding unfairness to the greater majority of Americans who were just innocent bystanders to this Great Finance Mess of 2008.

[Lafayette]

Then again, if the Treasury buys it at 20% of original value and sell it at 60/70%, you make one helluva profit -- which resuscitates the productive value of the SIVs (of which it is a part). It can be then sold forward as real-estate backed, good return, structured investment vehicles. Which is what they were supposed to be in the first place.

And, the profit from resale of the SIV is recycled into the Credit Mechanism, but via the Fed, meaning it remains public and not private money.

The Credit Mechanism, unblocked and turning again, allows banks (both commercial and investment) to start rebuilding their profits -- all by themselves. Because that is what banks are supposed to do -- service the economy, not go on a speculative binge earning hallucinatory profits with unforgivable risks.

[Patricia Shannon]

Lafayette says...

Because that is what banks are supposed to do -- service the economy, not go on a speculative binge earning hallucinatory profits with unforgivable risks.

And will this bill prevent it from happening again?

[Ken Houghton]

Ask Jamie what he thinks of the Senate version, which appears to pander even more and solve even less.

[ken melvin]

Many of the properties will fall/have fallen very little. These are not the problem. Those properties in the hi speculation areas, e.g., SoCal, SFBay, Fla, ... went up 2, 3 even 4 times value in 2-3 yrs. A lot of those LA area houses, as doc'd by Calculated Risk, went from $150k to $450-600k and were sold sub-prime to people who could scarcely afford the payments on a $150 home. These are the ones the govt. will be buying.

[Lafayette]

Inept and inadequate

PS: And will this bill prevent it from happening again?

With properly conducted regulatory authority AND execution, yes. For instance:
* TILA (Truth in Lending Act) was there to prevent predatory pricing. Was it employed? The results show that it was not.
* Greenspan has been proven dead wrong as regards asset inflation. He was looking at CPI and not housing inflation, which got us in to the present bind. That must change in the mentality of the Fed, or we change the people who still have that mentality.
* The rating agencies need very serious oversight auditing. They are the ones who qualified toxic waste as triple-A investment that the world swallowed hook, line and sinker.
* Implement tighter leveraging of assets for borrowing purposes. The forty-to-one rule has to go -- it's pure insanity. Limit it in a regulatory fashion, which the SEC seems incapable of doing.
* The Glass-Steagal Act should be brought back and put in place to disassociate Risk Aversion banking and Risk Management banking.
* I still cannot understand how this sub-prime stuff was accounted for "off the books"? Who the hell ever gave permission for that to be done? Banks should have started failing long ago, had the books not been cooked.

Etc., etc., etc. Let's clean up this mess not simply to fix the problem at hand, but assure that it doesn't happen again. Finance frenzies of this kind will always come around. We need the proper safeguards and cooler heads involved in regulating them.

Of course, if people still want to dither regarding this problem. Maybe when unemployment hits 15% ... they'll be convinced that they missed the boat? By then, the economic damage will have been really, truly done -- and it will take years to repair it.

The sub-prime mess IS systemic -- it indicates that the whole Finance System should be rethought by the incoming administration including the application of regulatory authority. Perhaps by an independent agency, responsible only to Congress, since those responsible this time, dispersed amongst various agencies, proved so inept and inadequate.

[Lafayette]

Headlines from the NYT on-line:
Senate Passes Bailout Plan; House May Vote by Friday

The Senate strongly endorsed the $700 billion bailout plan, leaving backers hopeful that the easy approval, coupled with an array of popular additions, would lead to quick passage in the House.

One might be led to think that American Senators are more wise than American Congressmen. Or, perhaps, many of them, who are quantifiably millionaires, are simply voting their vested interests ... ?

Nah ... they have, really and truly, the nation's interests truly at heart. Maybe.

Anyway, it's done.

[Lafayette]

km: Many of the properties will fall/have fallen very little. These are not the problem.

This prompts a very interesting question: Just what is the fall in national property prices that would affect the resale value (if they were part of an SIV purchased by the Paulson Plan).

There is not much out there on the matter, but I did find this. For what it is worth, since the study is not all that well documented, it would appear that property prices today are at about 35% less than 2003 (based upon the red-line, inflation adjusted prices), when the bubble was just forming. Of course, what the graph shows is that the price rise was steadily since 1997. But, just when did predatory sub-prime marketing begin?

Let's presume it was, indeed, five years ago. Which may be wrong - but, still, for purposes of debate it will have to do. The only way to really know is by a careful analysis of the content of the sub-prime SIVs. After all, they are at the heart of this Credit Mechanism seizure.

To my mind, nonetheless, this means that the properties sold in SIVs during this past five-year period are somewhere between 0 and 35% above present prices compared to their original transaction values. Most sub-prime houses were sold prior to 2007, when the bubble began to burst and no one wanted to buy property when prices were declining.

Of course, given the nature of the data and my interpretation of it, this may be discussable. I'm going with the 30 to 40% discount range of present value for unsold SIV properties.

[ken melvin]

Again, the bubble. The ReFis in bubble areas are interesting in that the borrower actual got the money and presumably used it to purchase stuff at Target, etc. They, too, owe tons more than their house is now worth. And, Anne, the ReFi group included an exceptionally high minority ratio. So, if let off the hook, they successfully gamed the system whereas the buyer of that got stuck with the peak mortgage was victimized.