Whether this $700B blank check for the treasury is bad, really bad, or a disaster depends a great deal on the price paid for the excess securities. If nominal price is paid, it’s a complete disaster, essentially giving money to the outer-reaches of the economy engaged in multiple levels of speculation with other peoples’ savings at the expense of its core, the working-consuming-taxpayer.
If a deep discount is paid, it’s more fair, but then the banks will come back for more relief as their insolvent balance sheets invite lower levels of saving, “bank runs,” and the like.
If the price varies from bank to bank or asset-backed-security-pool to pool, then claims of favoritism, unfairness, or lack of zeal will be levied. If after taking on all of these bad assets, syndicates rebuy them from the Treasury at an additional discount citing the lack of liquidity in the market, the taxpayer will have gotten fleeced both coming and going.
But the price is everything, and the price Paulson (or his successor) will pay is completely unknown. The Economist had a useful piece on this:
One of the big myths currently circulating is that banks simply cannot unload these bad assets. In reality, however, there is still plenty of interest if banks are willing to reduce the price low enough. At the end of July, Merrill Lynch liquidated US$30.6bn of asset-backed collateralised debt obligations for US$6.7bn — a discount of 78%.
Most other banks have been reluctant to accept such a steep discount. This unwillingness puts Treasury in a difficult position. Mr Paulson could demand a big discount, which would help protect taxpayers from overpaying on assets that already have a limited market. However, if banks were forced to sell at fire-sale prices, they would suffer a sharp increase in their writedowns, causing them to seek even more capital, which would defeat the plan’s initial purpose.
Instead, Mr Paulson seems intent on paying fair-market values for these troubled assets, noting that any punitive discounts would limit the participation of financial institutions. But it’s not clear what the fair value of these illiquid assets really is. There is a very real danger that Mr Paulson will overpay for these troubled assets just to help recapitalise the beleaguered banks. This could force taxpayers to hold billions of dollars of assets to maturity or try and resell them — either of which has the potential to generate huge losses, especially as long as the housing crisis continues.
The fear of contraction is creating additional inflationary pressure, which will, in turn, create more bad investments, excessive expansion, cheap money, declining US credit, and an eventual meltdown of the currency, whether in hyperinflation, deflation, or some kind of supply shock combination of both remains to be seen.
That McCain and Obama both see this as a tail of heros and villains where hidden piggy banks of money in the form of executive compensation can sort this all out is the most worrisome feature of all. The money is not there, and our collective national lifestyle of “leverage,” low savings, high consumption, high levels of debt, generous government programs, “wars of choice,” mass immigration, cheap labor, multi-trillion dollar debts, trade imbalances, resource profligacy, a mania for toys, and an overall absence of any national economic policy is the cause. Everyone who bought a house thinking he could flip it for 150-300% of its purchase price before the ARM kicked in bears some of the blame, as too do the race hustlers, liar loan liars, vacation-taking second mortgagors, and everyone in between. Worst of all, our President who said “spend as an act of patriotism” during a time of war, while ignoring the impending solvency impact of entitlement spending, showed a complete absence of foresight of leadership.
No one giving this kind of speech, however, will get very far in a democratic regime. It’s so much easier to blame a few fat cats, or a few greedy Wall Streeters–and greedy they were!–but their greed is an epiphenomenon of an unbalanced economy fueled by a culture of rank speculation, leverage, and get-rich-quick scheming.