Hank Paulson, Buy-Sider

The details of RTC II are emerging, and it's pretty simple: give Hank Paulson $700 billion, let him buy up mortgage-related toxic waste, and thereby rescue the banks and save the global financial system.

Henry Blodget asks one key question: how on earth will these things be priced? All we know so far is that it's going to be set up as a reverse auction, but that raises more questions than it answers. Reverse auctions are easy if you're dealing with something fungible. But CDOs and MBSs and the like are all unique, and I have a feeling that Paulson will have to hire a large number of highly-qualified bond-market professionals to look very carefully at every instrument on a case-by-case basis. My guess is that there will be some kind of performance-related pay, which will be an interesting development as far as the civil service is concerned.

The good news is that there are probably a lot of those highly-qualified bond-market professionals looking for work right now. The bad news, of course, is that they are the people who created the problem in the first place: is there any particular reason to believe that they'll be a particularly effective solution?

One thing does need to be cleared up: this, from the NYT, is confusing, and pretty much false.

The ambitious effort to transfer the bad debts of Wall Street, at least temporarily, into the obligations of American taxpayers, was first put forward by the administration late last week.

I'm pretty certain that Paulson is not going to buy up the obligations of Wall Street banks, let alone guarantee them. If you hold bonds issued by Goldman Sachs or Wells Fargo, they're going to remain obligations of Goldman Sachs and Wells Fargo. Instead, the government is going to buy bonds owned by Goldman Sachs or Wells Fargo -- bonds which, at heart, pay through to bondholders the income from millions of Americans' mortgage payments.

American taxpayers will have new obligations: in order to buy those bonds, the government is going to have to borrow hundreds of billions of dollars. That's new debt, and government debt. But there's no government guarantee on anything. And if you own a CDO or some other mortgage obligation, the government is definitively not going to step in and make sure you get paid in full.

This article has 31 comments:

Sep 20 05:21 PM
"how on earth will these things be priced?"

Let's see, Paulson is a political appointee, and wants to be immunized from any legal action against his unilateral choices of winners and losers. It's not hard to imagine how it will work:

1. What is the current market value of the security in question?

2. How much has the holder of the security in question contributed to McCain's presidential campaign? If significant, add 30%.

3. How much has the holder of the security in question contributed to Obama? If any, deduct 50%.

Any questions?
Sep 20 06:02 PM
As long as all these actions are helping and protecting the common people, why bother with all these little political details ! Don't make it more complicated than it is now.
By next Summer, it will all be forgotten. Relax !!
Sep 20 06:25 PM
People are behaving like this will be "it," however Banks will still have to write these obligations down to the Paulson "mark to market," they still have to raise gobs of Capital, and many still will collapse. Auto Loans, construction loans, HELOCs, and credit cards loans are defaulting and not because of subprime, so these banks are still in quicksand. Not much has REALLY changed come Monday.

The market will continue on it's merry way, down, as the global recession kicks in to second gear.
Sep 20 08:11 PM
Schweizer: thank you for pointing out the obvious, but most often forgotten. People are still stuck with mortgages they can't afford, people are still stuck with homes in negative equity. This bailout of Wall Street does nothing to help those: it doesn't boost the cash flow of subprime lenders to pay their bills, it doesn't magically raise home prices, it doesn't take a bunch of homes off the market.
Sep 20 08:45 PM
$700B....at a time. Read it. Enter Potato Chip Theory.....
Sep 20 08:45 PM
On Monday, we will still be anticipating the proposed 700 billion dollar corporate welfare fund. If you collect welfare (or, disability benefits/FICA) then, out of all the programs, the Section 8 Existing (rent or own) housing voucher is by far the most powerful. Food stamps, LIHEAP, and health insurance are as able, but you first need a roof over your head to collect the other benefits. Certainly, the social security or welfare check each month is as much a life saver in all times of need. And so to be supplemental security income accounts.

In market terms, we've seen GE caught in the credit crunch, because of the problematic nature of AIG folding, where AIG if I understand correctly secured GEs foreign mortgage portfolio. If correct the downwards pressure on GE last week bottomed near $22/shr for that reason.

With the federal 85 billion dollar 8.95% two year loan to AIG, presumably the mortgage exposure for GE, is now covered in a fashion that avoids some of the crunch they may well have already experienced from foreign delinquency exposure. GE is trading much higher as are the preferred securities of FRE-T, FRE-X, FRE-M.

Otherwise, GE is running clean and green, and is therefore a considerable role model of what Mr. Greenspan has said to be the unwinding of what we are about to get in to.

The reserve/treasury has either allowed the market to absorb firms after they dissolve, then lend money, or, as with FNM and FRE literally taken over. In doing so, it seems more apt that such extreme measure is effectively something on the order of an entity swap, as opposed to a convertible, or a short position. What you had invested in originally is now in fact, a different investment altogether, because the CEO has been discharged and so on down the line to the bottom line, of lending and borrowing from the Federal Reserve trust through treasury.

Your investment is good or secured in money markets, but only so far as the US borders when it comes to mortgages, because only US mortgages will qualify for buy-in/out protection policies. If it’s a foreign bank with US mortgages then a fixed rate is presumably set in place to cover toxic debt, or it is the sole discretion of treasury to negotiate the terms in such instance as to buy back from any institution or service US mortgages. The only exception to date is the AIG loan.

This is where it stands and the 700 billion is far, far, from a done deal. They are going to have to let the market place consolidate more, and to that Greenspan was against the short sell provisions we are under now.

Sep 20 09:12 PM
This is very simple. Banks and IB will pump up the assets to sell Uncle Sam an then they will dump them. This will be another classic fraud but on US.
Sep 20 09:55 PM
That's good because I know a lot of recently unemployed bond market specialists...
Sep 20 10:28 PM
This part needs to go: tell everyone

"Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency."
Sep 20 11:17 PM
I have an idea whereby you are (in my imagination at least) guaranteed a fair price for the toxic assets. If the owner prices them, then at the point they get bought by the US govt. the equivalent in equity (book value) is also transferred (in stock shares or warrants) to the gvt. as well. If the toxic assets are overpriced, it pushes up the total value of the equity transferred, and so a larger part of the total fractional equity is transferred as well.

In other words, a higher price for the toxic assets should be matched by larger dilution in ownership in the form of the coupled warrants or stock transferred to the US gvt.
Sep 21 12:47 AM
I think he will structure it as favorable to banks as possible (from the looks of his other deals). His logic is simple, if banks don't get a good deal they'll just pass and enjoy bankruptcy. So basically Paulson allows them to hand over some of their bad bonds (the illiquid ones). The other ones are also bad or going sour but everyone figures they just need to hold them about 20 years and use the revenue from the still remaining decent homeowners to pay off their excesses. In exchange the Fed will pay them over 50% on the dollar for the bonds plus if they sell them for more someday later they split the profit (after all, he understands the financial system is based on greed whereas the taxpayers are based on obligation to pay no matter what). Most likely they will not sell for more anytime soon. So in actuality, the bakers make a lot of money either way since they sell bonds worth as little as $0.05 to the dumb government at $0.50 who has no one to evaluate them. In fact, maybe they'll repackage them to make sure thaey are worth $0.00. I wouldn't put it past them.

But the real cost is the other bonds. $800 billion won't buy out all the bad bonds or the new bonds going bad as we slip into a recession. You pay that over the next 20 years as the money supply shrinks and the banks recapitalize. Enjoy the best case scenario for them...

You! Who cares about you. You voted them into office and let your banking system be run by bankers without a link to public scrutiny (then allow him to give 800 billion dollars away without congressional oversight or approval to public companies -bear,aig, Fannie and Freddie). The rest of the world is enjoying eating all your interest payments as you go the way of the other big superpower that fought dumb wars and overspent for years (USSR).

As an American the only patriotism is to call for rebalancing the budget and paying the piper before we the dollar becomes worthless and we go even more bankrupt at a later date. Even the IMF can't bail us out.
Sep 21 03:19 AM
Government may come out make $700 billion in due time.

They are buying discounted paper. Its an old real estate trick. You buy distressed mortgages for 50- 60 cents of full value. Mortgage is secured by our own homes and dwellings in our land with our own people!

When the market turns its worth full value in 2-3 years plus interest and penalties and other good stuff... I bet you wont call it toxic waste than.
Sep 21 07:47 AM
If nothing else, the Chinese and the Japanese will give a second thought about dumping U.S. Treasuries. With the 1.2 trillion dollar bail out, new Treasury issues will be generated and they will be extremely popular the world over. Bank stocks are going to continue to rise, but in the long run gold will come out the real winner.

Poltically, it means the end of the McCain candidacy and the GOP because of its treasonous maladminstration of the US government , and its criminal neglect while bankers , hedge fund managers and other thieves fleeced the "system". Not to mention the American people and their economy.

Mayor Mike Bloomberg can be as sanguine about New York City's ability to weather this mess as he wants to be, but the the truth is the financial hegemony of New York City as the money center of the universe is now history. It ended once and for all this past week.
Sep 21 08:27 AM
"Mayor Mike Bloomberg can be as sanguine about New York City's ability to weather this mess as he wants to be, but the the truth is the financial hegemony of New York City as the money center of the universe is now history. It ended once and for all this past week."

I agree, NYC will soon suffer a really ugly decline in real estate values, as well as employment. I realize that many jobs went away months ago - but there are tens of thousand more yet to disappear.

Let's face it, about half-a-million people there have been employed in what was just a huge, mostly valueless gambling game, taking large salaries and bonuses out of the economy, and adding almost no value to anything or anyone, except themselves. That is all melting down now, and these parasites need to find other jobs.

I'm not shedding any tears for these people - CDS's are the bane of the capital markets, if you ask me. Only the lawyers will have steady work going forward.
Sep 21 08:40 AM
$700 billion - Senator Dirkson would probably consider that real money.
Sep 21 09:13 AM
Well said copperbaron.
Sep 21 09:38 AM
You make this sound like another trivial episode in a trilogy of the dollar. I think we are hearing only the surface chatter and we need to view the bigger picture.

Sep 21 10:52 AM
An interesting development (sourced from drudgereport.com):

Foreign banks may get help
By MIKE ALLEN | 9/21/08 7:24 AM EDT

In a change from the original proposal sent to Capitol Hill, foreign-based banks with big U.S. operations could qualify for the Treasury Department’s mortgage bailout, according to the fine print of an administration statement Saturday night.

The theory...

www.politico.com/news/...

Sep 21 10:59 AM
In hindsight it could have been smarter for Hank to have saved Lehman with the necessary spin about how it was too interconnected etc. World confidence will have been shaken by hearing that the US President had no idea how bad things were and too many people got to see how deep the abyss could be during trading on September 18th
If this GSGC (Government Sponsored Garbage Can) scheme does start to look wobbly then picking up the tab for LEH and AIG would have been a bargain for the taxpayer
Sep 21 12:00 PM
"but the the truth is the financial hegemony of New York City as the money center of the universe is now history. It ended once and for all this past week."

Thank God. Looks like the banksters just got "offshored". Can we do politicians next?
Sep 21 12:57 PM
It's odd that Paulson stepped in in full force once Goldman got crushed. This whole market is rigged.
Sep 21 02:02 PM
This problem is far too complicated for anyone to have
a definite answer -- also weither this "bailout" will be
good in the longrun.
I'll be ready to pull the trigger and get out of the market
if things look to be falling apart in the next 1-2 weeks.

I'm letting my gold and energy mutual funds ride this
comfusing period -- I expect them to do OK for the
rest of this year -- but common stocks are on very
shaky territory.
Sep 21 02:48 PM
Goldman Scams was 3 days away from elimination, then magically Paulson steps in and declares that "all banks must be saved". He eliminates GS's competition: BSC, ML, and LEH. Paulson is a great friend/judge to have at a witch trial.

Our economy is a stacked poker deck. Cronyism is pushing all of our chips to the corrupt.

Paulson and Goldman Scams represent everything that is wrong with the U.S. economy. Disgusting. Under the table handshakes lead to more bailouts for the little guy to pay out. Nothing will change.
Sep 21 03:09 PM
what is the point of all this?
the junk is already on the Feds balance sheet anyways at almost face value. they can simply extend the term of the 'facility'.
....or maybe hunky paulson wants to pay more than fair value for it.
Sep 21 03:34 PM
"When the market turns its worth full value in 2-3 years plus interest and penalties and other good stuff... I bet you wont call it toxic waste than."

Another idiot in denial. 1929-1953. Is that 2 or 3 years?
Sep 21 05:32 PM
Will this new Government balance sheet save our economy?? I'd like to see the treasury's analysis of the after affects of this huge Government intervention. It probably all depends on how quickly the bailout repairs bank balance sheets. With the Government making the market in toxic mortgage debt it will ease forced liquidations which has been pushing down prices, like Bill Gross said. Once bank balance sheets are repaired it will ease the liquidity squeeze on the consumer allowing capital to freely flow to a new business start up or good standing home buyer, which will in turn bring employment, income and confidence to the system. So from here it really all depends on how resilient the consumer is. www.distressedvolatili...
Sep 21 06:35 PM
NEWSWEEK COVER:
King Henry Treasury Secretary Paulson on Taxpayer Bailout: 'It's Very Unpleasant for Me, But It's a Lot More Attractive Than the Alternative' The Former CEO of Goldman Sachs has Emerged as Investment Banker in Chief; Says There Will be Housing and Mortgage Issues for Years; 'The Key is to Get Stability'

www.marketwatch.com/ne...

I think the after affects are at least partially known. "There Will be Housing and Mortgage Issues for Years" . If we get through the next couple of weeks without a total meltdown housing is still screwed - cause interest rates will be heading north (didn't someone say that housing has to be fixed before the economy can start to heal). Paulson said anything was better than the alternative - lets hope we don't get both.
Sep 21 06:58 PM
What gets me is they don't even have a realtor’s license?
Sep 21 08:07 PM
I suspect that every comment here is correct . If so ,then the USA is in "deep shit" .

Sep 21 09:45 PM
Who is Paulson fooling?! Estimates around $700 Billion are absurd!!!

This is going to cost TRILLIONS FOLKS!

Please think about every single lie that this administration is responsible for before you consider the accuracy of $700B.

I STRONGLY encourage everyone who reads this to notify their congressional representative to vote AGAINST any and all bailouts on this matter.

Think about how strong the market will become after the crash!!!! Thats the market I want, not some sucker move that Congress is considering.
Sep 22 06:37 AM
why the treasury dont bailout the indebted household directly? it can be fair and effective at the same time, and avoid all these agency costs...

More by Felix Salmon

Zimbabwe Datapoint of the Day
on Nov 19, 2008
Will Berkshire Lose Its Triple-A?
on Nov 19, 2008 | about BRK.A,BRK.B
Yet More Paulson Revisionism
on Nov 19, 2008
Investing in Africa and Ecuador
on Nov 19, 2008

Seeking Alpha

Felix Salmon

Related Articles

This article has 31 comments:

More by Felix Salmon

Most Popular

Most Read

Editor's Picks

Most Commented

Investment Resources

Money Management

Research

Articles on related themes

Bonds

Dollar/Currencies

Earnings