Wow, that was fast! After saying "no" on Monday, the House of Representatives did an about face and sent the Paulson Plan to President Bush who signed it into law an hour and a half after the final votes were cast.
Now what? Will it work?
That depends on whether banks take losses on the securities they sell to the government. This gets tricky.
Thanks to Dave Zion at Credit Suisse for walking me through this.
Let's say you're a bank with a bunch of mortgage securities on your books. Over time you have watched the value of those securities fall from around $1.00 to 70 cents. That 30 cent loss gets put into an item on your financial statements titled "accumulated other comprehensive income."
Crucial point: AOCI is not counted as a loss against the amount of money regulators require a bank to hold on its books.
Now, if you actually give up on your mortgage bonds and sell them off, then you trigger what accountants call a "charge off" and you must deduct that AOCI loss as a real loss against your income and your regulatory capital.
So, if you had $1 in regulatory capital, you now have 70 cents. Now you have two choices: shrink your loans or raise more money. Either way, you're in a world of hurt.
Now let's bring in the Paulson plan. If this bank of ours has already written down it's mortgage securities to 60 cents and the Treasury buys them for 70 cents, we made a profit and have a lot more capital! We can lend again, maybe buy other banks.
But if more banks have AOCI they haven't recognized, they might use the Paulson plan as a way to clear the decks. They'll take their losses, but then they'll have less capital and less ability to lend.
If banks have written down a lot of their losses already, then the Paulson plan might get credit moving again. If not, there are more losses to come and less lending to be done.
Comments
The problem isn’t with our government (not all of it) or its process, but with the same industries that discovers or takes advantage of the laws/policies that our government creates in order to benefit during either affect of U.S. economic change.
Then they turn around and blame government for regulation or allowing people within our great state to buy homes or other items with the same products that they themselves created.
Let us see if we can sum this up, just trying to keep things straight.
• Banks/Lenders create super easy financing for people
• Tons of people get into the housing market and values increase
• Foreclosures start and the financial market blames 5% of the housing
market for the failure within our market.
• Oil/gas goes up.
• Government gets in and begin a round of bailouts, about $2.5
Trillion (don't forget the banks are borrowing from both ends the
people and the Federal reserve).
• This has now affected the world because Banks/Lenders sold this to
other investors around the world.
• Foreclosures increase as time goes on.
• Fed rushes in to approve $700B bailout… Oops its $850B!
• Bailout still brings down market
• Federal Government bends over backwards in trying to correct this issue.
• Federal Government destroys investor confidence in the market so
people began to pull out.
• Banks/Lenders still do nothing to assist in correcting issue.
• Bank/Lenders fight over and buy up so-call weaker banks (???)
• Foreclosures and job loss continue to happen.
• Bailouts do nothing still!
• Banks/Lenders still doing nothing, but hands (safes) are wide open!
Government states that they should not be governing private business,
but yet they are involved??? Why is that they want one side but not
the other.
The Banks/Lenders should be modifying these loans without government
intervention. Let the homeowners pay down their own balance, the banks
are allowed to take losses and sell off notes/securities at reduced prices and still get money from the Fed’s and us at an even cheaper rate. Yet they pay themselves very well. Doing all of this and they are allowed to get away with it and still make even more profit.
I suggest two options:
1. All homeowners under (current) foreclosure get the same lending
rate as the banks (1.5%) for the life of the loan.
OR
1. All homeowners under (current) foreclosure get a 3/5/8 loan. The
first 3 years they are allowed to pay down their principal balance, by making timely monthly payments. At year 4 get an increase to 1.5-3% of the unpaid principal balance. At year 6 get another
fixed increase to 5-6% for the balance of the loan.
The reason why I think this is better, is that the balance remains the
same and you will give them the benefit to pay down the agreed balance
themselves within a set period of time. No reduced principal balance amount will be given. Second,
they can pay any amount for that period of time without a prepay of other
liabilities. Of course we can also change this to a 5/8. Allowing more
time to reduce principal balance. Third since the foreclosure is stopped this
should reduce the amount of homes on the market. As well as help in maintaining value within the neighborhood, this should assist with maintaining values. As this will also allow time for our economy to recover and the homeowner (job loss, health issues extra) to recover from this as well.
This cost nothing, but some time and no BAIL OUT will be needed. Banks will not like it because they will need to wait on profits and also that they are waiting on our government to pay FULL price for notes/securities that they have either written off, sold and taken a loss on. That they will claim over the next few years to lower their own taxable profits once again.
My question is regarding the RFPs that are due today for managing the securities being bought with the proceeds of the $700 billion bailout. So, if I can get this straight, the same "whiz kids" who managed us into this financial crisis now not only get to sell their securities to the Treasury but also get to make money on managing the securities they sold?
Just Buy the Houses, Hank!
Why do Hank Paulson and so many legislators wish to spend $700 billion of tax dollars on extremely-hard-to-value derivative instruments based on faltering home mortgages, when buying the actual homes at foreclosure should suffice and cost half the price?
Paulson's bailout plan is 'a bandage' said Simon Johnson professor at the Sloan School of Management at MIT; it does not address the root cause of the banking crisis which is 'the spiral of rising foreclosures and falling home prices' (2008-10-04 WSJ, page B3)
According to RealtyTrac.com, this year to date there have been 2,234,518 foreclosure filings, and 479,461 foreclosure sales averaging $163,248 each—a 30% 'saving'. Buying them all at auction (up to a preset discount ceiling) would cost an estimated $364.7 billion.
Wouldn't it make more sense to spend tax payer dollars on discounted real estate than on hard-to-quantify devalued derivatives based on devalued underlying assets? The US Government is already in the real estate management business (Govt Housing, Bureau of Land Management). There is no reason for it to launch into the financial derivatives business.
Once the government buys these homes, they can be rented back to the ex-owners on short leases at a prorated rent close to the homes' newly established value. For example, a $1 million foreclosed home normally carry a $6,000 monthly mortgage bought at auction for a 30% discount, would be offered back to the ex-owner for rent at $4,200/month.
Announcing such a purchasing program might have another positive consequence: driving real estate prices up. This would cure the toxicity of the derivatives presently clogging the worldwide banking system. Equally, in a recovering housing market, rents could be raised or the homes sold back in the market at a profit.
The mortgages will have gone from non-performing loans to performing rents. The derivatives on the loans can become derivatives on rents —adjusted for longer maturities and reduced underlying asset value.
The banks will cut their losses and move on by writing down the value of their assets while gaining price surety. Banks will consolidate in the process, reducing the number of banks to less than the 8,000 we have today in the US. There will be large financial losses, but Wall Street and Main Street will have split the difference. And the government will have kept people in their homes, upkeeping their properties.
Joe Six Pack will become an increasingly cash flow positive renter instead of a currently negative equity homeowner, and will spend or save his excess cash flow—all good for the economy. For example, the difference between the old mortgage payments due on foreclosing homes ($6K/mth in our example above) and the rent due on the new rental properties($4,200/mo) will go a longer way to pump cash in the economy than implementing another relatively inconsequential one-time $600 stimulus check plan.
This will effectively neutralize the price uncertainty paralyzing a banking system bogged down with unquantifiable derivatives. We will have set a floor on the housing market while keeping upside potential, we will have directly helped many struggling homeowners, and saved a few hundred billions for another rainy day.
Your thoughts welcome.
Stanley G. Aïzenstark
OH DEAR This gets tricky "OH YES VERY TRICKY INDEED"and WHY ??????
Since the financial crisis began 14 months ago, the system has been hit by waves of onsetting and retreating panic.
Georges Bush has located a spare trillion of $$$ from the Main Street for his distressed friends on Wall Street, all that money dropped from the skies of Manhattan, very generous indeed with all that talk about free market.
In a meantime there are still more than a TRILLION of $$$ worth of risky debt associated with private equity takeovers that has not been aired because of those businesses no longer report earnings to the public, but the bankers are only too aware of the parlous financial position in which many of these businesses now find themselves overloaded with debt and facing a deep recession.
VERY TRICKY INDEED and Who are the lucky ones in this ugly financial disaster when things are getting tigh out there ???