Paulson/Bernanke: $700 Billion at 'Hold to Maturity' Pricing 29 comments
Michael Steinberg
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Treasury Secretary Paulson, Federal Reserve Chairman Bernanke, SEC Chairman Cox and FHFA Director Lockhart testified today before the Senate Banking Committee. Paulson and Bernanke made it clear that the $700B plan should not be designed to punish the participants, unlike the Bear Stearns (JPM) and American International Group (AIG) efforts. Purchases need to be priced high enough to attract participation by healthy (not just desperate) institutions, so that lending will be reinvigorated.
Bernanke explained that “hold to maturity” valuations are greater than the current fire sale market values. Paulson detailed that the Treasury would experiment with reverse auctions and other pricing mechanisms for instruments that are both complex and not interchangeable. They want to prevent further price erosion, and bringing in healthy institutions could actual push up the prices of mortgage securities. Paulson explained the difficult balance between promoting higher pricing to support financial institutions and causing tax payer losses by being excessively generous.
Price determination is so difficult that the Treasury will be contracting a slew of outside consultants and portfolio managers. There no time to build internal expertise.
Paulson further explained that his proposal is focused more at the mortgage securities than the individual financial institutions. The objective is price discovery in order to jumpstart market liquidity. Financial institutions will be helped indirectly through a more robust market.
The clear purpose of the Paulson plan is to boost the prices of mortgage securities and no more. It is up to Congress to determine whether taxpayers will be safe and foreclosures will be stemmed. Being as Paulson will be paying retail prices, he must add value to his purchases – not just trade them.
Lockhart predicted the GSE conservatorships for Fannie Mae (FNM) and Freddie Mac (FRE) will last about a year, or maybe longer. It could be a few years before preferred dividends are restored. Lockhart said his thoughts were contingent on any potential changes in the GSE structure by Congress. I found this refreshingly optimistic.
Cox addressed questions on short selling and mark to market accounting. He provided no new information.
Overall, I found what I heard today beneficial for troubled banks such as Washington Mutual (WM), and the GSEs. WaMu would be more attractive to an acquirer if its mortgages can be sold based on “hold to maturity” pricing, and might even survive on its own. If bad mortgages are priced high, the GSE good mortgages will be worth even more.
Disclosures: Author is long AIG, FNM, FRE, JPM and WM.
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This article has 29 comments:
If Bernanke knows exactly which home owners are going to default and which will not, he should definitely tell us -- and more importantly tell us where he bought his crystal ball that foresees defaults but somehow fails to warn him about the credit crisis.
Unless you know who will/will not default -- you have no way of knowing if a mortgage is worth par or zero.
If he really did earn his PhD, than Bernanke knows this very well and he is deliberately lying to us. Shame on him
If they need to dump all that bad paper (illiquid assets...who dreams up that crap) they'll come running to the watering hole.
Here is a solution - pass a law that requires all banks to open up their books to federal auditors, and mark ALL mortgages to market, AND dock them even farther down based on current housing trends. Plenty of banks will immediately be insolvent, have the FDIC seize them and make the stockholders and owners take a bath on it. This $700 billion can be used to shore up the FDIC fund so that common citizen's accounts are saved, and nothing more.
If we keep building up this bubble, the next thing to crash is the country, not just the market.
1.Mortgages that default are not worth zero.
2.Mortgages that pay are not worth 'par'.
3.There is no real market for these mortgages.
4.Just because there is no market (today) does not make the assets valueless.
5.Mark to market pricing is a disaster. Your house is not always worth what you could get if YOU HAD to sell your house in 24 hours.
6. epeat - some of these morgages have no real maket - period.
7.Yes, the taxpayers will take a hit. Some % of the bailout will not be recovered.
8.If 1/3 to 1/2 the financial institutions in America go insolvent, and business lending and consumer lending grinds to a halt, the tax payers will take a hit as well.
9.The plan is not perfect, but the alternative is mighty scary!
Becuase the rate of return on MBS is greater than Treasury's cost of funds, the operation would be profitable if done carefully. Perhaps treasury should pay 5% less than what it computes as the hold to maturity value.
Once any kind of a market is established, the vultures will come off the sidelines before Treasury buys anything like 700 billion of these assets.
The current financial crisis is not an anomaly, but a product of implicit forces within our economic system:
* individuals are encouraged to take risks, where the rewards grow exponentially with risk
* individuals are encouraged to use increasing leverage to obtain those rewards, be it financial (amount of debt) or organizational (size of corporation)
The result: executives of huge corporations and hedge funds risk the entire economy in order to make the most money.
The solution is not to have a few huge, regulated, partially government-owned companies, which is the direction we're heading, but to introduce opposing forces:
* individuals who receive large rewards have their personal fortunes placed at risk
* corporations are restricted from borrowing incrementally as they increase in size, with very large corporations prohibited from borrowing completely
This could be accomplished by two acts of Congress:
One, a Highly-Compensated Executive Act, would require any officer of
any organization to take on increasing personal liability for the organization's debt as their compensation rises about a certain point (say $10M) for the duration of the company.
Two, a Large Corporations Act, would increasingly limit the amount of leverage a company can use as it grows beyond a certain size.
Introducing these opposing forces into the markets is necessary to stabilize. The current game of you-take-the-risk-I-th... is inherently unstable, and the frequency of crises will increase as time goes on.
These acts also actually wouldn't expand the power of government, per se, since the absence of liability is not something naturally occurring in the markets, but a government invention. Without the ability to incorporate as a legal person without personal responsibility/liabili... we'd never be in the mess, but wouldn't be as developed either. Allowing more liability as the consequences of actions one's actions grows would be a natural deterrent for the current recklessness.
Boy, you are not kidding!. Tthe dominoes were already beginning to cascade last week.
But, for those skeptics out there..... let's take the proposed TARP-fix, and an example:
WaMu has $18.241 billion dollars of MBS's on its balance sheet (per of the 8-K filed July 22, Exhibit 99, page WM-4) that's 7.6% of its $239.627 billion loan portfolio (ibid). These MBS's earned $335 million of interest income (1.8%) for the quarter (ibid, page WM-2)
If the Treasury were to purchase these MBS's from WaMu for, say, just 50 cents on the dollar...... that would be $9 billion in cash to WaMu and elimination of the "bad paper" from their balance sheet. They would look better, financially; they might even get an improvement of their Moddy's rating; they might even be inclined to make a loan of some or all of that new $9 billion at current 5.9% (plus or minus) rates (if on the full $9 billion, they'd be making $531 million of interest income at 5.9% compared to the $335 billion they were receiving before this exchange arrangement).
Now, for Treasury's perspective: Treasury owns a $9 billion array of MBS's which are paying not 1.8% to the Treasury, but because of the 50% discount, a net rate of 3.6% - that's better than what the Fed is getting on its discount from member banks (2%). Nice.
If one or more of the securities ("securities" here meaning a property which secures a portion of the tranched MBS package) needs to be foreclosed due to severe non-performance, the Treasury will be holding onto a home which, in effect, it purchased for 50 cents on the dollar (more or less, depending on the LTV of the original loan, or how badly negatively amortized, or, on the other hand, and to WaMu's eventual credit...is located in California or Florida where real estate value recovers faster than anywhere else). In any event, there would be a significant if not considerably large value "cushion" which works to the Treasury's benefit when it sells the property at auction. Again, nice.
In effect, what Treasury is doing, is what the banks and the investment banks used to do (before those banks and investment banks got a little "loose" with their lending standards, and then freezed-up because their "let's make a loan" game began to disintegrate before their very eyes). The Treasury will buy and move these securities at "market" prices - and keep the credit "blood" flowing in the economic body.
Paulsen and Bernanke are correct. The risk to the taxpayers is minimal because the Treasury will receive value on the purchases.
The alternative is simply unimaginable.
Mike Hanson - long on this country - and the financially savy Paulsen, Bernanke, and Cox who are answering our 3 a.m. phone call.
Also not factoring in the Fannie, Freddie, FHA mortgage dump that's going to happen in conjuction with the buyouts. FHA has been refinanciing trash loans at a fevorish pace. New rules.... No minimum FICO, 3% down, OK if your behind on your current loan. All they are doing is cleaning up the banks books while kicking the forclosures down the road a few months.
Hank and Ben made it pretty clear, they want to pay near full face value for what they buy with no stipulations on the banks. There's no money to be made on this deal.
They are the "second act".
I also find it interesting that our Congress is finally having to do what we hired them to do - - make a decision and take the responsibility for it - like what the rest of us do every day.
Congress is usually so quiet around election time - they let the presidential candidates talk loudly - but they stay noticeably mum; they will rarely mention items like taxes, or social security, etc. - because the more they talk, the more likely they are to be repeated, in newspaper print - which can cost them an election.
What a nightmare for them this week.
"Oh my gosh, I have to make a decision on a very big issue, a very public and expansively disseminated issue, and then go home this Friday and explain my decision to my constituents."
It's tough when you finally have to start "doing your job".
do you know what he ask the 700 billion instead of 350 billion
they have to paid for the face value or maket price or else it will not work
the local bank are leverage 10-1 and the investment bank are leverage 30-1
let me put it into simple math
if you let 100 dollars and 5% is bad at a 2% interest profit
(100-5)*2%=$1.90
-5+1.90=negative $3.1
so think of like in billions and highly leverage banks
I lived through the Asian crisis - right in the middle of it. Whilst small in size vs the current crisis, I am amazed at how lacking a leadership and urgency the American people and Congress has showed in dealing in this whole affair. I watched the hearing last night and it came across that most were more interested in putting blame rather than finding a solution. There is still a lot of self denial going on and intention to fix a blame rather than find a solution.
On just looking on the various articles and comments from SA's forums, it seems like most Americans have lost hope and have turned very cynical. Yes, perhaps its right and natural to turn cynical on misdeeds of the past but with such attitude, how do you expect your regulators and leaders to act in the country's best interest. In fact, I see that many commentators likes to continue to paint a doom and gloom scenario - yes, perhaps its time America went down the drain and perhaps its constituents deserve it - not for the lack of ideas to deal with the current crisis - but for the lack of hope and respect in herself and ability to deal with it in the future and this insatiable need to keep looking back and pinning blame.
At this rate, the US will definitely be in the Great Depression - in fact, with the attitudes I see displayed here at SA, its already here.
The treasury buys up the loan with cash for a discounted mark-to-market value of the property determined by an auditor authorized by the congress and inject a capital through preferred shares into the company up to the difference between the cash value and the hold-to-mature value. The preferred shares have a punitive interest rate, such as 11%, redeemable in 5 (or given number of) years, and with exclusive voting rights on executive pays and dividends. The government keeps these rights until all preferred shares are redeemed.
The government can use some portion of the interest income from the preferred shares and the loans to fund programs for rewriting the loans. The rest of the interest income can be used for compensating future potential losses on delinquencies and foreclosures of these loans. The government can hold the loans to maturity, default or until someone willing to purchase it with the mark-to-market price after the loans have been adjusted to prime status.
Given that the financial institutions will have increased capital to fund regular operations, further restrictions on capital ratio can be phased in overtime and then phased out after all money have returned to the treasury.
A couple of months ago such "sweat" equity was likely again as wide spread as a barrel of oil that cost $2.50 to produce in Saudi Arabia could cost $145. To see dollars like that combust whether for transportation or livelihood encapsulated a breath of time, of compromising circumstances.
From such energy allocations, a gallon less used is many miles less traveled. Over 13 billion fewer miles in one month last summer and a further decline last week of 4%.
That creates a lag where in the simplest terms although the meter is running on the mortgage clocks, the warrant of conservation is more like a "stop" in the real time action of the economy.
Payments for some loans are fixed. Payments for other debt may offer at least a minimal amount to maintain credit while again the cost of the loan compounds.
The disintermediation of money supply changed faster than it registered on the GNP scale when the supply of money is shown more as debt than productivity or simply "sweat." It's the sweat that gets people worked up; it how they get the job done that counts and for which money supply transcends the balance sheets of banks. (and not the executives salary)
In terms of security the market is changing and the plan to absorb certain cost of change is being worked out to establish a new form of equity, that distributes credits in order to facilitate a change, to place order in the free market. Changes to earn the transitional build of money supply required to form a future that other sectors of the market are now emerging as alternative and far reaching.
It couldn't be any clearer.
Alternative 2) The government provides 50 year loans to the banks at treasury plus a lot. This loans can be used as regulatory capital.
Disclosure: long PST TBT GLD SLV gold and silver bars, short 2036 and 2038 Treasury bonds, USD/NOK.
This is bs. Why not then just nationalize the banks tomorrow? The market approach has failed.
Yes, there needs to be a good whoopin' on the housing asset bubble, and certainly the sellers of assets (institutions and home owners) are not getting "bailed out" without bearing a cost. Bernake is trying to thread a needle with his “hold to maturity pricing” statement – provide price support to get markets flowing again, but recognize that it comes with a tax payer cost. I also took it as some signaling that mark to market accounting in defunct markets is potentially problematic (which was tricky for him to state with Chris Cox sitting next to him). The difference between the market in the state when values were rising and today is that in the rising markets, markets are functioning (albeit somewhat irrationally, because the risk was not being priced right.) Now we have irrationality to a point where we are non-functioning.
Greenspan said -- "history has not been kind to protracted periods of low risk premiums." Smart statement – did he never recognize that low interest rates actually contribute to low risk premiums?
Paulson ought to be recognized as the Rudy Giuliani of this crisis.
But any buying of bad paper should include an incentive for the banks to hold some too. The more bad paper you keep on your books, the more bad paper the Fed will buy from you. There is no reason why the banks cannot hold onto to some of the bad paper. They would have some under any other market conditions, so they should have some now. Under no circumstances should any bank be allowed to sell 100% of its bad paper to the Fed.
There also should be conditions that encourage the banks to find additional capital, especially private equity, to strengthen their balance sheets. The more capital you bring in, the more bad paper the Fed will take off your hands.
As far as other conditions like equity and caps on pay, these and any other onerous conditions that anyone can come up with are absolutely necessary It is the only way to get their attention and make sure they will not ever screw up again.
The medicine has to taste so bad that they understand the cure is worse than the disease and suddenly that bad paper doesn't look so bad after all and it hurts just thinking about over leveraging.
U.S. Treasury
Office of Sekretary Henry (Hank) Paulson
LEGISLATIVE PROPOSAL FOR TREASURY AUTHORITY
TO PURCHASE TOXIC FINANCIAL ASSETS
Sec. 1. Short Title.
This Act may be cited as "Taxpayer networth annihilation and Investment banking wealth Recovery Plan" ("TwIRP") .
Sec. 2. Purchases of Toxic Assets.
(a) Authority to Purchase. – The Sekretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Sekretary in his sole, absolute, divine and knowing discretion, any and all manner of Toxic Assets from any Financial Institution, as those terms are defined in section 13 of the Act.
(b) Necessary Actions. – The Sekretary is authorized to take such actions as the Sekretary deems necessary to carry out the authorities in this Act, including, without limitation:
(1) appointing such employees and hiring konsultants (da Konsultanz with a K), unemployed investment bankers and advisors as may be required to carry out the authorities in this Act and defining their duties;
(2) entering into contracts, MOUs, LOIs, including lucrative contracts for investment banking and financial advisory services for the management of Toxic Assets;
(3) designating Financial Institutions as financial agents, revenue collectors, purchasing agents and proxies of the Government, and they shall perform all such reasonable duties related to this Act as financial agents and proxies of the Government as they deem fit in their sole and absolute discretion;
(4) establishing vehicles, including offshore SPIVs and conduits, pyramids and highly leveraged PONZI structures that are authorized, subject to new ideas by the Secretaries quantitative engineer, to purchase Toxic Assets and issue open ended obligations;
(5) directly and indirectly, granting bonuses, equity kickers, management fees, performance fees, restructuring fees, brokerage commissions, finders fees, entertainment accounts, unemployment compensation and other compensation arrangements; and
(5) formulating such regulations, fine print, boilerplate, standard terms, ISDA riders and other terms as may be necessary or appropriate to define terms or carry out the authorities of this Act.
Sec. 3. Considerations.
In exercising the authorities granted in this Act, the Sekretary shall take into consideration means for –
(1) Reinstating Wall Street investment bankers into the financial pecking order of society;
(2) shafting the taxpayers; and
(3) appropriate steps to paper over any conflicts of interest in the hiring of Wall Street contractors or advisors. Any regulation issued under this authority shall not be subject to the rest of the United States Code.
Only to the extent reasonably feasible, the Secretary shall attempt to provide stability or prevent corruption in the financial markets or banking system;
Sec. 4. Reports to Congress.
Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Sekretary shall only if feasible, attempt to report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.
Sec. 5. Rights; Management; Sale of Troubled Assets.
(a) Exercise of Rights. – The Secretary may, at any time, in his sole, absulute, reasonable or unreasonable, divinely inspired discretion, exercise any rights received in connection with Toxic Assets purchased under this Act.
(b) Management of Toxic Assets. – The Secretary shall have authority to manage, securitize and repackage Toxic Assets purchased under this Act, including conjuring revenues and engineering away all portfolio risks therefrom.
(c) Sale of Toxic Assets. – The Sekretary may, at any time, any place, to anyone, upon terms and conditions and at prices determined by the Secretary in his sole and absolute divine discretion, sell, or enter into securitiised loans, CDOs, CDSs, kickers, participations, synthetic securities, repurchase transactions, black holes or other financial weapons of mass destruction in regard to, any asset purchased under this Act.
(d) Application of Sunset to Toxic Assets. – The authority of the Sekretary to hold any Toxic mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.
Sec. 6. Maximum Amount of Authorized Purchases.
The Sekretary's authority to purchase Troubled Assets under this Act shall be unlimited, but for optical puroses shall be expressed as $700,000,000,000,000,0... outstanding at any one time.
Sec. 7. Funding.
For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Sekretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.
Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are absolutely non-reviewable and committed to absolute agency discretion, and may not be reviewed by any court of law, any administrative agency, any Congressional Committee, media, newspaper or press or other divine authority.
Sec. 9. Termination of Authority.
The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall be in perpetuity.
Sec. 10. Increase in Statutory Limit on the Public Debt.
Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof "such amount as is determined under Section 6.
Sec. 11. Credit Reform.
The costs of purchases of Troubled Assets made under section 2(a) of this Act shall be determined only if feasible and if we have more time.
Sec. 12. Indemnification and Release.
No consultant, agent, employee or other firm engaged pursuant to this Act shall be held accountable for negligence or shabby performance, including in particular, service and performance
in a grossly negligent and reckless manner. Such parties shall be fully indemnified with the full faith and credit of the USA.
Section 13. Definitions.
For purposes of this Act, the following definitions shall apply:
(1) Financial Institution. – The term "Financial Institutions" means any institution including, but not limited to, banks, thrifts, credit unions, broker-dealers, and insurance companies, having significant operations in the United States; and, upon the Sekretary's determination perhaps in consultation with the Chairman of the Board of Governors of the Federal Reserve, any other institution he determines necessary to promote financial market stability. For the avoidance of doubt, the term shall include Goldman Sachs, Morgan Stanley and any spin off, successor or surviving entity.
(2) Secretary. – The term "Sekretary" means the "Hank" Paulson and his heirs and or Phil Gramm.
(3) Toxic Assets. – The term "Toxic Assets" means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008; and, upon the determination of the Sekretary perhaps in consultation with the Chairman of the Board of Governors of the Federal Reserve, any other financial WMD, as he determines necessary to promote the strength of Wall Street; including without limitation, leveraged buyout credits, prime brokerage margin credits and and all CDS counter party liability.
(4) Black Scholes Formula.-- A term utilized to convince the cynics and skeptics that we know what we are doing.
(5) LTCM. A previous financial disaster that would have led to financial meltdown. Discounted by the regulatory authorities as a 1000 year aberation.
(6) Alan Greenspan. A once in a 1000 year goofball.
(7) George Bush. A circus clown who lives in the White House.
(8) SEC. Somebody please Eject Cox.
(9) 2 Big 2 Fail. 2 Stupid 2 Survive.
(8) United States. – The term "United States and USA" means the United Socialistic American States, territories, and possessions of the United States, Wall Street, East Hampton, Nantucket and the District of Columbia.
HEAR YE, HEAR YE, HEAR YE, may it be known by all thee present, that this TwIRP is hereby declared the law of the land.
audio.thisamericanlife...
Welcome to the Republican Recession folks.
Remember: the government does not have any money - so all we do is replace private il-liquidity with a greater public illiquidity. Now where will all that money come from? A combination of Saudi Arabia, China, the the US Gvt Printing Office. USA has now become a third world nation.
Thanks Mr. Bush! Waht a patriot.
Hey guys we tried to tell you 8 years ago that he ran his damn oil company into the ground, is it such a surprise he did the same to the country?
Thank you for an excellent summary of the bailout proposal. I might disagree with your seventh point. I think it is possible for the Government to make money on this proposal, as laid out by bigmike99 in his post.
Bernanke & Paulson have done a good job of developing and defending a very unpopular and unpalatable proposal. It's a proposal that is focused on bailing out the credit market not individual institutions. Nobody knows if its going to work or not. But, it has a lot more value in it for everyone than doing nothing.
A far bigger danger, for everyone, than this proposal, is 1) doing nothing, or 2) Congress delaying or making stupid changes.
I was originally in favor of compensation limitations for participating companies, but I now see that doesn't fit the conceptual framework. Making this a bailout bill for the homeowner is completely off track. If the bill as proposed works, everyone benefits.