The Truth in Advertising: $700B Means $700B (and Maybe More)

In the past 24 hours, the Bernanke, Paulson, & Co. talking points have begun to take great care to emphasize that just because the plan is going to cost $700B, that doesn't mean it'll cost $700B of taxpayer money. They're just purchasing assets, after all, with notional values of $700B (in this case, notional means they're pretending that's their value...). Heck, taxpayers could turn a tidy profit!

Yesterday afternoon, I happened to catch Bill Gross of PIMCO on CNBC taking his own cut at the Bernanke & Co. rationale. He explained that this mortgage plan was a heck of a deal for John Q Taxpayer. His simple math said if $100 worth of debt (face value) was purchased for the bargain price of $65, it'd kick off 10-15% in interest every year. Since the US borrows at 3-5%, that's a positive spread of 7-10%. Wow, thanks Bill. I'm starting to count my share of the profits already!

Both Paulson's and Gross' logic share a common flaw - that we'll be buying a representative cross-section of American real estate - good houses & bad houses, senior and subordinated tranches.

Though the plan details are still fluid, a few things seem clear. When Paulson opens up his financial waste treatment plant, those in the front of the line will be those whose debt is most putrid. That means the least senior tranches on the riskiest loans - the stuff affectionately known as "toxic waste".

As to Bill Gross's overly simplified math, he of all people should know that the MBSs purchased will all contain non-performing loans, and if Congress gets its way will also contain mortgages whose balances will be written down by judges in bankruptcy proceedings - which together will nullify that mythical 7-10%. None of this is to mention the (hard to quantify) hidden costs of a lowered willingness to lend to the US treasury, based on questions about our ability to repay without cranking up the printing presses and thereby devaluing the dollar.

Please know that I'm not against the program per se. I do think something needs to be done to unlock the capital markets, and time is of the essence. My sole point is that we should be honest with ourselves about what we're spending, not investing.

Stock position: None.

Comments

[User 269454:]

For sure... you are defiantly smarter than gross, and buffett, Either that or you are off your meds.

2008 Sep 25 04:56 AM

[CT Programmer:]

I think the author is right in that only the worst of the worst will be dumped into this dumping ground. The bottom line is this... IF this bailout even goes through, it needs to have strings attached for any company that uses it, and that means equity for the taxpayers. Not equity in these worthless tranches, but equity in the dumping company. If these debts were actually worth something, why would they be dumping them? Why aren't there clever hedge funds out there buying these up as investments for a future return? Because they won't have a future return. It's ironic, but I am actually rather proud of our Congress right now (both Democrats and Republicans) for standing up to the administration and saying "wait a minute!" They're actually doing their jobs --- representing the taxpayers' interests. I hope they stick to their guns. This dumping ground needs to be a hard pill to swallow for these companies, much like AIG's "loan" (which reminds me a little of a loan shark --- they have real incentive to pay it off as quickly as possible).

2008 Sep 25 09:31 AM

[DaveSeidel:]

This article is disingenuous. First, neither Bill Gross nor Hank Paulson has indicated any certainty that the tax payers will make money in this program. They have said there is a chance there will, and given some examples of how that might work.

What they have said, is that we can expect to get a large share back, perhaps with a profit. The fact that many of these mortgages are not worth anything near face value is not relevant. Paulson will not try to buy them for face value. He will try to buy them for fair value, which will be a lot less than par.

The purpose of using taxpayers' dollars here is to free up liquidity. Using them to buy stock in banks would be irrelevant, since there is already liquidity in those markets. If we demand that, it just means we would be paying more than we need to create liquidity in the mortgages. Buffet bought stock in GS because he thinks the stock is a good investment.

2008 Sep 25 09:44 AM

[ebworthen:]

It's just another step in the enslavement of the working class by the elite and the victim classes.

It will end in a violent revolt with riots and bloodshed.

Enjoy your Monday night football and memories of America while you can comrades; a new era of indentured servitude via Socialist Capitalism is dawning.

2008 Sep 25 09:50 AM

[Belvedere R...:]

Thanks for the comments. User: Buffett got warrants - he is (very) smart. Gross went on national TV and explained that we'd make a profit on this. Here's the video. www.cnbc.com/id/158402...

If I was shaping policy, I'd say: do the bailout, structure the subsequent MBS deals with warrants for anything purchased over current market clearing prices (ie if treasury thinks the market is paying fire sale prices for a certain security and wants to pay above that...)

2008 Sep 25 11:31 AM