Paulson's Plan is About Marking to Market 10 comments
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The interesting thing about the Paulson proposal is that it gives the US Treasury carte blanche to buy any of these toxic assets at any price it chooses. This is relevant because of mark to market rules in FAS 157. I have posted a few times on the mark to market rules of FAS 157 that have caused a ton of writedowns at major money center banks.
Why this is relevant is that if the Treasury buys these toxic assets at relatively high prices, not only does the holder of the asset get the asset off its books, all other companies holding these assets can mark the assets higher to the new price paid by Treasury. Paulson wants to revalue the entire banking sector's balance sheet. This is the most important feature of Paulson's Patriot Act.
FAS 157 was enacted by the FASB (Financial Accounting Standards Board), the US accounting group that delivers edicts to US listed companies. FASB describes the edict on their website like so:
Summary of Statement No. 157 Summary This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles [GAAP], and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. Reason for Issuing This Statement Prior to this Statement, there were different definitions of fair value and limited guidance for applying those definitions in GAAP. Moreover, that guidance was dispersed among the many accounting pronouncements that require fair value measurements. Differences in that guidance created inconsistencies that added to the complexity in applying GAAP. In developing this Statement, the Board considered the need for increased consistency and comparability in fair value measurements and for expanded disclosures about fair value measurements.
Fair Value Measurements
The crux of the edict is that companies must mark to market. However, marking to market is considered to be very pro-cyclical, meaning it overstates assets on the balance sheet when the economy is in an upswing and it understates asset value during downturns like the present one. Given the market panic, it is probable that many assets have been marked down far below their ultimate fair value.
On Wall Street, there has been a lot of buzz about the fact that some distressed assets, while toxic, are trading below fair value. Paulson, being a former denizen of Wall Street, has probably heard this chatter and agrees with the overall thrust of it.
In my opinion, this may explain the hidden agenda behind his plan: Paulson wants to revalue assets on all banks' balance sheets in order to stem the tide of writedowns.
Under Paulson's Economic Patriot Act, taxpayers will be on the hook only if these assets the Treasury plans to buy are overvalued. They might even see a gain if they are undervalued. Paulson is clearly betting that the assets are undervalued.
But even if they are overvalued and more writedowns are likely, Paulson certainly believes he can prop up asset prices, at least temporarily. This buys banks time. Time is an valuable asset here because:
Again, I don't like his plan and I don't like the tactics the Bush Administration is using to promote it smack of fear mongering - hence, my designation of this as the Economic Patriot Act.
Nevertheless, the fact that Paulson believes he can revalue the whole asset class en masse makes his plan's calculus that much more interesting. With everyone else focused on the deficit, we should realize asset revaluation is the real story behind this plan.
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This article has 10 comments:
But what I really don't understand is why they felt the need to sweep this mess under the Constitution, or what's left of it. Especially since this kind of thing has happened several times before (Continental Illinois, RTC, etc...) It seems the tools and techniques to fix this crisis are already in the Government's toolbox (perhaps a bit dusty?) : the bailout principles seem the same, albeit on a much larger scale. No need, and no excuse, to rewrite or suspend the Supreme Law of the Land to fix this mess.
There was no bailout announcement during the failures of Lehman, Freddie, Fannie, AIG etc. But when Goldman started to drop toward $100 per share there was the bailout idea / announcement by Hank Paulson / George Bush. Why did the bailout come at this time? It is because Paulson owns $500 million of Goldman stock. If you were going to lose that kind of cash you would bow down / get on one knee to whomever you thought could save your ass!!! In fact some of you may have done a lot more.
Why not let institutions separate their MBS holdings into 2 groups: hold for sale and hold for maturity. Held for maturity securities would be valued on the books at mark to model prices with impairment write-offs taken based on actual impairments. Held for sale securities would be marked to current prices. Any government purchase-based bailout would apply only to held for sale securities. An FDIC-like insurance program paid for by the participating institutions could be instituted to further bolster the value of the held to maturity securities group. Any institution wanting to move securities to the held for sale group from the held to maturity group would have to take an immediate write-down if this occurred before the panic has subsided. Other penalties could possibly be applied.
This proposal would significantly reduce the value of the securities that the government would have to purchase. It would reduce the number of institutions failing because of mark to fire sale market prices. It would buy the necessary time for the part of the current panic due to MBS valuations to subside.
Neither the above proposal nor, to my knowledge, any aspect of the currently proposed bailout package deals with credit default swaps in any way, shape or form. This form of toxic derivative waste needs to be dealt with as well since the notional value of CDSs is in the tens of trillions. CDSs were a major contributor to the failures of Lehman and AIG.
They announce an auction of say $100B and break it into 4 categories - subprime, option-arm, other prime and home equity. Each category is broken into classes that give granularity to the underlying markets of pools that make up each MBS. Could be many per category, but lets say there are 5 per category for a total of 20 'bidding' traunches.
But it is a reverse auction, so they are 'offer' traunches. Each holder offers a price they will take for $X face value of MBS's to derive a pennies on the dollar price. For each traunch, the Treasury takes the lowest price and works upward until the total dollars allotted to the traunch have been reached. Thus 'we the people' get the best and lowest price and thus the best upside potential as the Treasury can hold the MBS's to maturity.
The prices will be higher than where institutions have been dumping and thus marks to market will be higher. So the holders of all similar MBS's will recover asset value and credit markets open up!
But here is what will happen after the first auction - hedge funds and vultures will offer to buy the MBS's the Treasury just bought! Why, because the auction established floor prices. Thus the Treasury makes a quick profit and recovers part of its $700B in purchasing power - yes it revolves!
When the next auction is held, there could be lower prices in some traunches [but not likely] as some whose offers were not accepted the first time will make sure they get accepted the second time as they MUST get cash.
The taxpayers will make out like bandits - but the Treasury cannot say this publicly.
[note: JP Morgan gave some insight as to values of the 4 categories each in aggregate as part of their evaluation of WaMu. In a sense, they set a floor price.]
Paulson pulled out the bazooka because of the seizing of commercial paper and not because of GS losing value, that was an effect of the collapsing credit markets. They had the bazooka all the time as simply an outline and had considered many other alternatives including, briefly, the non-workable insurance plan that. The plan offered was purposely an outline as only Congress can add the flesh - as they are doing.
There is no need for punitive actions against the institutions holding the MBS's - they are selling at the lowest price - that's punitive enough. Remember, the institutions include pension plans, insurance companies - not just banks! They thought they were buying the best rated traunches and still found out the value has dropped. They acted prudently with the information given to them by the rating agencies. So some would want these institutions that hold the people's retirement and annuity money to give a piece to the Treasury?
This will liquify the banking system, but will not prevent recession.
if this is verifiable, then he should step back from his conflict of interest
www.marketwatch.com/Ne...
NEW YORK (MarketWatch) - Former Goldman Sachs CEO Henry Paulson filed to sell about $500 million worth of Goldman Sachs stock late Thursday shortly after the U.S. Senate voted to confirm his appointment as U.S. Treasury Secretary.