Saturday, October 04, 2008

Bailout bill passed; now comes the hardest part

Yes. Getting the $700 billion mother of all bailout up and running.

From what it seems like Hank Paulson and his crack team (filled with ex-investment bankers, attorneys and accountants) has its priorities cut out. It will have to decide which assets to go after first, and who to buy them from. Congress has given Treasury wide discretion to decide what assets to target. Although most of the funding is likely to go toward buying up mortgage-backed securities and whole home loans still held on the books of the lenders who originated them, Treasury can also buy up construction loans, home equity loans, or even credit-card debt or car loans if it decides that is necessary.

Does that mean Treasury is likely to start out buying from banks, in an effort to shake the credit markets back into shape – biggest banks first, in that order? If so, whether to go after widely held MBS or exotic one-of-the-kind stuff…? Whoever Treasury buys from initially, the biggest issue is one of pricing the assets since market for these securities has dried up, making it hard to figure out what any of them are worth amid fears that the underlying mortgages have gone sour faster than expected. If they price it too low, banks won’t attend the auctions. If they price it too high, the government will be taking too much load. The task will be somewhat simpler when Treasury buys assets from firms that have already marked down the value of their assets to current fire-sale prices. Anyways, the initial success of the plan should have a multiplier effect in helping bolster other banks, even if they don't take part in the auctions. By purchasing assets similar to those that other institutions hold, Treasury would essentially establish a new market price, which the nonparticipating banks could use to improve their balance sheets. That might also reassure other investors enough that they start buying as well.

The irony is, Paulson will not be able to find asset managers to run this that don't already have distressed assets on their own books; there's no one else to do it. Hiring people to fix the very problem they helped create will be an issue. For that matter even Hank Paulson is an ex-Goldman Sachs alumnus – a part of the problem in a way. Conflict of interest or not, success of the program could hoist Hank Paulson a big hero, may be win him a candidature for next Presidency. Failure would mean a return to economic dark ages - not just for America, if the downward drift of global markets (post passage of the bailout bill) is anything to go by!
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