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The Trouble With TARP (II)

Daniel Alpert has some observations on the problems with what Paulson and Bernanke told Congress and with the bailout plan.  This one seemed particularly important, since it seems pretty devastating to the claim that there is much potential for any upside once these securities have been purchased: Chairman Bernanke is using the argument that there is […]

Daniel Alpert has some observations on the problems with what Paulson and Bernanke told Congress and with the bailout plan.  This one seemed particularly important, since it seems pretty devastating to the claim that there is much potential for any upside once these securities have been purchased:

Chairman Bernanke is using the argument that there is a meaningful valuation differential between hold to maturity values and market values of troubled securities. When management of Fannie Mae and Freddie Mac tried to advance that very same logic to the government a few short weeks ago, the government said “no sale” and within days they were under conservatorship. There is no objective way to compute so-called “hold to maturity value” in an environment where ultimate cash flows from such securities are in serious doubt.

Alpert also raises a question similar to the one that occurred to me earlier today:

We are being told that the purpose of the $700 billion request is to recapitalize distressed institutions that so desperately need to sell us their sludge, in order that that the system may survive. But we are also told that those same institutions will back away from participating if we dare to ask for equity participation. We are essentially being asked to believe that if we throw a lifeline to a drowning man, he will refuse it because we want to be paid for the rescue (as the boards of AIG, FNM, FRE, and BSE proved, right? – um, not).

There is another basic reason why the taxpayers are probably never going to see this money again once it is used for the bailout:

On the other side of the looking glass is a world in which taxpayers recover their handout (or maybe even profit handsomely) after buying impaired securities at higher than the values they have been marked to by financial institutions to date (which, in some cases may not even be adequate markdowns, as the government found out when teams from the Fed and Treasury went into other institutions and ultimately recommended that the government take them over or shut them down). This scenario can only be based on the recovery of the assets underlying those securities – American homes – to levels approaching their bubble-era value.

In other words, purchasing the securities at a higher price in order to encourage participation by financial institutions essentially guarantees that the public never sees a dime of that money, because house prices are going to continue to decrease and make these securities worth less than whatever the government ends up paying for them.  I know this point has been made before, but it bears repeating.

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