Understanding the Treasury’s Bail out plan

by Jennifer Kesler

If you want to understand the Treasury’s proposal that we give them $700 billion without oversight, accounting or court review and then they um something something with the money, Peter Orszag is your best bet. I’m no financial expert, but I watched his testimony today and was blown away with how easy he is to understand – if you’ve been following this stuff up until now, anyway. Now I get how the plan could possibly work with a lot more details. I’m also more convinced than ever that Paulson’s vagueness (and his curious initial terms that insisted there must be no review or oversight) should be taken as an indication his real goal is to give the money to hand-picked firms, then go back into the private sector in a few months and curiously find himself a chief officer at one of the now well-funded firms.

The above-linked blog entry is basically what Orszag said in testimony, but it’s a lot easier to understand hearing it than reading it. I’ll attempt to sum up, including some snatches I’ve learned from other sources.

Orszag is Director of the Congressional Budget Office. That office accounts for the Congressional budget, and his testimony was intended to help members of the House Finance Committee decide what to do with Paulson’s plan. He didn’t take sides or offer advice, but he was clear on a couple of things: Paulson’s plan provides “nothing” in terms of detail, making it impossible for the CBO to give meaningful estimates of what the plan might cost. He described ways it could cost very little and ways it could end up costing the bigger portion of the $700 billion with no return for tax payers.

The problem Paulson and Congress are seeking to address have to do with assets that are so far divorced from reality it’s a bit like selling non-specific promises. A lot of people are holding “mortgage-backed securities”, which are bundles of random residential and commercial mortgages, some of which will be paid and others defaulted. Because – for reasons that aren’t clear to me, but probably involve a great deal of stupidity – Wall Street firms have bought these securities with no idea who owns which mortgages in them nor which ones are likely to default. Now they need to sell them, only… no one can begin to guess what they’re worth. Their value was previously based on the word of the seller, who had good credibility… until the mortgages he’d brokered started to default.

So suddenly no one wants to lend anyone money, and this threatens to crush the normal flow of business and economy, resulting in not only an inability to get a mortgage or buy a car, for example, but also job losses as businesses can’t function normally.

The solution: we need to find a market value for the securities and/or buy some of these “toxic debts”. The first solution would help fix the liquidity problems – businesses would feel confident about lending again. The second solution would give the businesses capital. The first solution could be done at probably no expense to tax payers if they use a reverse auction process under other specific conditions Orszag describes, because that’s a good way to find a fair market value, which means the government is getting its money’s worth with these purchases and the balance sheet records no gain/loss. The second solution is trickier – and you’ll notice it’s the one Paulson keeps on about – because there’s no real way to tell if we’re getting fair market value for the toxic assets, and the banks will be motivated to get us to overpay. Which seems to be Paulson/Bernanke’s goal – they want to overpay, on the theory that this will give the businesses enough capital to get going again. But since we can’t tell what’s a fair market value, this method would cause us to likely end up subsidizing some businesses that don’t need any help, throwing money at some who can’t possibly recover, and failing to subsidize some that really could’ve done good with that little bit of capital. Orszag described this method as “haphazard.”

It sounds to me like there are ways to make a plan like this work, if you flesh out the details and put the right conditions into it. The fact that Paulson would even ask for a $700 billion blank check to spend any way he sees fit forces me to distrust him and the administration he works for.

And here’s a question: has anyone considered the probability that if we buy some of those securities, we’ll open them up and find they contain mortgages for non-existent properties? That’s the most basic sort of accounting fraud, and with people actually buying these packages with no idea what’s in them, it would be so easy to do. I can’t be the only person to think of it.

Unfortunately, all the Democrats can see is a bill that’s bound to pass, onto which they can tack a few things. Some of the Republicans – the real Republicans, who believe in personal responsibility for businesses as well as individuals – are raising good questions and may vote against the bailout, but they’re outnumbered. As usual, the Democrats are being aggressively useless – posturing for the voters without really thinking through the danger of passing this bill without a hell of a lot more details, and Republican leadership is functioning as counter to its party’s alleged ideals as is humanly possible.

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Posted in Class on September 24, 2008
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