Oddly the government could come out smelling like a rose if they manage to buy them for less than they are worth.

Not gonna happen. The only way it works is if we overpay. Right now these securities are on the books at most companies at unrealistic valuations. If the government actually tries to get a fair price for them then suddenly we have price discovery and a lot of companies have to write down their holdings, exacerbating the problem.

What we need (which wasn’t part of Paulson’s initial proposal but has been worked into Dodd’s plan) is to get some kind of mechanism that gives the Treasury back money from firms who sell securities to the Treasury that ultimately end up losing money but who ultimately end up surviving the crisis and becoming profitable once again. We’ll see if we end up being so lucky.

Some in the government are in panic mode – which to a certain extent seems to be justified. But the government should be cautious about giving careless CEOs everything they hope for. There should be a penalty to pay and the government should actually own something for all the money it is putting into this.

But we shouldn’t forget that government ownership of a major piece of the economy comes with its own problems.

I certainly agree about the pound of flesh part. The companies that need this to survive should not get something for nothing.

I wouldn’t mind getting a percentage of any profit taken off my next tax bill.

I do agree that even though none of this happened on their watch, Obama or McCain is going to have trouble getting re-elected in four years if the economy keeps going in this direction.

I do agree that even though none of this happened on their watch, Obama or McCain is going to have trouble getting re-elected in four years if the economy keeps going in this direction.

Well John McCain has been a deregulation champion for most of his career (basically until this week), so you could place some blame on him since it’s pretty apparent that deregulation is a big part of this mess.

Whoever becomes the next president will definitely have their options limited by this. The national debt is going to surpass $10 trillion by the time GWB leaves, and has nearly doubled since we took office. The Iraq War and the $1.3 trillion in bailouts (the current one, Bear Stearns, GSE’s, AIG) are big parts of this. I personally can think of a lot of ways that the money would have been better spent. A lot of the campaign promises made by both sides (tax cuts and new spending) will have to be curbed.

mike d.,

I was just reading that same entry and the one previous to it and came here to link to them. Clearly you beat me to it.

I agree that the govt has to pay more than the current market value for the plan to work. If the plan works spectacularly well then it is possible that the assets will be worth more than that by the time they are sold. I agree that this is not the most likely scenario. Again, pricing these things in order to make the bail out work without evaporating $700 billion is the trick. It would be nice if in the worst case the $700 billion could last through at least a few rounds of buying and then selling.

when you go to the ER with a severe injury, first they help you out, and only later does the insurance company call to find out whose fault it was and whether they can go after someone else to pay your claim.

trying to put CEO compensation into this plan is like the ER triage nurse grilling you about why you are there and demanding that it not happen again. there’ll be a time and place, but it’s not now.

moreover, if the plan is excessively punitive then fewer institutions will want to take advantage of it. it is voluntary. if troubled banks etc. don’t take advantage of the plan, then we will have (many) more situations where the government does takeovers or lets firms die.

yes it sucks that CEOs make so much. Paulson himself is halfway to being a billionaire if I have my numbers right. but that is worrying about the wrong thing at the moment.

moreover, what no politician wants to say is that American consumers share at least half of the blame for taking out loans beyond their means. sure there are brokers who won’t give you the time to read the fine print, but no one forces you to take the mortgage. a lot of us (myself included) reasoned that the housing market would keep going up, and we were wrong. that’s not John Mack’s or Dick Fuld’s fault.

oh henry!

moreover, if the plan is excessively punitive then fewer institutions will want to take advantage of it. it is voluntary. if troubled banks etc. don’t take advantage of the plan, then we will have (many) more situations where the government does takeovers or lets firms die.

I don’t agree. If the situation is as bad Paulnake says it is then the financial institutions don’t really have a choice. Their options are either take the deal or insolvency. They’re going to take the deal because no one else is going to offer anything better than the Fed will.

And of course we are going to end up taking on the worst of the securities out there, so we’d better have something that’s a good deal for the taxpayer, not the institutions. When you’re bordering on insolvency you shouldn’t be the one in the bargaining position. We just need to ensure that the deals aren’t so punitive that they force the firms into failure even if they take it. We need them to survive so that they can become profitable again and pay the Treasury back for the losses that it will inevitably take on the deal, and need to have that be part of the deal (via warrants or whatever other mechanism).

moreover, what no politician wants to say is that American consumers share at least half of the blame for taking out loans beyond their means. sure there are brokers who won’t give you the time to read the fine print, but no one forces you to take the mortgage. a lot of us (myself included) reasoned that the housing market would keep going up, and we were wrong. that’s not John Mack’s or Dick Fuld’s fault.

But it is Wall St.’s fault. They have a fiduciary duty to their shareholders to avoid a situation like this. They pushed for complete deregulation of many of the securities in question. You can’t expect Joe Six Pack sitting on his couch to exercise proper constraint in the face of unlimited offers of credit, but you should be able to expect the financial leaders receiving salaries in the 7 figures plus range to know that you can’t indefinitely lend more and more money to over leveraged consumers and expect them to pay it back. And you can’t expect the big institutional buyers of these securities to keep on buying them when it’s clear that Wall St. was selling them basically a bundle of turds for the past few years. Wall St. just planned in indefinitely collecting fees and bonuses and figured that a collapse may come, but hopefully on the next guy’s watch, and besides, they can’t make us give back our bonuses anyway.

Sure on a personal level we should all strive to be financially prudent, but that in no way should let Wall St. off the hook, or the Congress and Executive Branch for failing to provide oversight.

@15 it is absolutely in the ER. Caterpillar borrowed $1.3B yesterday @ 7% interest, more than double the interest just a couple of weeks ago. That will drive things to a halt if it continues. I don’t disagree with “some deliberation” but when I hear folks talk about weeks or months I cringe.

@16 you may be right but I don’t think it’s quite as black/white as you say. many firms will limp along and not take the $ if they think the terms are excessively punitive. maybe boards of directors will do the right thing even if CEO salaries get slashed, but maybe not. but it will take extra time, and that’s what I worry about.

btw I didn’t say that the crisis is not partially Wall Street’s fault, just that borrowers who took out lousy loans can’t escape culpability. Everyone has their hand in the cookie jar, Fannie/Freddie more than anyone. Lots of insightful articles about how they opened the market for “liar loans” in order to curry favor with lawmakers like Frank who sought homeownership-ueber-alles.

i see your point. well said, although I still punitive compensation limits will hurt the effectiveness of the bill for the other reasons i put forth.

Washington Mutual, the biggest bank failure ever, issued a press release 2 days ago, just before they failed and the FDIC had to arrange for its assets to be purchased by another bank.

The import of it is this: “[Washington Mutual] ranks in top ten of Hispanic Business’ Diversity Elite and earns perfect score on the Human Rights Campaign’s Corporate Equality Index.” Sounds to me like they had the wrong priorities. One could wonder whether they’d have fared better if they were focussing on old fashioned values, like greed.

Seth R, have you read anything about the banking industry collapse?

It’s centered on the sub-prime market. Over the past two decades, Federal regulators pushed banks to make loans to people with shaky credit histories who couldn’t make down-payments. Republicans were happy to endorse this lapse in regulatory oversight by calling it “the ownership society.” Since these groups were disproportionately black and hispanic, Democrats were happy to play the race card and endorse the lapse in regulatory oversight by calling for an end to lending discrimination.

Making bad loans to first-time home owners with poor credit history and zero savings created the home pricing bubble, and led to the sub-prime collapse. Now, the same people who triumphed over the ownership society and the end of lending policies that hurt minorities are saying that the banks who implemented such policies were “predatory lenders.”

Now, we’re going to return to the credit-worthiness standards that government regulators (and quazi-government regulators — the Fed was in on it, too) deemed “outdate” (the actual word used by the chair of the Boston Fed). Because there’s no end to the pool of goodwill that can be triggered by appealing to white guilt, folks will soon forget the current crisis and begin to push for less discriminatory lending practices.

But I’d just love to hear your explanation for what happened.

DKL, pumping up minority ownership was part of the problem, but I doubt it was most of the problem. I think the middle-class did its part too, hollowing out their equity through refinancing to buy who-knows-what, instead of paying down their debts, all with the encouragement of the old Fed chairman, who thought creating new wealth by doubling house prices was a swell idea.

arj, there are a variety of devices.

The Government Sponsored Enterprises bill, passed in 1992, creating quotas for Fannie Mae and Freddie Mac. These quotes encouraged “affordable” and “underserved” mortgages. “Underserved” is officially defined as “low-income census tracts or in low- or middle-income census tracts with high minority populations.” This was a direct response to a study by the Boston Federal Reserve Bank, which concluded that home lending practices were highly discriminatory.

HUD raised these quotes. First, under Clinton to require 21% of Fannie Mae and Freddie Mac loans to go to “underserved areas.” Then, under Bush, HUD raised the quota for “underserved” area loans to 39%(!)

For more examples, search the web. There are a number of economists writing about it. Here’s a pretty good example of what you’ll find, (and it’s the source of tidbits above).

arj, I suppose you’d love for me to say, “yes, the practices should be discriminatory,” because that would say, in effect, “screw minorities.” But the problem with using the word “discriminatory” is that it’s too often normative. If requiring a 20% down-payment on a home disproportionately keeps minorities out of home, people want to say that the policy is discrimination, and that in-and-of-itself becomes a justification for changing it. And that sort of thinking has bad economic consequences; what we’re seeing right now is the market telling us how profoundly bad it is.

I use the term “affirmative action” because the quotas were defined in terms that of “tracts with minority populations.” Thus, there were targets set for Fannie Mae and Freddie Mac saying that they needed to have some percentage of their loans go to areas with tracts of minority populations. That’s affirmative action, plain and simple.

I have mixed feelings about whether this is actually a bad thing. I made a comment on another thread to the effect that since only a small percentage of the mortgages have failed, that the gambit to increase home ownership has, on the balance, been very effective. It comes at a cost, but it’s nothing that’s not amenable to a cost-benefit style of analysis. In other words, we can argue over whether increasing home ownership among minorities is worth the price we’re paying, but it’s inarguable that a substantial increase has occurred that would not have occurred otherwise, and it’s inarguable that this is a good thing.

Here’s the direct answer to your question. Fannie Mae and Freddie Mac bundle the mortgages together, and then they insure them. There’s basically zero risk. That’s why they needed a bailout. Why other, non-insured, mortgage-backed securities traded for similar amounts is anybody’s guess.

Regarding default rates, here’s a paper by HUD that analyzes data through 1998. It presents a variety of statistical findings, among which are loan default rates in 1996 as follows:

Whites: 1.6%
Blacks: 3.2%
Indian: 2.7%
Asian: 1.9%
Hispanic: 3.3%
Other: 3.6%

These reflect lower default rates than the 1992 numbers, where there were more defaults overall. The distribution, however, is not too different.

It is, however, very difficult to obtain numbers that break anything down by race any more. I call this “The Charles Murray Effect.”