As the press goes, last week Fed Chairman Ben Bernanke told ‘congressional leaders’ that the US faced an imminent meltdown. We heard from the horses’ mouths that this was scary. It couldn’t have been written any better for a movie. Surprise – now we have yet another bailout plan.
You can find the full proposal (for now) at the end of this post. The first thing you’ll notice is that it is pretty short, and the second thing you’ll notice are some of the egregious terms. The press and the blogosphere were quick to point out the latter, and various conspiracy theories were quickly generated around Section 8, which deals with the Treasury’s unilateral and unobservable authority, included protection from litigation. Amateurs, each and every one of them.
You don’t go to the negotiating table with a proposal, particular one that outlines to a country full of people how weak they’ve become without a game plan. And you especially don’t bring such a proposal to a band of lawmakers that you know have a penchant for changing things to directly benefit themselves, and who, while complicit in the problem to begin with, will do everything in their power to try and convince said country’s people that they are there to help them. The sticking points in the proposal are nothing more than “throwaways” – terms purposely put there only to create a little unrest and be caved on later – terms designed specifically to make those on the far side of the negotiating table think they won something.
Will it work?
I’m going out on a limb here…no. First and foremost, we are talking about the purchase of fairly complex mortgage instruments, including but not limited to the over-the-counter insurance which backs them in case of default. It’s that insurance that is causing most of the problems – a market of many 100’s of trillions of dollars – and if it collapses at one point it sets off a ripple of defaults elsewhere in the transaction chain. So while this move is probably quite necessary, the problem has been known for years. The Treasury really doesn’t have a clear idea of how much these assets are worth because the bankers that presently own them don’t – the market for these assets has become extremely inefficient, with few buyers asking very low prices, and the bankers demanding higher because they paid much more just a few years back. Sound familiar?
Now a new buyer steps into the fray – this buyer has well-publicized, deep pockets, and has publicly stated it is willing to pay more. How do you expect these sales are going to go? The Treasury is going to wind up paying entirely too much for these assets, and when the obligations finally sell taxpayers are going to be looking at a loss. The cap on purchases has been initially set at $700 billion, but I say that’s a drop in the bucket – the Fed injected roughly $150 billion into the system just last week to prevent a money market meltdown. As a result of this cap, the Treasury will be forced to liquidate positions prematurely in order to buy additional product. The result – more losses. They’ll be back at the national debt trough in no time, which brings up the second problem, borrowing capacity.
It isn’t just the US markets that are roiling – this is a worldwide financial crisis. Even China, who until now has had an unquenchable thirst for US Treasury securities, is getting tired. And with the US economy slowing, even they are going to see their need for dollar-denominated government securities wane. Either they (and every other foreign creditor still standing) starts getting bonds at deeper discounts, or interest rates have to rise – either way yield is headed up. If the former happens, Congress is going to be mighty busy raising that debt ceiling. If the latter, nobody is going to be able to afford domestic credit.
This is all a temporary fix just like the last three (or is that four) bailout proposals presented over the last year, including the one which laughably sought to have Fannie Mae and Freddie Mac doing the bailing (those GSEs are now being bailed out themselves, in case you’re just joining). It’s just that this one is bigger.
Regardless of its merits (or lack thereof), I suspect this proposal will pass. There will be oversight, and there will be further help for struggling homeowners.
And there will be more proposals.
UPDATE: It looks like the proposal may now include auto loans, student loans, revolving credit lines, and other ‘troubled assets’. The price tag is getting bigger already.
UPDATE 2: Congress seems to be biting on the wrong stuff.