Hating the Proposed Buyout

Naked Capitalism breaks it down. This paragraph stood out (ht to mr).

Now to the substance. The Treasury has been using the formula that it will buy assets at "fair market prices". As we have noted, there is simply huge amounts of cash ready to bottom fish in housing-related assets (we saw an estimate of $400 billion a couple of months ago). The issue is not lack of willing buyers; it's that the prospective sellers are not willing to accept prices that reflect the weak and deteriorating prospects for housing. Meredith Whitney, the Oppenheimer bank analyst who has made the most accurate earnings and writedown calls of her peer group, has noted how the housing market price decline assumptions used by major banks fall short of where the market is likely to bottom, given traditional price to income ratios and expectations reflected in housing futures prices.

In addition to the factors that Whitney (and others) have cited, the duration of the 1988-1992 US housing bear market and major financial crises suggests that that a peak-to-trough decline of 35-40% is realistic (obviously, this average masks substantial variation across markets and housing types). We are thus only a bit more than halfway through, as measured by the fall in prices.

Yet as we discussed, the plan makes no sense unless the Orwellian "fair market prices" means "above market prices." The point is not to free up illiquid assets. Illiquid assets (private equity, even the now derided CDOs were never intended to be traded, but pose no problem if they do not need to be marked at a large loss and/or the institution is not at risk of a run).

I always thought that whatever this thing was, it was a bailout at above market prices. Anyone will buy anything at any price. The question with the securities has always been what were their real prices? Since no one knew the default rates, the risks of the subprime securities weren't properly priced. I figured that whatever Paulson was doing, he was essentially trying to take the bad debt out of circulation so as to avoid a liquidity trap, but if he was doing that, he was of course going to be buying things at above market prices. Otherwise, there'd be no point in doing this. So we're taking a $800 billion gamble that is clearly negative expected value because Paulson, Bernanke and the FOMC believe the multiplier effects from a shock in aggregate demand of this sort will be much larger. If you believe in the Keynesian story of business cycles, that's the framework for interpreting this. The taxpayer isn't getting a "deal" in the sense that the worth of these securities is going to go up. Given the state of the world as it is now, and ignoring how we got here, the forecast is that the taxpayer will pay far more if no action is taken, or if we wait for a natural market correction. "In the longrun, we're all dead," saith Keynes.

What scary times it is.