A Stitch in Haste

“It’s not based on any particular data point,” a Treasury spokeswoman told Forbes.com Tuesday. “We just wanted to choose a really large number.”

To review: A key selling point girding up the proposed Emergency Economic Stabilization Act of 2008 (a/k/a the Wall Street Bailout) is the insistence by its authors and supporters that the “cost” (i.e., the initial taxpayer outlays) of the program — whether $700 billion or some other arbitrary number — will end up being vastly lower as the mortgage-based securities rise in value — “We’re not wrong, the market is!”

I originally cited none other than President Bush as the prime example of “We’re not wrong, the market is!”

Second, as markets have lost confidence in mortgage-backed securities, their prices have dropped sharply. Yet the value of many of these assets will likely be higher than their current price, because the vast majority of Americans will ultimately pay off their mortgages. The government is the one institution with the patience and resources to buy these assets at their current low prices and hold them until markets return to normal. And when that happens, money will flow back to the Treasury as these assets are sold. And we expect that much, if not all, of the tax dollars we invest will be paid back.

The president just recently reiterated this almost-certainly-wrong puffery:

It is expected that much, if not all, of the tax dollars invested by the Federal government into these troubled financial institutions will be paid back over time. Under the purchase program, the government would sell the acquired assets, with the proceeds going back to the Treasury, to offset much, if not all, of the initial cost, and under the program to guarantee troubled assets, the Treasury Department would charge risk-based premiums to cover any anticipated claims.

The passive voice is the last refuge of scoundrels: “is expected” — by whom? Not by investors, not by bankers and not by academics. Just by the politicians and bureaucrats. “We’re not wrong, the market is!”

Over the weekend, several other commentators raised, in one form or another, this same concern. So I thought a round-up would be helpful. We’re not wrong, the politicians are…

–Bryan Caplan:

As Newsday explains: “If after five years the Treasury Department has lost money in its program to buy and resell the mortgage-backed securities, Congress and the next president will develop a program to recoup its losses from participating companies.” I’m not holding my breath about “recouping,” but if the bill passes, the government will have to say whether it lost money. (Notice: The bill carefully times the assessment to come after the next election. How clever is that?) And while I expect some fishy accounting, I don’t think it will be enough to turn a loss into a gain. So I’m tentatively willing to bet at even odds that, in five years, the government will say it lost money.

–Barry L. Ritholtz:

A series of OpEds in the Washington Post and the Wall Street Journal (and who knows where else) are all pushing the same nonsensical line: The bailout plan is a big money maker[.]
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Now, I have a few question[s]: What does this say about the private sector? Why can’t the all of the private equity funds, sovereign wealth funds, and enormous pools of capital do this themselves? There are trillions of dollars sitting around in cash, yet none of it that sees any value here?

I guess that Hank Paulson, George Bush and Ben Bernanke — all of whom have been been unequivocally, expensively, tyrannically wrong about the entire crisis from the beginning — are smarter than both the markets, and all of the private equity pools, about this paper?

Does that sound right to you?

–Peter Grant (WSJ – $):

Other opportunistic investors, though, say they likely will stick to the sidelines for now. They are skeptical that the government’s purchase of distressed assets will accurately establish what they are worth. So far, there have been few transactions, despite the desperation of banks to sell, because of disagreements over pricing.

–Robert Shimer, University of Chicago (via Greg Mankiw):

Indeed, looking back over the last 13 months, it should be clear that the Fed and Treasury have repeatedly underestimated the extent of the problem. In such an environment, the distributed knowledge of professional economists and other imperfectly-informed observers may be superior to the knowledge of the Fed staff.
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I think we can agree that it is implausible that the government would be better than other buyers at determining the current value of the stream of payments from those securities. This gives financial institutions a strong incentive to sell the government their lowest quality securities at the highest possible price.

–Charles Hugh Smith:

What is never mentioned in all this giddy talk of taxpayers “profiting” from buying the most distressed mortgages (and the MBS which bundled them) is that the future value of many of these properties is a negative number: that is, even if a buyer paid only $1, the house requires tens of thousands of dollars in repairs just to become habitable again.
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In other words: if this debt was so risk-free and profitable, then private capital would already be snapping it up. These MBS are sitting unsold at 70 cents on the dollar and not even catching a bid at 55 cents on the dollar because private capital has made the intuitive assessment … that there is a huge risk of losing most of your money[.]

–Arnold Kling:

Even better than the distributed knowledge of professors is the distributed knowledge of markets. It is not just efficiency at issue. There is a fundamental moral issue.

If my broker gives me bad market advice, I don’t have to take it. (Actually, I have never taken advice from a broker, and I never will.) But if Henry Paulson thinks that there is a profit opportunity in risky mortgage securities, I have no choice but to invest.

–Arnold Kling again:

In fact, what this represents is a classic opportunity for government to do what [others criticize] Wall Street for doing: taking short option positions that work out well most of the time but which under rare circumstances blow up.
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The U.S. Treasury will be betting a lot of the net worth of the the American people that there won’t be a severe further decline in house prices. Feelin’ lucky, punk?

Stated differently: Feelin’ like the government’s not wrong, the market is?

Filed under: Economics & Finance, Politics, Taxation & Fiscal Policy