First a disclosure: this is written from the perspective of somebody who was in charge of purchasing at two Fortune 500 companies, not somebody who has made a living on Wall Street. Also, the floor is moving as I write this.
There are lots of distracting issues, but the central question is whether the federal government can be reasonably effective in buying distressed mortgages and complex mortgage-based financial instruments. The underlying premise of the Paulson proposal is that we will not pay a net $700 billion on these instruments, but that we may spend that much to buy them, and recover the majority of that amount (and maybe more) when we sell them. For the moment, I will stipulate that the Treasury knows how to manage and sell financial instruments (although that may be a good subject for another day), so the question here is buying them.
So, what can get in the way?
1. There will be conflicts of interest. The Treasury will apparently hire firms from Wall Street to do the buying - business conflict. Congress and lobbyists will want favored institutions protected - political conflict.
2. The objectives will be unclear.
a. The taxpayers will want purchases to be made as cheaply as possible.
b. Some will want to be providing capital to banks to facilitate lending. In order to do that, prices will have to be above the current "mark to market" valuations, or there would be no positive impact on balance sheets - and therefore no increase in capacity to lend.
c. This will be immensely more complicated if somebody is given authority to restructure individual mortgages so that "Main Street benefits as much as Wall Street". This was done by local banks before the current practice of bundling and selling mortgages to Wall Street. Nobody knows how to do this all from Washington, but it will likely be required, making valuation difficult.
3. Information will be imperfect. In order to properly value the instruments, it will be necessary to make assumptions about the structure of the instruments and their underlying mortgages - what will happen to housing prices regionally; what will be the default rates; how much of the value has already been written down; to what extent the banks are keeping the good stuff and dumping the poison on the government?
4. The mechanics of the process may be imperfect. If the objective is to give the Treasury an equity interest in the participating banks, there would be an implication of paying some amount above what a free market would pay for the instruments alone. An auction approach would seem to make sense, injecting an element of competition, but the devil is in the details of how instruments would be grouped for auction, who would be allowed to submit securities for bid, and whether there would be other bidders.
5. We will employ the wrong performance measures. Bureaucrats will be judged on how many mortgages they can clear - not on whether they paid a fair price. And bureaucrats will maximize performance in terms of what is measured.
- It is to the credit of the general public that there is a lot of skepticism about the government's ability to manage this process fairly and effectively.
- There will be a high requirement for transparency and oversight. Secretary Paulson's proposition for a blank check is insulting to Congress and to the American public; doubly so because we do not know who will be managing the process.
- In all likelihood, we will blow through the $700 billion.
This week's You Tube is a compilation of Joe Biden's gaffes, before he told an environmentalist that he and Obama opposed new coal-fired utilities, contradicted Obama on bailing out AIG, called an Obama campaign attack ad on John McCain "terrible", and stressed that we needed a president who could talk to the people on TV like FDR did in 1929 - three years before he was president and 10 years before TV was broadly introduced.