Fed Is Likely to Make Money from Its Bank Buyouts
I think the federal government is much more likely than not to make money off of AIG (AIG), Fannie (FNM), Freddie (FRE), and whatever else it winds up buying. The underlying goal is to recapitalize the banking system--where a "bank" is anything that borrows short thus promising liquidity and lends or invests long--and to reduce the outstanding stock of risky assets to a level where the private sector is happy holding them at a reasonable price.
Can the government do this? Can it, by buying risky assets, simply extinguish risk? Isn't the risk simply transferred to Treasuries?
The answer is no. First of all, the size of the equity and risk premia we see in normal times tells us that the private market is really lousy at mobilizing the risk-bearing capacity of the economy. The government--or at least a government that balances its budget--mobilizes that risk-bearing capacity automatically, spreading it out via the tax system rather than having risk-bearing concentrated on equity, junk debt, and derivative holders.
The question, I think, is on what terms to do the nationalization, and on what terms thereafter to run the financial markets. I believe that we have to see a substantial expansion of the government's role. Organizations that promise liquidity--whether commercial banks, money market funds, insurance companies, investment banks, hedge funds, whatever--that do not match their assets and liabilities in duration need to be buying some kind of government-provided insurance. Thus not only the level of short-term interest rates becomes an administered, government-determined price, but the price of lower tail risk becomes the government's business to set as well.
Paul Krugman:
Crisis Endgame: On Sunday, Henry Paulson, the Treasury secretary, tried to draw a line in the sand against further bailouts of failing financial institutions; four days later, faced with a crisis spinning out of control, much of Washington appears to have decided that government isn’t the problem, it’s the solution. The unthinkable — a government buyout of much of the private sector’s bad debt — has become the inevitable.
The story so far: the real shock after the feds failed to bail out Lehman Brothers (LEH) wasn’t the plunge in the Dow, it was the reaction of the credit markets. Basically, lenders went on strike: U.S. government debt, which is still perceived as the safest of all investments — if the government goes bust, what is anything else worth? — was snapped up even though it paid essentially nothing, while would-be private borrowers were frozen out.... [B]anks are normally able to borrow from each other at rates just slightly above the interest rate on U.S. Treasury bills. But Thursday morning, the average interest rate on three-month interbank borrowing was 3.2 percent, while the interest rate on the corresponding Treasuries was 0.05 percent. No, that’s not a misprint. This flight to safety has cut off credit to many businesses, including major players in the financial industry — and that, in turn, is setting us up for more big failures and further panic. It’s also depressing business spending, a bad thing as signs gather that the economic slump is deepening.
And the Federal Reserve, which normally takes the lead in fighting recessions, can’t do much this time because the standard tools of monetary policy have lost their grip. Usually the Fed responds to economic weakness by buying up Treasury bills, in order to drive interest rates down. But the interest rate on Treasuries is already zero, for all practical purposes; what more can the Fed do?... There’s only one bright spot in the picture: interest rates on mortgages have come down sharply since the federal government took over Fannie Mae and Freddie Mac, and guaranteed their debt. And there’s a lesson there for those ready to hear it: government takeovers may be the only way to get the financial system working again....
We don’t know yet what that “comprehensive approach” will look like. There have been hopeful comparisons to the financial rescue the Swedish government carried out in the early 1990s, a rescue that involved a temporary public takeover of a large part of the country’s financial system. It’s not clear, however, whether policy makers in Washington are prepared to exert a comparable degree of control. And if they aren’t, this could turn into the wrong kind of rescue — a bailout of stockholders as well as the market, in effect rescuing the financial industry from the consequences of its own greed.
Furthermore, even a well-designed rescue would cost a lot of money. The Swedish government laid out 4 percent of G.D.P., which in our case would be a cool $600 billion — although the final burden to Swedish taxpayers was much less, because the government was eventually able to sell off the assets it had acquired, in some cases at a handsome profit.
But it’s no use whining (sorry, Senator Gramm) about the prospect of a financial rescue plan. Today’s U.S. political system isn’t going to follow Andrew Mellon’s infamous advice to Herbert Hoover: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” The big buyout is coming; the only question is whether it will be done right.
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This article has 6 comments:
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David Martin
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91 Comments
Sep 22 08:37 AMIt appears that Paulson is actually aiming at a financial dictatorship, where he can provide sweet deals for his buddies to get 'administration' fees whilst gutting the companies and landing the waste on the taxpayer, and all this with immunity to the law of the land and not subject to any review or check!
Nothing like this has been seen since the oligarchs stole the Russian economy.
These are thieves and scammers who seek to violate the American constitution.
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User 267065
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2 Comments
Sep 22 09:04 AM-
Brian27
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37 Comments
Sep 22 09:43 AMLet’s substitute the collective judgment of hundreds of millions of Americans for a bureaucrat in the setting of prices. And what happens when the bureaucrat makes a mistake or foreign markets disagree with the set prices? How is the government going to stem domestic and foreign capital flows that are going to take advantage of mistakes and force changes in prices?
On matching assets and liabilities wouldn’t it be sensible if the government actually matched social security liabilities with assets? Even a couple of dollars worth.
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gramps2
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113 Comments
Sep 22 09:56 AMIf this is such a money making opportunity for the government, please explain why deep pocketed, smart, long term investors such as Warren Buffet, Texas Partners, Blackstone LP, Carlyle Group, etc don't leap in and buy these assets?
What do you **think** you know that all these other people don't?
Given the government's history of paying $100 billion to bail out Katrina victims without actually doing so, including warehouses that were still filled with ice for New Orleans a year after the storm was over... Given the government's long standing history of paying over a billion dollars for a single airplane, and $10,000 for a coffee maker... given that the government has had a **spending** deficit every single year for 40 years...
How do you figure the government is going to turn a profit on assets when smart money like Berkshire Hathaway and private equity funds can not?
There is a reason these people are billionaires and the government is in debt trillions of dollars...
It is really unhelpful when supposedly learned professors write ridiculous articles such as this one.
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OldLimey
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201 Comments
Sep 22 02:09 PM-
sumosama
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237 Comments
Sep 22 02:32 PM