Sunday, September 21, 2008

Just one question...

Will The Big Bailout work?  The answer: NoYes. Doubtful. It all depends.

While many Americans are taking NYSE numbers as the evidence a solution is found, I can't make the connection between saving lenders and investment banks form collapse and the fundamental problem underlying this emergency: home prices are falling.

I'm not alone.
Will it work: The jury is still out, although experts are cautiously optimistic the plan will help the housing crisis.

The plan will help banks shore up their balance sheets by removing hard-to-value assets. This would address the seemingly endless rounds of writedowns and capital raising that have been rocking the financial sector.

Without these bad loans weighing on their books, banks may be more willing to lend. Or at least that's the goal.

The problem is that the bailout will not automatically make banks profitable, nor will it stop the slide in home values that is wreaking havoc on the economy.

Will it help homeowners: It's unclear at this point. If the government buys an entire securitized loan, it could opt to help struggling homeowners by modifying the terms. This could include reducing a loan's interest rate or principal balance.

But it could prove difficult to snap up all the securities sold on a mortgage, experts said. And as long as investors still hold a piece, they could block any changes to the loan.

If the plan doesn't stem the tide of foreclosures, home prices will not stabilize and the economy will not recover, experts said. [More]
Much of the problem for the housing industry was overpricing to the point that almost any mortgage was questionable by former financial standards.  Most people could not afford most homes. Instead the expectation of rising prices meant today's dubious lending would be justified a few months from now.

So how can having the US Treasury hold those largely under-secured and mostly unserviceable (folks simply can't afford the payments) loans solve the problem?  It's all in the details of how they buy the securities and how much they pay.
Any analysis of the plan was hamstrung by a lack of details. Economists warned that the spending splurge could put enormous strain on an already weak economy by raising interest rates and creating inflationary pressures. Many are also concerned that the plan does little to address the underlying problems in the housing market, which continues to sink, putting heavy pressure on American consumers. [More]

Two reasons we don't know how much this effort will cost is we don't know what the US government will pay for the pile o' mortgages and what they will be worth in say, two years.  In other words, our government could either look like a shrewd housing speculator or will have become our largest landlord.
The person who will be on that cover is someone we've all heard of, Ben Bernanke. As Andrews points out, Bernanke is selling treasuries to buy the assets that Karabell thinks are undervalued. Meanwhile, the market is falling all over itself to go in the opposite direction.

The best case scenario is that the U.S. government hedge fund makes a big profit for the taxpayers over the next few years. The worst case scenario is that house prices go into free fall and the taxpayers take a loss. But in that case, you could argue that the Fed's actions were at least countercyclical.

The accounting issue is a tough one. When the market prices are obviously right, then firms that refuse to mark to market so they can keep adding to their risk are a menace. The S&L crisis is the notorious example.

When market prices are obviously wrong, then mark-to-market is a bad thing. Karabell makes that point eloquently.

I think that market prices are more likely to be right than wrong, and it is particularly difficult to identify when they are obviously wrong. Even now, when I think the odds favor the Bernanke hedge fund making a profit, that's just my opinion. Others think that he is going to take a bath, perhaps an awful one. Ken Rogoff, in the piece I linked to yesterday, seems to be in that camp. So, I still think that, in an imperfect world, mark-to-market is the best choice. [More]
As you can tell, our best economic minds are all over the board on this one, but most fall into the camp that doing nothing could have produced this century's Great Depression. I'm not so sure we have truly avoided it, nor am I convinced our hard-pressed national credit rating will support more efforts like this.

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