[IWE] Galbraith's OpEd on what should be done about the Bailout.

Ben Tilly iwe@warhead.org.uk
Thu, 25 Sep 2008 21:29:45 -0700

On Thu, Sep 25, 2008 at 6:51 PM, Jay Mehaffey <jaym667@yahoo.com> wrote:
> That brings up an interesting point that I have not seen addressed yet.
> Which is, what is the real value of these securities?
> That there is no good model for their value is one of the problem.
> But I would love to see some breakdown of how much money one
> might return over it's life.

The real value is indeterminate.  By that I mean that the real value
depends on how much of the loans get paid out.  But that depends on
things like how severe an economic downturn we have.  Which means that
if there is a government bailout, then the value of these securities
will likely be higher than if there isn't.  That doesn't mean that we
still won't lose money on the bailout - but the fact of government
action would make that portfolio be worth more.

> There is the rather significant possibility that many of these things
> are literally worthless. That they have already lost so much money
> in foreclosures that even if the housing market where to turn around
> they would never actually return any money.

Many are, but I suspect that those aren't the important ones.

> I would expect the top rated trenches will eventually return
> something, but the lower rated trenches might be underwater
> no matter which way things go now.

That brings up a strategy question that only Paulson can answer.  The
question is whether he plans to do the rescue by identifying specific
institutions and saying, "How can we make you OK", or whether he plans
to identify certain classes of security and say, "OK, we'll make a
market in these".  In the former scenario we'll be buying toxic waste
at whatever price Wall St dares name.  In the latter we'll be buying
top rated tranches.

My preference would be for the latter strategy.  Because if he makes a
market for them, then suddenly banks that have lots of those
securities will once again have assets with book value, and will
suddenly have equity on the books and can lend again.  I also don't
like him picking winners and losers.  My guess is that he will follow
the former strategy, simply because it looks simpler to implement.
Plus Congress may accidentally force him to follow it by restricting
CEO compensation - it is easier to get a few CEO's to agree to pay
cuts than to get everyone who has a certain type of security and wants
to unload a few to agree instead.

> It is a significant problem for the bailout plan if it's aim is to be
> honest. So far though, I've been operating under the assumption
> that one of the goals is to prop up Wall Street by buying them
> at inflated value. In which case a good value model is not important.

I think that assumption is a good one.  One of the debates, however,
is whether the government should be aiming for a good value model.