Understanding the financial rescue/buyout plan
Being one of those out of work people, whose unemployment was caused by the real estate meltdown, I’ve spent considerable time educating myself on this issue. CNBC and Bloomberg became my textbooks along with other print mediums.
Given that we are now in this financial mess, I don’t see a way out of it unless the federal government steps in. There are a few ideas being broached today about having the FDIC and Federal Reserve take a more active role in calming the financial markets with cash infusions from their reserves, but everyone with any knowledge of financial markets agrees that it would be only serve as a stop gap.
What is needed to open the frozen credit market is to remove a good many of those bought and sold, sliced and diced, repackaged mortgage securities from the books so banks feel comfortable lending again. Right now, banks are hoarding their cash to show the FDIC that they’re liquid enough to stay in business as well as their being afraid to loan to other banks for fear of not getting their money back, given how many banks are on the threshold of being taken over.
However, once the government purchases those securities — and no one knows what they’re really worth which is part of the problem — then the government can break up the packages, hold them until stability returns to the mortgage/real estate market, and sell the securities at the new, higher market value. Potentially, the sale will bring additional money into the Treasury which can be applied to the debt.
For example, (very simplistically) the Government buys a mortgage security that was originally worth $250K but because real estate has dropped in value so much the security is now work $125K. So the Government buys it for $125K (or less at fire sale prices). The government then holds the security until the market returns to value and sells the security for the original $250K. The government just made a 100% profit (or more) on its original investment.
Now if the government buys up the so-called toxic securities, it means that the government is buying the foreclosures caused by bad, inappropriate loans. Those homes are selling at highly reduced prices so they, at this time, are worth considerably less than market value right now. For example, a $500K house might sell for $100K. These types of fire sale homes make up the toxic securities.
Unfortunately, the toxic securities are mixed in with good securities (the current, good mortgages). Therein lies the challenge for the Treasury. How do you price the securities packages accurately when they’re all mixed up? And who will have the authority and oversight to make sure the prices are accurately set when no one knows what the mix is or what the securities are worth? (Treasury or some other board? That’s a major sticking problem for Congress.)
Nevertheless, that’s part of — if not all — of the argument against the mark-to-market argument in Congress. Mark-to-market means marking the price of something — a building or a security or some other asset — to the price it would get today, not sometime in the future or sometime in the past. Right now, banks assets, including buildings, are being assessed on a mark-to-market rule by bank examiners. Since real estate overall has decreased in value as well as their real estate mortgage holdings, banks are finding themselves with a less equity to liquidity (cash/deposit/profit availability) ratio than the FDIC wants them to have.
But where does Congress draw the line? If mark-to-market is eliminated then any securities purchases would be much higher and not affordable. (A security originally bought at $250K would be purchased at $250K, as I understand it.) If kept, banks are stuck with not being able to provide loans because they need to hang onto their cash reserves to show liquidity.
Otherwise, the bill appears very sound. It provides all the oversight needed and punitive measures against the original speculators. It allows the government to take an equity position (hold stock) in the company that sells securities to the government, thus potentially realizing a profit from an increase in stock prices. It allows the government to hold onto the securities until the real estate market stabilizes or grows in value. It allows banks to buy industry-paid-for insurance, covering their mortgage securities, rather than opt into selling to the government and hold onto them until such time as they can be sold at a profit or covering them if they lose money on the sale. It provides some relief to homeowners to renegotiate their mortgages.
And in addition, if the government doesn’t make all its original investment back within five years, the government is required to go back to the original sellers of the securities for a “make good” on the price.
Where Congress is getting hung up is less on the faulty details than on figuring out how to sell the whole plan to their constituents. While a few, like Sen. Shelby, are adamantly opposed to any government intervention in the markets, most are probably weighing their jobs (re-election) against a negative public sentiment.
And the public, apparently, really doesn’t understand what is involved. They only see Wall Street getting bailed out and made whole again at their expense. The truth, however, could not be further from their perception, though.