Ander's Market Theories

[AnderL]

Bernanke on Fire-Sale Prices

by CalculatedRisk

the gist of it is that the Fed will buy mortgages at or near the full value of the mortgage (plus interest???) and the Fed will then hold those mortgages until they mature, regardless what the asset price is. Say a dishwasher from Detroit bought a $300,000 townhouse subprime. His mortgages is owned by FNM, FRE, JPM, MS, etc. The Fed will pay the full value of the mortgage 300k plus a kickback to the seller. If the house after raped for metal is worth $5k, then the Fed will hold the mortgage until it is paid of IF, I REPEAT IF it is paid off. It will not get foreclosed on and will probably sit on the books forever until the asset price inflates to the full value of the mortgage. 20yrs, 30yrs, 50yrs, 100yrs. You see what I'm getting at. Who pays the property taxes on that real estate, maintains it, etc. What if the cost of gov. ownership is more than what it gains in value?

Now we see why the banks pushed to get Paulson into the Treasury so quickly. Just before the first shoe dropped. They needed an inside guy to fix the mess and get the financial institutions covered before he leaves and you bet he will leave once he has this set in motion, thus why no one can challenge the $700bil bailout. Lock it in and have the taxpayer suffer.

From Reuters: Bernanke's comments on asset auction process

I believe that under the Treasury program, auctions and other mechanisms could be devised that will give the market good information on what the hold-to-maturity price is for a large class of mortgage-related assets. If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price, there will be substantial benefits.

Banks will have a basis for valuing those assets and will not have to use fire sale prices. Their capital will not be unreasonably marked down.

Originally I expected the plan to have two components: 1) buy troubled assets from institutions, and 2) an RFC type recapitalization plan. However the plan did not include the recapitalization provision, so the clear intent is to pay premium prices (to current market prices) for troubled assets to recapitalize the institutions (with no equity participation for taxpayers).

Bernanke and Paulson are clearly arguing the current market prices are wrong - that they are "fire sale prices".

Krugman has more: Getting real — and letting the cat out of the bag

[T]he key question is what price Treasury pays for the assets. And here we have Bernanke effectively saying that it’s going to pay above-market prices — prices that allegedly reflect “hold-to-maturity” value, but still more than private investors are willing to pay.
...
[T]he plan only helps the financial situation if Treasury pays prices well above market — that is, if it is in effect injecting capital into financial firms, at taxpayers’ expense.

What possible justification can there be for doing this without acquiring an equity stake?

No equity stake, no deal.

One thing is clear - something we all guessed correctly - is that the intention of the plan is to pay premium prices for troubled assets to recapitalize the banks. It’s still not clear how the price mechanism will work, and unfortunately Paulson and Bernanke are unable to describe how this will work.

Except Paulson did say they would hire “really good asset managers” to determine the price. A little sarcasm: I suppose these are asset managers that have been shorting financials for the last couple of years (hat tip Seminole).