From Mehrling and Kotlikoff:
Rather than ask Hank Paulson to
determine the price of each and every toxic asset, let’s have him
simply set prices for the ABX insurance policies (or credit default
swaps, as they are called). Right now these insurance policies are
selling for crazy prices because nobody can insure against systemic
risk. Nobody, that is, except the government. The government is in a
unique position to insure against system-wide risk because its own
decisions determine, to a very large degree, the extent of this risk.Were the government to start selling the ABX insurance policies at
reasonable prices, our Cinderella mortgage-derivatives market would
suddenly wake up and start pricing every mortgage-related security in
sight based on these ABX prices. If Hank does this, the market will do
essentially all the pricing; Hank will have only a handful of prices to
set, not thousands.
Here is another explanation of the same. And more here. I miss the good ‘ol days of squabbling about single-payer plans and the Milton Friedman Institute.
You’re assuming the goal of the bailout *really is* to prevent widespread financial collateral damage.
It’s not. It’s a giveaway to Paulson’s buddies at best, an attempt to make the financial industry dodge a loss that the rest of us are going to have to eventually take at worst.
Do not continue to dignify Paulson’s lies.
I don’t see how this is a good idea.
The bonds are BAD. If they’re insured, they’ll still be bad. That will just be bad bonds where the US government is paying out. This is the most expensive way I can think of to shore up the market.
Credit default swap insurance has nothing to do with the market prices of the assets. It has everything to do with underlying value. As an insurer, I am not on the line for a cent unless it ACTUALLY DEFAULTS. Insurance rates are insane because these are junk bonds, and insuring junk bonds is expensive.
Govt backed insurance would be a much bigger giveaway, with the US paying out for decades to come. It would also do nothing to help in the long run, since these assets would still be opaque and unknown.
Peter, I think the difference is that a government insured bond, no matter how toxic, would be more readily accepted as collateral for debt, allowing credit to start flowing again.
The flaw in the plan it seems to me, is that the only stuff to be insured will be the stuff where the the gov’t premium is a bargain.
It would be better *for the bond holders* to get government insurance. It would be much worse for taxpayers as far as I can tell.
In order for the insurance to not drain the treasury dry, it will need to be pretty expensive, thus causing only people with bonds which they know won’t pay to buy it.
Treasury backed bonds will sell well, but they’ll also be defaulting at very high rates. The underlying bonds are junk.
It seems like a much more expensive, and much less fair way to get credit flowing.
Person – so why’s Bernanke and the Federal Reserve going along with it?
We should ask Bernanke that after the smoke clears and the mirrors are broken.
I keep hearing that there is no market for mortgages. This is pure nonsense. Sellers simply haven’t discounted far enough to find the market — it’s there.
The owners of these securities need to spend some time un-bundling them to provide some transparency. The government needs to provide them the time to do that — possibly by setting a price for valuation purposes prior to a true valuation — like a market price when the market is closed. Then we need an organized market to clear them. A market price will appear.
Andrew, I’m talking about “the true long-term value”. What is the likely future cash-flow of a 4th pay sequential bond with 9% current credit support, that takes losses sequentially and for which 40% of the collateral is already 90+ days delinquent? Last I checked you can find such bonds in recent ABX-AAA vintages.
Metaphors/models involving pawn shops and fire sales are nice and easy to understand and all, but I’m looking for evidence that the people convinced, with Paulson, that current levels are way too low have actually looked at the actual collateral and cashflows.
P.S. to Andrew, I think there may be some confusion as to what banks are and aren’t “showing”. In some cases they may not be showing where they have a given bond marked, but as for what the bond is, for most of the bonds we’re talking about (i.e. excluding some of the more obscure/privately-placed CDOs, etc) there’s no huge secret here. Deal structure, basic collateral detail, current performance are all freely available, and cashflows/yield tables can be run by virtually anyone with the right tools. It is simply not the situation that other ‘pawnbrokers’ can’t know how much a bond is worth because the bank ‘won’t open the box’ and show it to them. Offering the bond for sale is showing it to them.
Sonic,
No one can value many of the tranches accuratly. The only people making a bid on anything are a couple of funds who are bidding exceedingly low prices (Lone Star’s Merrill Transaction). Either they are correct in their analysis of the collateral value and essentially every large bank in the country will soon be insolevent (in which the US follows a path to a very severe depression no matter what the government does).
The other alternative is that the bidders have monopsony powere and are excercising it. In that case, some banks can be saved and the government will likely make good money on their purchases (even if the underlying bonds eventually have high default levels).
CS, if you believe your deposits are FDIC insured, you will believe your money is safe. Your money will in fact be safe so long as FDIC is solvent.
But more important, if the bank doesn’t announce it will go bankrupt then your money is safe for the next few days.
At the moment it’s more important that the good banks look good than that the bad banks avoid problems while they collapse.
Let’s add one more bank to the trouble mix. Wachovia is taken over by CitiBank today. Who’s next?
Corporate Serf, let’s assume that everything you say is right. So we will have some troubles when banks declare bankruptcy. OK.
The problem we have now is that banks which are not declaring bankruptcy are having great big troubles because nobody knows they won’t do it today.
With your proposal of advanced notice of bankruptcies, this problem won’t go away while the “rush to exit” problem will be far more dire.
Just to re-iterate, the following is the point I am responding to. Not the larger point that a problem of confidence exists in the credit market.
Perhaps it would help to require that any US bank give four days notice before they go bankrupt. Then if you do a routine transaction that’s sure to be done in 3 days you’ll be safe.
I think no purpose will be served discussing this any more.
And the more cheap Final Fantasy XI Gold is very good for you.
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