Paul Krugman has some questions:
Financial
institutions that want to “get bad assets off their balance sheets” can
do that any time they like, by writing those assets down to zero – or
by selling them at whatever price they can. If we create a new
institution to take over those assets, the $700 billion question is, at what price? And I still haven’t seen anything that explains how the price will be determined.
I suspect, though I’m not certain, that policymakers are once more
coming around to the view that mortgage-backed securities are being
systematically underpriced. But do we really know this? And how are we
going to ensure that this doesn’t end up being a huge giveaway to
financial firms?
Here is more detail on various plans. I see it so: If the assets are undervalued by the market, buying them up is an OK deal. Presumably the price would be determined by a reverse auction, with hard-to-track asset heterogeneity introducing some arbitrariness into the resulting prices. If these assets are not undervalued by the market, and indeed they really are worth so little, our government wishes to find a not-fully-transparent way to give financial firms greater value, also known as "huge giveaway."
Right now it seems to boil down to the original TARP idea or nationalization, take your pick. You are more likely to favor nationalization if you think that governments can run things well, if you feel there is justice in government having "upside" on the deal, and if you are keen to spend the TARP money on other programs instead.
Nationalization means letting the FDIC take over banks. I don’t know why people try making it sound sinister. Let the FDIC take over. Let the shareholders and bondholders take a hit. Let the FDIC relaunch the banks in smaller pieces with fewer branches and better balance sheets. If we are going to spend trillions of dollars anyway, let’s spend it fixing the actual problem.
Nationalization would result in utter chaos to the capital markets as every one would dump the shares of all financials all around the world. It will also defeat private participation which is the core concept of capitalism which is the founding theme of our great american society. IMO, Nationalization would be a grand disaster. The problem with the asset pricing is there is a panic in the markets and true value is much higher as these loans are given against real properties. Even if there are lot of foreclosures, assuming 40% still there is value in those homes. It is not close to the fire sale prices these assets are valued at. That is why the government is trying to see if it can value these assets fairly and buy them through the aggregator bank.
babble, why don’t we try to raise money together and buy up some of these securities? It’s a no-brainer! Everyone else is just in a panic but I am glad that you and I know the true value.
We’re going to make a killing.
Paul says he’s “not dead set against the idea.” For those with a memory of more than a few weeks, we now see the effect of partisan affiliation. Paulson’s horrible idea becomes Geithner’s idea that is worth discussing.
One reason that these assets may have little value in the market is that the market believes the financial crisis will continue, with the usual effects of that sort of meltdown spread throughout the larger economy. Any efforts to counteract those effects might raise the value of the securities. Would that mean that any efforts would be a giveaway to financial firms? If we oppose giveaways to financial firms, should we oppose all efforts to counter this crisis? Aren’t these efforts just a way of fighting the market?
Krugman favors giving $2 trillion or so of taxpayer money out to various interests over the next two years, as fiscal stimulus. I don’t recall his expression of concern that these funds expended might be a “huge giveaway.” Is there something about financial firms that makes them different from construction firms, alternative energy companies and their venture capitalist backers, and welfare recipients? If a huge giveaway is necessary, it’s necessary–at least, I thought that was Krugman’s position on huge giveaways.
Babble,
Chaos? There is no reason for the large banks to exist. They can only make money by funding unneeded housing and business investments. They’ve proven they can’t handle risk. They have no plans to change their business models. Why would we want them around? Besides, we already have chaos. Over a year’s supply of extra housing, retail space with no retailers to fill them, and businesses that grew too large and now have to liquidate or shrink themselves (bankruptcy).
We will be spending trillions of dollars in the next few years digging holes and refilling them. It would be nice if the government used that money to make banks that work instead.
Aren’t banks typically closed down due to people wanting their money out because they rightly or wrongly (which self-fulfills) believe their will be a run, NOT because they refuse to lend as much as Paul Krugman would prefer?
If one were to create a clearing house or market for the information about the assets, you could solve the information quality problem.
I doubt your plan would work. Lots of paperwork was faked. If people admit to having information they admit to criminal activity.
Besides, there isn’t any problem in valuing assets. Banks can easily value their assets. It’s just if they did, they would have to admit they were no longer solvent. Also, if as a rule, they spent time to do due diligence their profit margin would evaporate and there would be no reason for them to still exist.
How exactly does something become “underpriced” in a free economy? Underpriced by whom, exactly? And if that were the case, why would a bank want to get rid of those assets?
The problem is that the assets are impaired and the banks are not reporting their value in an honest way. The government doesn’t want the banks to because its citizens might realize how stupid and criminal the whole ‘big government’ concept it.
Many senior i-bankers with whom I’ve met recently have suggested that prospect of erratic government intervention is what is preventing the market from clearing. Assets are going from zero value to some value based on a stroke of a pen and vice-versa. The first few PE firms who treaded into the illiquid markets lost everything. Until TARP is over, nobody is apparently going to put a bid out there.
That won’t stop jerkoffs such as Krugman for advocating ideas based on flawed premises. So long as you can set up a linear equation showing the benefits, Congress will apparently listen.
Right now it seems to boil down to the original TARP idea or nationalization, take your pick.
Or, if one thinks so, he is allowed to say, “Both of these ideas sound awful.” And if the person is a tenured economics professor, some might actually listen.
I took out two mortgages, a first and a second, in summer 2007. They totalled up to $210,000, and I used them to buy a house for $210,000; I think I was one of the last people in America to get 100% financing on a house.
Now, 18 months later, the balances have been paid down to under $205,000. I have paid on time every month and there’s no reason to think that I won’t continue to do so. However, the banks are saying that they have no idea how much my mortgage is worth or how to value it.
It seems to me that the obvious solution to finding a value is to offer to sell the MBSes behind them back to me. If they’re really worthless, I should be able to buy them for $50,000 and have the bank be glad to sell them to me.
I concur with Murphy. Why constrain yourself to those two options?
Can someone explain why price discovery in this case is so difficult?
I’m an armchair economist at best so all I know about toxic asset disposal comes from The Economist’s descriptions of the Swedish bailout. As I understand that scheme, banks voluntarily surrendered their bad assets to one of two bad banks. Those banks had staff specialized in disposing bad assets and did an excellent job selling what was otherwise toxic. Once the disposal was complete, the original banks received shares of the resulting revenue in proportion to their contributions, based on the pre-crash value of those assets. The banks wrote down the difference.
Needless to say, I imagine that to be a gross over-simplification. Nevertheless, I’d like some help in understanding what part of the process is as complicated as most American economists believe it to be.
It seems to me that most economists have a “damned if you do damned if you don’t” attitude about this process when in fact Sweden gives us a straight forward best practice case study that doesn’t end in either bank calamity or massive tax payer outlays. What am I missing here?
I’m assuming that the problem is that they are being priced as if you had to sell them all today. The problem is that the “price” is based on the last share sold. We are in a financial panic. Berkshire Hathaway stock would likewise sink like a rock if you said “what’s the price if we had to sell it all today?” Inventory was built up over years, why do we force banks to value it as if it has to be sold in a fire sale?
How ’bout a little financial innovation? What about a housing put? People trying to sell a home could buy an insurance policy against further drops in market price. This would give buyers and banks a bit more visibility on home values. I’m on the fence about a home purchase. Something along these lines might get me moving. How ’bout a similar clawback if you want to buy through TARP? Every tranch comes with a -10% put issued by the bank.
Here is a third way: Why do anything? Why do we have to push the issue? Let the banks fail if they fail. If they don’t, let the sleeping dogs on the balance sheets lie.
Tyler: “If the assets are undervalued by the market, buying them up is an OK deal.”
David:
If the assets are undervalued, then why hasn’t someone bothered to buy them up? There are plenty of potential buyers — look at all the money pulled out of the stock market and put into T-bills.
@mk
“So why not go back to the borrowers for each mortgage M1 … Mn and attempt to more clearly assess their credit risk?”
Many of these MBSs are written against mortgage pools of 25K houses in size. So we’ve taken 25,000 Alt-A mortgages and sliced them up into pieces to form the tranches. These tranches were then sold to a bank, whose risk manager re-packaged them into new CDOs and sold them on again.
There is fundamentally no way now to put the mortgages back together in an efficient fashion, and even if you could, the fraud at origination – see House Oversight Committee docs – means there is most likely inadequate paperwork to do so. You would apparently literally have to have an appraiser visit each house.
These specialty deals were handcrafted from the start and were always illiquid. They were only worth the cash flow, which is dwindling to nothing as rates go down and defaults rocket. We know the credit risk! They were Alt-A to begin with! Thus the “opportunity!”
“Look, this is completely idiotic. The reason no one is buying up these assets and such, and why they are “undervalued” is that the markets are “pricing in” the chance of a government take over.”
Govt take-over of what? I don’t understand this, but maybe my model of how these securities work is seriously wrong.
My understanding is that, basically, you’ve got some MBS aggregating mortgages, if everyone pays off at term the thing should be worth $120. But of course some people are going to default, some will pay it off early, so it’s really only worth $100.
Now home prices start to drop, the economy goes into the tank, we realize that tons of these mortgages should never have been issued. In short, we realize that default rates are going to be much higher. So the thing is now worth $60.
That’s basically my super-simplified picture of what’s going on.
But now you seem to be saying that *really* these things are worth more than $60. Say $80. That the extra $20 discount is because people fear that the govt is going to take some action that will make default rates even worse that it appears based only on the economy and general junkyness of the loans.
For example, maybe the govt would legislate that the amount due on every mortgage in the MBS will be cut in half. Now no-one will default, but interest payments will be much lower. So the real value is $60.
But as far as I can tell, this is *not* part of any govt plan. Cram-downs in BK proceedings – yes, that appears very likely to happen, but it should only apply to the bad loans anyway, so how could it make MBS values that much worse?
So what govt action am I missing? Or is my model for valuation way off?
Vibram five fits like a glove covered hand. Shoes give an idea of how to guarantee a fully naked, with adequate protection in the field of security. Each five fingers are independent, Moscow, like a second skin, a real foot, Augloves Au.They very easy, so fans of his bare feet feel a great vibram shoes freedom.
Comments on this entry are closed.