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Wednesday, September 24, 2008

My additions to the Dodd plan

William H Gross argues that the Treasury will profit while saving the banking system.
He is not disinterested.

I estimate the average price of distressed mortgages that pass from "troubled financial institutions" to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent.

via Kevin Drum.

I'm sure the Treasury could buy toxic waste for 65 cents on the dollar, but I'm not sure I trust them to do so. They sure seem eager to give public money to banks. How about 2 clauses in the authorizing bill saying
a) they can't pay more than 70 cents on the dollar
b) they can't buy any assets repackaged after the bill passed.

b is so banks can't stamp a fake face value on a new security to evade a.

Now this means the treasury will get the most toxic of the sludge and won't be able to reassemble mortgages and deal with homeowners who have fallen behind on payments. That means that there would be more need to authorize judges to step in (as proposed in the Dodd bill) than their would be if the Treasury also bought the more senior tranches, which won't be for sale for 70 cents on the dollar.

Also I still like

2) bank officers skin in the game.

The banks are in financial distress and might be willing to sell assets for less than they are worth to a non-liquidity constrained investor like The Treasury or Berkshire Hathaway.

Officers of the troubled banks have done very well indeed during the bubble. They should have a lot of cash (or they are too profligate to be trusted as officers of banks). If the rescue plan is profitable to the treasury, it should be profitable for officers of banks to participate as investors.

I think they should be required to kick in 1 cent for every 99 cents contributed by the Treasury and own 1% of the proceeds on the transaction with their firm. This creates gross conflict of interest between the officers of the bank and the shareholders. Right. If they are being bailed out, the normal rules don't apply and we don't want them to do everything they can to transfer wealth from the treasury to their shareholders.

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