The Volokh Conspiracy
[Todd Zywicki, September 22, 2008 at 10:22am] Trackbacks
The Old Banking Adage:

Eric's excellent post illustrates a key point--it looks like Paulson has already given away the store before he even sits down to negotiate. He has already implied that the public interest requires buying up these mortgages for the good of the country, so (oversimplified) the sellers already know that Paulson is more desperate to buy the mortgages than they are to sell. So, ironically, it is now the sellers who have the upper-hand in fighting over the valuation of the paper they hold.

Not to mention the apparent "lemons" problem--presumably there is an information asymmetry here such that current holders have more information about the value of these securities than the Treasury. Which means that with respect to paper that is overvalued, the banks will sell. With respect to paper that is undervalued, the banks can keep it and resell it to someone else.

This all reminds me of the old banking adage: "When you owe $100,000 the bank owns you. When you owe $100 million, you own the bank."

But what if you owe the bank $100 billion? And the bank is the Federal Reserve?

Frog Leg (mail):
An added irony of the situation is that they really don't have to sit down to negotiate at all. Rather than a negotiated purchase, an exercise of eminent domain over the commercial paper should cause the holders to equalize the information deficit. In addition, since the government is paying above market value, there is no problem on the compensation side.
9.22.2008 12:03pm
Philip_B (mail):
I don't understand why the Fed is buying these securities, when they could take them as collateral for loans. I.e. the banks would get liquidity (cash) but still own the securities and eventually have to wear any loss on them.

While this is being sold as solving the liquidity gridlock, the Fed will take them off the banks books and any losses will not be charged against the bank's capital. The banks capital is shareholder equity, and hence this is a bailout of shareholders.
9.22.2008 12:10pm
MartyA:
Lemons? What the heck do you think those MBAs and financial mafioso were doing in the office all weekend? They were separating the "good" bad assets from the "bad" bad assets.
By linch on Monday, the "good" bad assets will probably all have been transfered/sold to shelf corporations that will begin trying to issue new stock by Friday. Why not? If the new company fails, there is always the bailout.
Imagine what a clever crook with some cash and a lot of brass could do with available Soutern California property?
9.22.2008 12:12pm
darelf:
This idea of the government buying home mortgages is horrendously bad. I agree they might, at best, take them as collateral for a loan, but I don't even like that idea. These are bad assets.

IMHO they should ignore the mortgage market, and spin off all of Fannie/Freddie for the purpose of permanently closing the government's interest in home mortgages at all. It's one thing to grease the banking wheels, it's a completely different one to be in the home mortgage market.
9.22.2008 12:27pm
Bob from Ohio (mail):
Paulson could not avoid this "giving away the store" problem. He needs Congressional authority. How does he get it without asserting the public interest requires it?
9.22.2008 1:29pm
DCP:

This all reminds me of the old banking adage: "When you owe $100,000 the bank owns you. When you owe $100 million, you own the bank."

But what if you owe the bank $100 billion? And the bank is the Federal Reserve?



Then you're both owned by the Chinese
9.22.2008 1:55pm
trad and anon:
Or, here's a particularly cynical take on it: the plan has been designed for the purpose of giving the financial industry the largest possible piece of taxpayer pie on the most favorable (to them) terms possible.
9.22.2008 2:39pm
Fub:
This all reminds me of the old banking adage: "When you owe $100,000 the bank owns you. When you owe $100 million, you own the bank."

But what if you owe the bank $100 billion? And the bank is the Federal Reserve?
Heck, I was thinking of a whole other old banking adage. I think I read it a few decades ago in an Adam Smith (George Goodman) book.

It goes something like "what you never want to hear from your banker is that he had an exciting day."
9.22.2008 5:32pm
EIDE_Interface (mail):
Who said any Bushie ever negotiates in good faith about anything? One hallmark of this administration is a dictatorial approach to everything, and I'm a Bush voter. I don't like his methods, though I agree with him on some policy. I think his heavy-handed methods cost him approval rating more then how Iraq went.
9.22.2008 5:34pm
ReaderY:
I think it reasonable for Treasury to intervene, but I it unreasonable to buy securities or permit them to be used as collateral at full price. If we're going to take problem loans off people's hands, we should do it at a steep discount -- high enough to keep everything from failing, but low enough to reduce the moral hazard involved at least a little bit by making sure people lose, if not their shirts, at least some of the gold-plated tuxes in the spare wardrobe.
9.23.2008 2:47am

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