The Bailout: Considering Ryan's Plan

Just a rumination here...is it "valuation" or "gimme money"?

Paulson's original story was that The Bailout was created to 1) establish a value for troubled Bank assets, and after the 'value' was established by reverse-auction 2) the Treasury would buy the loans, giving the banks the liquidity they need to continue functioning.

OK. Nothing necessarily wrong with that, albeit the details were skimpy and there are a few negatives--such as delivering cash to banks which were (obviously) poorly managed, and getting not-too-much in return. If one trusts Paulson and his eventual appointees to the BailBoard, the deal will come out reasonably close to even, and maybe deliver a small profit. Some economists argue that the Gummint will come out ahead almost no matter what. Maybe. Maybe not.

But is it necessary to deliver cash to the banks? To buy them out of bad loans?

We have a note of skepticism from P-Mac, who writes:

House Republicans, including Wisconsin's own Paul Ryan, are proposing, ...to sell federal insurance against defaults to holders of possibly bad debt, something that transfers the risk and cost to people who made the bad loans instead of to taxpayers

P-Mac also cites a WSJ editorial which supports the Paulson plan:

Another reality is that taxpayers are already going to pay to refinance the banking system. The only issues are how and how much. If the Paulson plan fails, the Fed will still have guaranteed $29 billion for Bear Stearns, will still own AIG, and will still have a balance sheet that increasingly piles up ugly assets. Those are taxpayer obligations too. Meanwhile, banks will continue to fail, and the Treasury and FDIC will eventually have to come up with the capital to rescue those. One hope of the Paulson plan is that it will mean fewer such failures by letting banks sell bad assets for which there is now no market.

But P-Mac is not convinced by the WSJ's logic.

For good reason!

'Selling bad assets' actually does TWO things: it establishes a value for those assets AND sends cash to the banks, as we mentioned above.

But if 'valuation' is the principal concern, then what's the matter with Ryan's plan, which would establish value through Gummint insurance of 'bad' assets?

In other words, Banks legitimately argue that "mark-to-market" forces them to de-value assets to ridiculously low numbers, harming their capital ratios for lending purposes. That is true.

Ryan's plan insures the banks against losses, thus allowing "mark-to-market" valuations to float back to 100% of the face value (par) of the notes (or thereabouts.) The banks cannot lose on the bad loans, but they will pay an insurance premium for that privilege.

Best part: no cash is sent to banks. Bank shareholders pay the insurance premium; and if it is a large premium, shareholders will fire their management for being idiots.

There is no question that something must be done about bank liquidity. Ryan's plan is simple, focused, and transparent--which is all one wants.

And as a bonus, it does not allow for ChristmasTree crap that Barney Frank (D-Boys) and Chris Dodd (D-Not My Fault!!!) would pile onto the Paulson plan.

Definitely worth considering.