Sunday, September 28, 2008
A Canadian Perspective On The Bail-out
Rescuing a financial system from toxic waste TheStar.com - Business - Rescuing a financial system from toxic waste
September 27, 2008 David OliveBusiness Columnist
By Monday, it appears, the U.S. Congress will have approved the biggest corporate bailout in history, amounting to $700 billion (U.S.), to rescue America's stricken financial sector.
The bailout's sponsor, irony of ironies, is free-market champion George W. Bush, who used the word "panic" in justifying a massive government intervention in the private sector, using language more alarming than any president since Franklin Roosevelt in the earliest days of the Great Depression.
The fear and urgency is justified. Total losses from the low-grade residential mortgages accumulated during the U.S.'s biggest-ever housing boom are now estimated at about $2 trillion (U.S.). Only a quarter of that financial toxic waste has been written off by the world's leading banks and brokerages, leaving the potential for utter global collapse very real without a government rescue mission of drastic proportions.
And given the complexity of the work to come, getting on with the task can't begin soon enough. What comes next is more difficult than prising the bailout funds out of a reluctant Congress, and entrusting the U.S. Treasury Department with the task of buying from lenders their most toxic "assets" – that is, failed or delinquent loans for which there usually are no other buyers, and which are inhibiting lenders from providing the liquidity on which capitalism runs.
No one, least of all the managers of the crippled institutions, knows the true value of these dismal loans and other soured investments that Treasury will buy. "The reality is that we are not going to know what the right price is for years," Boston bond manager Andrew Feltus of Pioneer Investments told the New York Times on Wednesday. "It might be 20 cents on the dollar or 60 cents on the dollar, but we won't know for years. No two pieces of paper are the same."
And there is a lot of paper, about 1.1 million troubled residential mortgages of a total of 51 million U.S. home mortgages. The soured assets, as you've heard repeatedly during this crisis entering its 13th month, are monstrously complicated.
Mortgages were bought by Wall Street banks and brokerages from mortgage brokers in the field, then repackaged, or "bundled," into as many as three dozen different types of bonds. These were flipped, for lucrative upfront fees, to other banks, brokerages, pension funds, hedge funds, insurance companies and credulous buyers worldwide, until the diaspora found its way into university endowments funds, the portfolio of the Caisse de dépôt et placements du Québec and UBS AG, Europe's largest bank, which has already taken a staggering $36 billion in losses on its U.S. securities.
Some of those bundled bonds were re-bundled as "collateralized debt obligations" (CDOs), a type of derivative now trading at pennies on the dollar, since placing an accurate value on these black boxes is impossible. Citigroup Inc. carries its CDOs on its books at 61 cents on the dollar, claiming they are of relatively high quality. But Merrill Lynch & Co., forcibly merged into Bank of America Corp. this month, firesaled $31 billion worth of CDOs earlier this year at just 22 cents on the dollar in a desperate bid to shore up its eroding reserves.
In a process increasingly referred to as the Great Unwind, Treasury minions will spend years cracking open the black boxes and tracing the ultimate assets on which the Wall Street-invented paper is based – a split-level in Lansing, Mich.; a tract-home development in suburban Phoenix; a luxury condo in overbuilt Miami. Treasury will then have to decide whether to take an immediate loss on a hopeless asset, or hold the property to maturity in hopes of an eventual rebound in the local real estate market.
The quandary for the Treasury is that if Uncle Sam pays a San Diego bank the undoubtedly inflated value at which the bank is carrying a troubled loan on its books, the bank is being rewarded for its fecklessness by U.S. taxpayers.
Conversely, if Treasury officials drive a hard bargain, paying less than the bank's claimed value for its impaired assets, the bank will have to take a writedown on the difference. That would eat into the bank's reserves, and make the bank even more gun-shy about lending to creditworthy customers – the very condition the massive bailout is intended to reverse.
There is arguably a silver lining to this catastrophe, which is that capital diverted for most of this decade to housing and consumer consumption, dating from the buying panic that began after the terrorist attacks of Sept. 11, 2001, when Bush exhorted Americans to keep shopping "or the terrorists win," can now be deployed more usefully.
Housing and shopping sprees at Target and Home Depot contribute little to the nation's productivity. Economic activities that strengthen America's competitive advantage have been starved of capital for years. These heavy investments in infrastructure, education, R&D, energy saving retrofits of buildings, and more efficient – and efficacious – delivery of health care.
"This crisis could become a chance to re-evaluate our priorities as a country," Business Week economist Michael Mandel argued this week. "Rather than stressing home ownership and consumption, we should focus on investment and innovation, which have a bigger long-term payoff."
Certainly there are more productive uses of capital than the eye-popping salaries and bonuses Wall Street managers accumulated in the fat years from knowingly peddling shoddy goods.
The new government controls on executive pay that are part of the extraordinary bailout plan under negotiation are a dagger planted in the free-market doctrine of the current Republican administration.
But without them, the rescue package urgently sought by Bush would have been politically impossible.
David Olive writes on business and political issues.
Congressional leaders and the Bush administration reached a tentative deal $$$$
LAUREN VICTORIA BURKE/AP
Secretary of the Treasury Henry Paulson, left, and Kevin Fromer, Assistant Secretary of the Treasury, arrive for a meeting in Speaker Nancy Pelosi's office regarding legislation on the financial crisis, Sept. 27, 2008, on Capitol Hill in Washington.
September 28, 2008 Charles BabingtonAssociated Press WritersAlan Fram
WASHINGTON – Congressional leaders and the Bush administration reached a tentative deal early Sunday on a landmark bailout of imperiled financial markets whose collapse could plunge the nation into a deep recession.
House Speaker Nancy Pelosi announced the $700 billion accord just after midnight but said it still has to be put on paper.
"We've still got more to do to finalize it, but I think we're there," said Treasury Secretary Henry Paulson, who also participated in the negotiations in the Capitol.
"We worked out everything," said Sen. Judd Gregg, R-N.H., the chief Senate Republican in the talks. He said the House should be able to vote on it Sunday, and the Senate could take it up Monday.
The plan calls for the Treasury Department to buy deeply distressed mortgage-backed securities and other bad debts held by banks and other investors. The money should help troubled lenders make new loans and keep credit lines open. The government would later try to sell the discounted loan packages at the best possible price.
At the insistence of House Republicans, some money would be devoted to a program that would encourage holders of distressed mortgage-backed securities to keep them and buy government insurance to cover defaults.
The legislation would place limits on severance packages for executives of companies that benefit from the rescue plan, but details were sketchy.
Also, the government would receive stock warrants in return for the bailout relief, giving taxpayers a chance to share in financial companies' future profits.
To help struggling homeowners, the plan requires the government to try renegotiating the bad mortgages it acquires with the aim of lowering borrowers' monthly payments so they can keep their homes.
The measure's main elements were proposed a week ago by the Bush administration, with Paulson heading efforts to push it through the Democratic-controlled Congress. Democrats insisted on greater congressional oversight, more taxpayer protections, help for homeowners facing possible foreclosure, and restrictions on executives' compensation.
To some degree, all those items were added.
At the insistence of House Republicans, who threatened to sidetrack negotiations at midweek, the insurance provision was added as an alternative to having the government buy distressed securities. House Republicans say it will require less taxpayer spending for the bailout.
But the Treasury Department has said the insurance provision would not pump enough money into the financial sector to make credit sufficiently available. The department would decide how to structure the insurance provisions, said Sen. Kent Conrad, D-N.D., one of the negotiators.
Money for the rescue plan would be phased in, he said. The first $350 billion would be available as soon as the president requested it. Congress could try to block later amounts if it believed the program was not working. The president could veto such a move, however, requiring extra large margins in the House and Senate to override.
Despite the changes made during an intense week of negotiations, the heart of the program remains Bush's original idea: To have the government spend billions of dollars to buy mortgage-backed securities whose value has plummeted as hundreds of thousands of Americans have defaulted on their home loans.
Senate Majority leader Harry Reid, D-Nev., said Saturday that the goal was to come up with a final agreement before the Asian markets open Sunday night. "Everybody is waiting for this thing to tip a little bit too far," he said, so "we may not have another day."
Hours later, when he and others told reporters of the plan in a post-midnight news conference, Reid referred to the sometimes testy nature of the negotiations.
"We've had a lot of pleasant words," he said, "and some that haven't always been pleasant."
"We're very pleased with the progress made tonight," said White House spokesman Tony Fratto. "We appreciate the bipartisan effort to deal with this urgent issue."
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