How Will the Bailout Work? No One Actually Knows
If taxpayers are having trouble understanding the Bush administration’s Wall Street rescue plan, they might want to think of it in terms of some popular TV shows: "Who’s the Boss?" "Deal or No Deal" and "Jeopardy."
Though Congress has expressed legitimate concern about adequate oversight and transparency, the bigger questions may be about concept and execution—or how the game is played—as it concerns management, assets and pricing.
"Who's the Boss?"
Though no one wants the creation of a massive government agency, the program will have to be administered by someone.
Neither the Treasury nor the Federal Reserve is an appropriate choice. At one time, Freddie Mac and Fannie Mae might have been, but those organizations been discredited in the credit crunch crisis.
In the S&L bailout, the government had “existing government resources,” says former regulator and White House economist Lawrence White. “It had the benefit of an asset-disposal unit already up and running at FDIC.”
“What government agency is going to oversee see this?” money manager Eric Novde told CNBC, referring to a million properties and assets to “make sure they are properly managed.”
Though there's been some talk about the FDIC, Treasury Secretary Henry Paulson seems to be counting on “really good asset managers,” as he called them during his Congressional testimony Monday, under the supervision of the Treasury, which will have “full discretion over the management of the assets,” according to the outline released over the weekend.
All of this raises the question of competence.
“I don't know if anyone can answer that in an affirmative way,“ says Donald Riegle, chairman of the Senate Banking Committee in the S&L era.“You need a workout team. Whether or not we have people in place today. Administratively, I’d be surprised if we had it."
Steven Seelig, who ran a huge asset disposal team at the FDIC during the S&L crisis, says “one reason the bailout worked well” was because “we had people with expertise in doing this, including management.”
At one point in the process, Seelig approved the transfer of 800 FDIC employees—many of them middle managers—to the RTC in a single day.
"Deal or No Deal"
Though there’s been general acceptance of the reverse auction mode, there are many doubts about an effective pricing of assets.
“The question is: Is this going to be an asking process or a telling process?” says Scott Rothbort, president of LakeView Asset Management.
Much like the glut of homes on the market and the risk of foreclosure, if everyone is trying to sell, there’s a natural downward spiral on prices, says Alex Pollock of the American Enterprise Institute, so there’s always that risk.
On the other hand, sellers of the debt—like homeowners—may be reluctant to go too low in price, either because they can’t afford to or they’re unrealistic about the market.
“You're not guaranteed the government is going to take it,” adds Seelig, who’s now with the International Money Fund.
Pollock, who was president of the Home Loan Bank of Chicago for more than a decade, says the government needs to say it’s “only going to buy the cheapest one, [those] at the best price.”
Presumably that’s preferable to what’s happening in the private sector with vulture investors.
Jay Brinkman, chief economist at the Mortgage Bankers Association, says lenders have already had “numerous opportunities to get rid” of distressed loans at a “deep discount” but most haven’t.
Fed Chairman Ben Bernanke seemed to be addressing the price question Wednesday, telling Congress: “Over time, there’s no way to hide the real value of an asset.”
There also remains considerable question about the mix of assets involved in the auction, which will affect both their management and resolution.
Both the FDIC and RTC wrestled with that in the S&L bailout, says Seelig
“A lot depends on the types of assets you have,” says Seelig. “You can take mortgages and turn them over to a mortgage service, get them into shape, clean up the documentation, so you could sell them,” partly because you have the underlying value of the real estate.
Seelig says it was also “relatively easy” to sell other, small consumer loans but the FDIC had “trouble” moving “large commercial, non-performing loans,” such as some of assets of Continental Illinois, the big bank failure of the time.
That gets even more complicated as the debt becomes more derivative, which has also crossed the mind of investors.
“What can anyone do that holds those securities?” Doug Dachille of First Principles Capital Management said in his appearance as a CNBC contributor Wednesday. “There's hundreds of thousands of little pieces of these securities. You don't know the borrower…What is the government really going to do then hold these to maturity?”
Paulson’s plan seems to anticipate that possibility by seeking authority to hold the assets as long as it likes.
“They have to be able to add some value to it,” says Seelig. “In some cases, you'll have to restructure the loan to turn it into a cash-flowing loan,” which could mean forgiving some principal or lowering the interest rate.”
Holding the assets has it’s own set of pluses and minuses.
The more debt the government has to hold and the longer it has to hold it, the worse the balance sheet because less cash is generated and money needs to be borrowed at a faster rate.
At the same time, waiting may benefit both the credit market and the rescue program, which—first and foremost—wants to avoid any appearance that it dumping assets.
“I think they want it to age a little bit,” says Rothbort, who's also a professor at Seton Hall’s Stillman School of Business. “and show that it is worth more than people think. Otherwise, it's back to one big guessing game.”