The Paulson Plan Will Make Money For Taxpayers (aka the government)

[rushmc 18]

http://online.wsj.com/article/SB122230704116773989.html

Now it is starting to make some sense.


In 1992, hedge-fund manager George Soros made $1 billion betting against the British pound. In 2007, John Paulson's Credit Opportunities fund correctly bet against subprime mortgages, clearing $15 billion for the year and $3.7 billion for him. Warren Buffett is now hoping to make big money on Goldman Sachs.


Chad CroweBut these are small-time deals. My analysis suggests that Treasury Secretary Henry Paulson (a former investment banker, no less, not a trader) may pull off the mother of all trades, which could net a trillion dollars and maybe as much as $2.2 trillion -- yes, with a "t" -- for the United States Treasury.

Here's what's happened so far. New technology like electronic trading meant that Wall Street's bread-and-butter business of investment banking and trading stocks stopped making much money years ago. So investment banks took their enormous capital and at first packaged yield-enhanced, subprime mortgage loans into complex derivatives such as collateralized debt obligations (CDOs). Eventually and stupidly, these institutions owned them for themselves -- lots of them, often at 30-to-1 leverage. The financial products were made "safe" by insurance products known as credit default swaps, a credit derivative from companies such as AIG. When housing turned down, the mortgages and derivatives were worth a lot less and no one would lend Wall Street money anymore.

Then the piling on started. Hedge funds could short financial stocks and then bid down the prices of CDOs stuck on Wall Street's balance sheets. This was pretty easy to do in an illiquid market. Because of the Federal Accounting Standards Board's mark-to-market 157 rule, Wall Street had to write off the lower value of these securities and raise more capital, diluting shareholders. So the stock prices would drop, which is what the shorts wanted in the first place. It was all legit.

There is a saying on Wall Street that goes, "The market can stay irrational longer than you can stay solvent." Long Term Capital Management learned this lesson 10 years ago when it got its portfolio picked off by Wall Street as its short-term financing dried up. I had thought the opposite -- hedge funds picking off Wall Street -- would happen today. But in a weird twist, it's the government that is set up to win the prize.

Here's how: As short-term financing dried up, Fannie Mae and Freddie Mac's deteriorating financials threatened to trigger some $1.4 trillion in credit default swap payments that no one, including giant insurer AIG, had the capital to make good on. So Treasury Secretary Henry Paulson put Fannie and Freddie into conservatorship. This removed any short-term financing hassle. He also put up $85 billion in loan guarantees to AIG in exchange for 80% of the company.

Taxpayers will get their money back on AIG. My models suggest that Fannie and Freddie, on the other hand, are a gold mine. For $2 billion in cash up front and some $200 billion in loan guarantees so far, the U.S. government now controls $5.4 trillion in mortgages and mortgage guarantees.

Fannie and Freddie each own around $800 million in mortgage loans, some of them already at discounted values. They also guarantee the credit-worthiness of another $2.2 trillion and $1.6 trillion in mortgage-backed securities. Held to maturity, they may be worth a lot more than Mr. Paulson paid for them. They're called distressed securities for a reason.

Now Mr. Paulson is pitching Congress for $700 billion or more to buy distressed loans and CDOs from the rest of Wall Street, injecting needed cash onto balance sheets so that normal loans for economic activity can be restored. The trick is what price he will pay. Better mortgages and CDOs are selling for 70 cents on the dollar. But many are seriously distressed (15-25 cents on the dollar) because they are the last to be paid in foreclosures. These are what Wall Street wants to unload the quickest.

Firms will haggle, but eventually cave -- they need the cash. I am figuring Mr. Paulson could wind up buying more than $2 trillion in notional value loans and home equity and CDOs for his $700 billion.

So the U.S. will be stuck with a portfolio in the trillions of dollars in bad loans and last-to-be-paid derivatives. Where is the trade in that?

Well, unlike Mr. Buffett or any hedge fund, the Treasury and the Federal Reserve get to cheat. It's not without risk, but the Feds, with lots of levers, can and will pump capital into the U.S. economy to get it moving again. Future heads of Treasury and the Federal Reserve will be growth advocates -- in effect, "talking their book." While normally this creates a threat of inflation and a run on the dollar, and we may see dollar exchange rates turn south near term, don't expect it to last.

First, with Goldman Sachs and Morgan Stanley now operating as low-leverage bank holding companies, a dollar injected into the economy will most likely turn into $10 in capital (instead of $30 when they were investment banks). This is a huge change. Plus, a stronger U.S. economy, with its financial players having clean balance sheets, will become a safe haven for capital.

Europe is threatened by an angry Russian bear. The Far East, especially China, has its own post-Olympic banking house of cards of non-performing loans to deal with. Interest rates will tick up as the economy expands -- a plus for the dollar. Finally, a stronger economy driven by industry instead of financials means more jobs, less foreclosures and higher held-to-maturity payouts on this Fed loan portfolio.

You can slice the numbers a lot of different ways. My calculations, which assume 50% impairment on subprime loans, suggest it is possible, all in, for this portfolio to generate between $1 trillion and $2.2 trillion -- the greatest trade ever. Every hedge-fund manager will be jealous. Mr. Buffett is buying a small piece of the trade via his Goldman Sachs investment.

Over 10 years this could change the budget scenario in D.C., which can also strengthen the dollar. The next president gets a heck of a windfall. In the spirit of Secretary of State William Seward's purchase of Alaska for $7 million in 1867, this week may be remembered as Paulson's Folly.

Mr. Kessler, a former hedge-fund manager, is the author of "How We Got Here" (Collins, 2005).

"America will never be destroyed from the outside,
if we falter and lose our freedoms,
it will be because we destroyed ourselves."
Abraham Lincoln

[AWL71 0]

I hope it works out as described and that this bailout will benefit the treasury in the long run but I keep hearing the following famous last words in my head: "I promise I'll pay you back man." It is a big risk.

The most terrifying words in the English language are: I'm from the government and I'm here to help.

[rushmc 18]

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I hope it works out as described and that this bailout will benefit the treasury in the long run but I keep hearing the following famous last words in my head: "I promise I'll pay you back man." It is a big risk.

WHAT????? Are you nuts?

Do you think they will reduce the gov spending or debt or anything else?

Think about it man

"America will never be destroyed from the outside,
if we falter and lose our freedoms,
it will be because we destroyed ourselves."
Abraham Lincoln

[AWL71 0]

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I hope it works out as described and that this bailout will benefit the treasury in the long run but I keep hearing the following famous last words in my head: "I promise I'll pay you back man." It is a big risk.

WHAT????? Are you nuts?

Do you think they will reduce the gov spending or debt or anything else?

Think about it man

No, I know for a fact that it won't work out but I am HOPING it will because I think the bill will be passed even though personally I am against any type of bail out. It is a bad move to make and the whole "we are gong to make money off the bailout" is pure BS.

The most terrifying words in the English language are: I'm from the government and I'm here to help.

[rushmc 18]

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I hope it works out as described and that this bailout will benefit the treasury in the long run but I keep hearing the following famous last words in my head: "I promise I'll pay you back man." It is a big risk.

WHAT????? Are you nuts?

Do you think they will reduce the gov spending or debt or anything else?

Think about it man

No, I know for a fact that it won't work out but I am HOPING it will because I think the bill will be passed even though personally I am against any type of bail out. It is a bad move to make and the whole "we are gong to make money off the bailout" is pure BS.

Ok, I did not understand your post.

I think it is bad way past what you post.

To a degree the corps are pushing this now. (they got into the mess with laws and regulations alowing and pushing) Sarbanes Oxly plays a part to with the accounting rules in place.

Long story short, these institutions now have no cash with which to do businees (in a big part because of what I listed above) Bankruptcy is also in play because of what I listed above.

So, these financial instittutions will sell weak or bad loans that are (and get this part) not yet in default for pennies on the dollar. The gove will eventually sell those loans back (the good ones) at a huge profit. Increasing treasurey revenues.

What a shit hole of a mess.

"America will never be destroyed from the outside,
if we falter and lose our freedoms,
it will be because we destroyed ourselves."
Abraham Lincoln

[jcd11235 0]

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Sarbanes Oxly plays a part to with the accounting rules in place.

Sarbanes-Oxley allowed the problem to come to light, instead of allowing companies to hide their financial woes from Wall Street traders long enough for the executives to dump their stock at prices much higher than informed investors would otherwise pay. In other words, without Sarbanes-Oxley, the situation would be worse than it is now when it finally came to light.

Math tutoring available. Only $6! per hour! First lesson: Factorials!

[rushmc 18]

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Sarbanes Oxly plays a part to with the accounting rules in place.

Sarbanes-Oxley allowed the problem to come to light, instead of allowing companies to hide their financial woes from Wall Street traders long enough for the executives to dump their stock at prices much higher than informed investors would otherwise pay. In other words, without Sarbanes-Oxley, the situation would be worse than it is now when it finally came to light.

Maybe, but is it also responcible for the key accounting rule that is a major part of the problem

"America will never be destroyed from the outside,
if we falter and lose our freedoms,
it will be because we destroyed ourselves."
Abraham Lincoln

[Gawain 0]

Now they're using this as another massive redistribution of wealth. To what end, I don't know...helping the unworthy finance their first homes? ...again? I'm pretty much against anything that involves tax dollars at this point. The government will not make money off it, it has never been successful at operating at a profit anyway (not that I want it to anyway)...

They're going to sweet talk a "never again" $700B, that within 5 years, will cost us $2Tr+...

So I try and I scream and I beg and I sigh
Just to prove I'm alive, and it's alright
'Cause tonight there's a way I'll make light of my treacherous life
Make light!

[jcd11235 0]

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Sarbanes Oxly plays a part to with the accounting rules in place.

Sarbanes-Oxley allowed the problem to come to light, instead of allowing companies to hide their financial woes from Wall Street traders long enough for the executives to dump their stock at prices much higher than informed investors would otherwise pay. In other words, without Sarbanes-Oxley, the situation would be worse than it is now when it finally came to light.

Are you suggesting that the problem occurred because corporate entities are required to be honest with shareholders regarding the value of their investment holdings?

Maybe, but is it also responcible for the key accounting rule that is a major part of the problem

Math tutoring available. Only $6! per hour! First lesson: Factorials!

[rushmc 18]

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Now they're using this as another massive redistribution of wealth. To what end, I don't know...helping the unworthy finance their first homes? ...again? I'm pretty much against anything that involves tax dollars at this point. The government will not make money off it, it has never been successful at operating at a profit anyway (not that I want it to anyway)...

They're going to sweet talk a "never again" $700B, that within 5 years, will cost us $2Tr+...

Bigger government. I think it is that simple

"America will never be destroyed from the outside,
if we falter and lose our freedoms,
it will be because we destroyed ourselves."
Abraham Lincoln

[rushmc 18]

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Sarbanes Oxly plays a part to with the accounting rules in place.

Sarbanes-Oxley allowed the problem to come to light, instead of allowing companies to hide their financial woes from Wall Street traders long enough for the executives to dump their stock at prices much higher than informed investors would otherwise pay. In other words, without Sarbanes-Oxley, the situation would be worse than it is now when it finally came to light.

Are you suggesting that the problem occurred because corporate entities are required to be honest with shareholders regarding the value of their investment holdings?

Maybe, but is it also responcible for the key accounting rule that is a major part of the problem

The rule I post to effects the way companies are forced to value the property used as colateral

"America will never be destroyed from the outside,
if we falter and lose our freedoms,
it will be because we destroyed ourselves."
Abraham Lincoln

[jcd11235 0]

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The rule I post to effects the way companies are forced to value the property used as colateral

It forces them to value their holdings honestly and realistically, at market value. How is that bad? Do you not trust the market to determine values?

Math tutoring available. Only $6! per hour! First lesson: Factorials!

[Gawain 0]

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The rule I post to effects the way companies are forced to value the property used as colateral

It forces them to value their holdings honestly and realistically. Why is that bad?

Because it appears that it isn't happening anyway...therefore, let them fail. Or rewrite the rules that allows them to restructure or restate the debt.

So I try and I scream and I beg and I sigh
Just to prove I'm alive, and it's alright
'Cause tonight there's a way I'll make light of my treacherous life
Make light!

[rushmc 18]

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The rule I post to effects the way companies are forced to value the property used as colateral

It forces them to value their holdings honestly and realistically. Why is that bad?

I give up.

You keep infering things that have nothing to do with it. Look it up yourself.

"America will never be destroyed from the outside,
if we falter and lose our freedoms,
it will be because we destroyed ourselves."
Abraham Lincoln

[jcd11235 0]

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Because it appears that it isn't happening anyway.

Any examples?

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therefore, let them fail.

Great idea, except that they are too large to fail without harming the economy in far costlier ways than $700 billion.

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Or rewrite the rules that allows them to restructure or restate the debt.

The bankruptcy laws? How would you like to rewrite them?

Math tutoring available. Only $6! per hour! First lesson: Factorials!

[billvon 2,476]

> To what end, I don't know...helping the unworthy finance their first homes?

Nope, that's the odd part. No one is going to "save their homes" because of this bailout. (Other than indirectly i.e. someone works for AIG and will lose their home if they lose their job.) This is purely to prop up a failing market in debt instruments.

[jcd11235 0]

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You keep infering things that have nothing to do with it.

It sounds like you don't really understand why properly valuing holdings is a good thing.

Math tutoring available. Only $6! per hour! First lesson: Factorials!

[rushmc 18]

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You keep infering things that have nothing to do with it.

It sounds like you don't really understand why properly valuing holdings is a good thing.

Sounds like it huh

"America will never be destroyed from the outside,
if we falter and lose our freedoms,
it will be because we destroyed ourselves."
Abraham Lincoln

[Gawain 0]

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Because it appears that it isn't happening anyway.

Any examples?

um...I don't know...Fannie Mae and Freddie Mac? Do you not know about their restated earnings umpteen-times the past several years?

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therefore, let them fail.

Great idea, except that they are too large to fail without harming the economy in far costlier ways than $700 billion.

I seem to remember the calamity of the hugeness of WorldCom and Enron going under...

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Or rewrite the rules that allows them to restructure or restate the debt.

The bankruptcy laws? How would you like to rewrite them?

No, but there has to be a way for the accounting standards to adjust for a situation like this, from top-to-bottom.

Example: John Doe gets a house out of his reach, but it's not a "NINJA" loan, the ARM adjusts, and the market value of the house has gone down. John Doe has a job, but can't afford the adjustment for very long. The bank doesn't want to foreclose because this situation (x20,000) would force them to acquire assets and not be able to loan any more money. The current system of accounting tells them that they're on the hook for what they loaned. I think allowing the consumer to restructure their agreement with the bank, the bank to restructure its agreement for these transactions withing the banking system, and have the government insure the "hard" cases is a better option. Less money out of the taxpayer, and all responsible parties are held to accountability.

95%+ of the "mortgages" are trudging along. The banks aren't going to "securitize" these as much. Privatize Fannie and Freddie or break them apart. Hold other market solutions to strict account with the Fed when passing money out of the system to loans. I don't think that'll cost $700B...

So I try and I scream and I beg and I sigh
Just to prove I'm alive, and it's alright
'Cause tonight there's a way I'll make light of my treacherous life
Make light!

[jcd11235 0]

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um...I don't know...Fannie Mae and Freddie Mac? Do you not know about their restated earnings umpteen-times the past several years?

Yep. They got caught and called on it, hence the restatements. That's evidence in favor of SOX, not against it.

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I seem to remember the calamity of the hugeness of WorldCom and Enron going under...

I don't suppose you recall all the people who lost money (some of them losing substantial retirement funds) when they failed? Do you think those investors would have invested had the companies utilized honest accounting practices? Unfortunately, their accounting practices were largely within the constraints of GAAP, highlighting the necessity for stricter accounting regulations.

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No, but there has to be a way for the accounting standards to adjust for a situation like this, from top-to-bottom.

Example: John Doe gets a house out of his reach, but it's not a "NINJA" loan, the ARM adjusts, and the market value of the house has gone down. John Doe has a job, but can't afford the adjustment for very long. The bank doesn't want to foreclose because this situation (x20,000) would force them to acquire assets and not be able to loan any more money. The current system of accounting tells them that they're on the hook for what they loaned. I think allowing the consumer to restructure their agreement with the bank, the bank to restructure its agreement for these transactions withing the banking system, and have the government insure the "hard" cases is a better option. Less money out of the taxpayer, and all responsible parties are held to accountability.

How do you suggest such adjustments be made after mortgages are rolled up and resold? It's not a practical solution, unless the mortgages aren't resold. If that is the case, there's no need to change any regulations to allow such restructuring.

Math tutoring available. Only $6! per hour! First lesson: Factorials!

[Gawain 0]

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um...I don't know...Fannie Mae and Freddie Mac? Do you not know about their restated earnings umpteen-times the past several years?

Yep. They got caught and called on it, hence the restatements. That's evidence in favor of SOX, not against it.

It didn't stop the underlying problem to reform the rules overall though. It didn't change the corporate behavior per se.

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I seem to remember the calamity of the hugeness of WorldCom and Enron going under...

I don't suppose you recall all the people who lost money (some of them losing substantial retirement funds) when they failed? Do you think those investors would have invested had the companies utilized honest accounting practices? Unfortunately, their accounting practices were largely within the constraints of GAAP, highlighting the necessity for stricter accounting regulations.

And those that lost their retirement in those messes overlooked what is common knowledge in long term investing: don't put all your eggs in one basket. Some of these outfits in the current situation restructured themselves as banks, because they were so "in-bed" with these mortgage securities...all the eggs in one basket, and now we have to put up a $700B+ tit? I don't think so.

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How do you suggest such adjustments be made after mortgages are rolled up and resold? It's not a practical solution, unless the mortgages aren't resold. If that is the case, there's no need to change any regulations to allow such restructuring.

I don't know off the top of my head. I do know that a knee-jerk reaction of fronting up $700B now, trillions later is not the only answer. As taxpayers, certainly we can accept that this is going to cost something, but I don't trust this. The Fed chair, Sec Treas, Rep. Frank and Sen. Dodd should be as far away from this solution as possible. Grab the top 20 economists and top 20 strategists lock them in a hotel for three weeks, and let them chew on a solution. If there's one thing I'm certain of, "more" government will not fix this. It will hurt it, irreparably.

So I try and I scream and I beg and I sigh
Just to prove I'm alive, and it's alright
'Cause tonight there's a way I'll make light of my treacherous life
Make light!

[TheAnvil 0]

Bullshit.

SOX was and is an overkill response to the Enron fiasco. It has increased operating costs for companies, who in turn have passed those costs on to the consumer. Cost of accounting is absurd under it, and it is REALLY a pain for the smaller companies.

SOX didn't cause this fiasco - nor did it prevent it. When discussing ways to improve the economy, modification of SOX should certainly be part of that discussion.

Vinny the Anvil
Post Traumatic Didn't Make The Lakers Syndrome is REAL
JACKASS POWER!!!!!!

[jcd11235 0]

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It didn't stop the underlying problem to reform the rules overall though. It didn't change the corporate behavior per se.

That's like claiming that since murders still occur despite legislation that makes murder illegal, we should just legalize murder. Personally, I disagree, but I'm one of those pesky liberals who believes that sometimes some government intervention is appropriate.

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And those that lost their retirement in those messes overlooked what is common knowledge in long term investing: don't put all your eggs in one basket.

That doesn't change the fact that the companies utilized lax accounting regulations to deceive their stockholders.

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Some of these outfits in the current situation restructured themselves as banks, because they were so "in-bed" with these mortgage securities...all the eggs in one basket, and now we have to put up a $700B+ tit? I don't think so.

The government deregulated the industry enough to allow that to happen, so yes, the government should do what it can to limit the repercussions to the economy, repercussions that would otherwise be suffered by people who didn't take out sub-prime mortgages or invest in companies or funds that held securities backed by such mortgages.

Consumers can pay big via bailout loans or bigger via natural market corrections.

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How do you suggest such adjustments be made after mortgages are rolled up and resold? It's not a practical solution, unless the mortgages aren't resold. If that is the case, there's no need to change any regulations to allow such restructuring.

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I don't know off the top of my head. I do know that a knee-jerk reaction of fronting up $700B now, trillions later is not the only answer.

It's the only credible solution anyone has yet proposed.

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As taxpayers, certainly we can accept that this is going to cost something, but I don't trust this.

Nor do I, but it appears to be the best of the possible solutions, all of which are bad. At least bailout loans offer the reasonable possibility of returning a profit.

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The Fed chair, Sec Treas, Rep. Frank and Sen. Dodd should be as far away from this solution as possible. Grab the top 20 economists and top 20 strategists lock them in a hotel for three weeks, and let them chew on a solution.

There's no way around involving Congress. That's simply how the federal government works, as outlined by the Founding Fathers in the Constitution. I do think that reputable economists with strong mathematics backgrounds should be consulted by Congress.

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If there's one thing I'm certain of, "more" government will not fix this. It will hurt it, irreparably.

I disagree. The government helped cause this with deregulation legislation. The government can help in the short term with bailout loans, and can provide the necessary regulation to prevent this from happening again in the long term, at least until the lessons of history are once again forgotten, and too much deregulation occurs once more.

Math tutoring available. Only $6! per hour! First lesson: Factorials!

[jcd11235 0]

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SOX was and is an overkill response to the Enron fiasco. It has increased operating costs for companies, who in turn have passed those costs on to the consumer. Cost of accounting is absurd under it, and it is REALLY a pain for the smaller companies.

SOX didn't cause this fiasco - nor did it prevent it. When discussing ways to improve the economy, modification of SOX should certainly be part of that discussion.

Most any legislation could be improved (or made worse) with modifications. SOX is not likely to be an exception. However, what has been proposed is to remove some of the most important parts of SOX, in order to allow executives to misrepresent a corporation's investment holdings' values to shareholders. That would not solve the current problems, and would almost certainly make things worse.

Math tutoring available. Only $6! per hour! First lesson: Factorials!

[billvon 2,476]

>Because it appears that it isn't happening anyway...therefore, let them fail.

This makes no sense.

Imagine for a second that there's a drop zone where unlicensed 100-jump wonders were taking first jump students on AFF jumps. Students were breaking their legs, having their canopies deploy in the doorway, and having AAD firings. What's the best solution?

1. Get rid of the AFF jumpmaster certification program, and have USPA encourage 100 jump wonders to take up first jump students - since some dropzones are doing that anyway.

2. Do your best to make it clear to everyone that this particular drop zone uses unlicensed instructors, and then let people decide if they want to take that risk.