THIS IS A TOUGH SITUATION

I get the fact that we’re in a bad situation. Banks aren’t making as many loans to one another because the assets of many banks cannot be easily valued…so, the liquidity freeze in lending among banks makes it more difficult for farms, small businesses, and consumers to get loans. This freeze in lending is just as psychological as it is rooted in numbers. Think about it…the businesses that have the toxic paper on their books haven’t taken their losses on this paper, so their bottom line (net income) has not been negatively impacted yet. Bank A says ‘I’m not lending to Bank B cuz’ I don’t know how much their assets are really worth!’ If banks don’t lend to each other, they don’t lend to us. Would you lend money to a friend in trouble if you weren’t sure that friend could pay you back? (in this scenario, your friend needs the money to make a loan to another person)

I understand that something has to be done here to flush the toxic waste and bring the losses onto the bank’s books…if Paulson’s goal is to buy as much of this paper as possible, I just don’t see how we’ll pay rock-bottom prices for the junk (see GOOD IDEAS, BAD IDEAS blog for my thoughts on the reverse auction)

If banks sell their paper at too low of a price, they run the risk of recording too much loss. When this happens, they run a higher risk of becoming insolvent. So…my argument is that banks will try & get the highest price they can for their mortgage security paper, which means a higher price tag you and I must pay as taxpayers.

Paulson's argument must be that the gov & the banks are more concerned with simply getting the bad paper off bank's books so that lending can resume...fair enough. I just see that there are limits as to what banks will be able to sell...also, with this plan, there are NO LIMITS to how much the taxpayer will have to ultimately pay. I understand the short-term thinking behind the deal...it'll probably work in the short-term; however, the plan doesn't take into account the inherent Washington tendency to turn a deal like this into something worse a few years down the line.

I prefer open market mechanisms be used to the greatest extent possible if we’re going to tinker with the bank system. There has to be a plan that will have the desired effect of giving banks an opportunity to slowly unload their mortgage securities over time, while at the same time borrowing funds from the government at low rates that these banks would have to pay back.

I don’t know what all of the mechanisms would be, but I don’t like Paulson’s blank check idea with the reverse auction…this approach puts the banks in the driver’s seat. Yeah, this would get banks moving again quickly, but it would put strain on the taxpayer and lay the groundwork for more government programs. Larger government programs are what I fear the most…Paulson’s plan would work in the short-term, but can you imagine the types of federal programs that could easily be inspired by such a massive bailout?

Sure, more banks would fail under a slower moving approach to the bailout, but as a taxpayer I’m not as concerned with helping every bank. If you’ve read my previous posts, you know that I’m of the mindset to let the weakest banks go under; many of these will get bought up anyway by the likes of JP Morgan, USBank, etc.

The massive banks have more capital and are big enough to handle the losses of the banks they’ve just acquired….this is why JP Morgan just bought a failed WaMu! The big boys like JPM have enough capital to buy distressed banks and are in a better position to wait things out until home values stabilize.

v/r,
FMC