Bailout Thoughts

So there is a lot of back-and-forth about whether the Paulson Bailout will cost the U.S. trillions of dollars; or whether it will in the end reap a windfall of trillions of dollars.

The question that I have for those that think this may actually make money is this:

Are you nuts?

(Note that I generally applaud buying up distressed assets a fire-sale prices, then making a killing once everybody starts to realize how stupidly they have acted. I am, after all, a heartless capitalist.)

Andy Kessler makes this point in his Wall Street Journal article:

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 Crowe

But 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...

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.

So where is the downside?

L. Willaim Seidman and David C. Cooke list some of the lessons they learned from the Resolution Trust Corporation in the Savings & Loan bailout of the 1985:

Here are the most important lessons we learned from our experiences in the late '80s and early '90s:

- Acquired assets require active management. Assets tend to lose value while in government hands, as the government seldom can duplicate a private owner's interest in enhancing value. The RTC employed over 10,000 people in the first year of operation.

- Holding large inventories of assets will lead to depressed prices. No one wants to buy when the market has a large overhang of assets just waiting to be dumped when prices improve.

- To get the market started, assets have to be sold at very low prices. Such sales will attract buyers, with a resulting increase in prices. At the same time, selling at low prices could trigger accusations that the agency is "depressing the market."

- Every government sale or purchase creates winners and losers. This results in intense political and economic pressures to influence the actions of the agency. The RTC's independent governance and operations protected against fraud and political influence.

So the government (via its new version of the RTC) becomes the mortgage holder for hundreds of thousands of Americans. Already the cry from Democrats is "People before profit."

Will the US be able to resolve the most clear out the very worst of these loans in an fiscally responsible manner?

If there is any possibility of making money on these loans, won't that cause an outcry on the Left?