September 24, 2008
We read that Paulsen and Bernanke became convinced of the need for the $700 B bailout last Wednesday when the country's commercial paper market locked-up. Late Tuesday, Putnam Investors announced that its Prime Money Market Fund, holding $12.3 B had "broken the buck," it was worth 97 cents on the dollar. The Fund held commercial paper from AIG. On Wednesday, institutional investors withdrew close to $170 B from money market funds (retail investors did not; they actually increased their money market holdings). Institutional investors knew what many retail investors did not that the funds also hold MBSs and ABSs backed notes (rated AAA) as well. Most retail investors assume that commercial paper consists of short term notes from blue chip companies or government units, rated AAA. The retail market does not know that AAA notes from SPVS holding mortgages have been included in the pool for several years.
Paulsen and Bernanke watched as the commercial paper market locked up, funds were not buying the new commercial paper; they were selling their paper to generate cash to pay for the redemption's. This meant that operating companies needed cash to make payroll and pay supplier could no longer "roll" expiring commercial paper or sell new paper. Paulsen and Bernanke, at that point, knew for certain that the economy was in deep, deep trouble.
The Fed immediately guaranteed money market funds loses, up to $50 B each, loaned money to commercial banks so they could buy AAA asset-backed notes, and purchased short term notes of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Paulsen and Bernanke also decided to ask Congress for $700B to buy toxic mortgages and mortgage backed securities going after "the core of the problem."
Why not just have the Fed buy at auctions, AAA rated MBS commercial paper? It would cost much less (the government losses would be minimal if any); AAA rated commercial paper is easy to price and to auction; it would free up the commercial paper markets for all operating companies; and it would let the MBSs markets in subordinate securities clear. If the commercial paper market failure is the critical event, the core of the problem would seem to be separating the commercial paper market from the mortgage market and letting the mortgage market clear. We would not then be faced with 1) how to price mortgage backed securities 2) whether to buy from foreign banks 3) whether to buy newly transferred or newly issued securities 4) whether to hold equity 5) whether to cap executive salaries 6) whether to create an oversight panel and 7) whether to stop foreclosures.
September 24, 2008 | Permalink
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I agree wholeheartedly with your suggestion that the correct solution for the government right now is to buy the commercial paper, thus eliminating the hard choice between (1) taking equity (socialism; government controlling our financial industry + accompanying practical concerns) and (2) pretty much just flushing tax payer money down the toilette buy just buying the toxic debt. Furthermore, there would be little if any loss to the taxpayer with this plan, as we can continue to allow the companies to roll over their commercial paper obligations until they once again have the cash flow to pay them (while allowing the interest owed to accrue accordingly). The expected payback period for this plan is likely in the same vicinity as the equity solution, without the additional socialist (and practical) concerns. Let the mortgage market bottom, then let investors get back in and gobble up the "deals" and begin the recovery...stop delaying the inevitable by costing taxpayers trillions.
Posted by: Mike | Sep 25, 2008 2:37:05 PM
Like millions of Americans, I am really skeptical about this whole 750 Billion bail out. And, I'm especially skeptical about the RUSH to spend the 750 Billion dollars of tax payers money ... which does not allow independent economists the time to properly investigate and evaluate this plan. In addition, Bush and the Democrats seem to be united on this bail out. My guess is that Bush wants to pay back big money Wall Street people, who helped him over the years ... and, since the Democrats expect to rule both houses and, possibly the White House ... they are salivating at the chance to control spending the 750 Billion. In spite of all the rhetoric about careful spending and oversight, the Democrats have already allocated 20% of this huge sum to fund crooked liberal programs, like Acorn. If we simply print Billions for bail outs, even if the market returns, inflation will make our currency virtually worthless.
P.S. Did anyone ask Alan Greenspan what he thinks???
Posted by: Howard | Sep 27, 2008 3:13:22 PM