Commenter "geee" asks a very good question:
[W]ould banks and other financial institutions be allowed to act as conduits to hedge funds selling these securities?
Given that Ben Bernanke has conceded that it is the government's intention to purchases assets at a "hold-to-maturity" price rather than at a price near market bids, banks favored by Paulson could earn a nice living serving as a market-maker to any entity in the world holding bad paper. Bank buys "toxic" asset from hedge fund, individual, foreign government, whomever, for something above the market bid and then resells to Treasury for the "hold-to-maturity" price, earning a nice spread. All those "blockages" in the financial system might start flowing real fast, into as well as out of our poor sclerotic banks.
This adds to concerns expressed by others that banks would acquire bad mortgages and structure new assets eligible for "hold-to-maturity" sale. (The plans do have language specifying "originated on or before", but it is ambiguous whether that refers to the mortgages or the securities that wrap them, and there is a big loophole, see below).
A related concern is that the Treasury would purchase assets that are simply inappropriate. Both the Paulson and Dodd plans now permit the purchase "any other financial instrument, as [the Treasury Secretary] determines necessary to promote financial market stability." The term "financial instrument" covers a lot of ground. In particular, I am uncomfortable with the prospect that the Treasury might take over third parties' contingent liabilities, as the Fed did when it acquired a book of derivatives from Bear Stearns. (The Fed is at least somewhat shielded from liability by its holding company, Maiden Lane LLC. As far as I know, the Treasury would not be.)
With all the world nervous about counterparty risk, having the US government become a "risk-free counterparty" would undoubtedly soothe nerves, but it could put tax-payers on the hook for indeterminate payouts in a bad scenario. Suppose a hedge fund or non-US insurer that has written a lot of CDS protection goes down, and the dreaded counterparty cascade does occur? I don't think the Treasury should be in the business of trying to insure the 60+ trillion dollar CDS market. (Yes, that's notional, but blown counterparties mean questionable netting, so liabilities in a bad scenario could become a significant fraction of notional even on a hedged book.) Nothing in either of the major proposals forbids the Treasury from going down that road, and there are all kinds of reasons, some public-spirited and some corrupt, why it might. There needs to be hard and fast language forbidding positions in financial instruments on which losses are not limited to the upfront cost of purchase.
I don't mean these to be very constructive suggestions. I still don't like either plan, though I'd much prefer Dodd to Paulson. But in any plan, there have to be controls on what sort of positions can be taken, including when the asset was last restructured, when ownership was most recently transferred, and that the Treasury's liability must be strictly limited.
While I'm on this, I want offer a shout out to Calculated Risk for continuing to push on transparency. I cannot believe that the government may trade nearly a trillion dollars of assets on my behalf, and I may never learn exactly what it did. I would never invest in a "rocket science" hedge fund whose manager refused to disclose what he was up to. It looks like I may end up paying taxes to one. There is a lot about this plan that really has me angry, but the shrouded-in-shadows aspect more than anything else has me wondering whether this is still America. A Congressional oversight committee is not enough. Investors with 700 billion dollars under management at the very least deserve the frequent statements that any retail brokerage would issue, enumerating and detailing the performance of all assets transacted.
|Steve Randy Waldman — Wednesday September 24, 2008 at 6:56pm||permalink|