Capitalism Today!

So let's try and parse the latest Obama bailout plan. Bad debts, these bloody mortgage back securities and the like, are auctioned off by this program, whatever the hell its called now. And who knows how it's decided which securities get auctioned off and which don't, let's just assume lot's of political back-room influence peddling and, if we're lucky, some outright bribes. Anyway, so private investors are making the bids at this auction, setting the price of these securities through "the magic of the market" so that they get valued somewhere below their face value but above zero. But here's the thing, though they are setting the price, they are not actually footing all the cash to make the purchase. Oh no not at all. They are, in fact, footing 1/14th of the cash, aka ~7.14%. Where does the rest of the cash come from? Well the US Treasury foots another 14th, part of the leftover cash from TARP. The rest of it is covered by miracle of "leverage," a loan guarantee of the remainder of the amount from the FDIC (so essentially, the Federal Reserve Bank).

Now this all works out okay if the these securities never fall apart and mature at par. In fact everyone makes money that way. Hooray! Of course, the fact that the party setting the price of these securities (through the auction) has so little money at risk will likely drive up the prices to unnatural levels, but that's alright, cuz it just mean the banks will get more money from this, right?

But what happens when it all goes tits-up? Well the private investor loses his/her money first, since apparently this whole thing is structured like a CDO, with different tranches at different risk levels, and the private investor get the riskiest tranche. This is supposedly to ensure that the prices investor pay for the securities aren't inflated because the investors are insulated from all the risk. Which is questionable, because in a way they ARE insulated from all the risk, or at least most of it. The Fed has the lion's share of the risk. And that's how it goes, next the Treasury is hit up for cash, and then the Fed, which is really just another arm of the US Gov't. Which means it all ends up in the taxpayers lap, resulting in higher taxes and/or inflation. Especially since the reason why these mortgage backed securities would have defaulted would be because the economy would have continued to decline == less tax revenue for the gov't == no money for them to pay for any new debt.

Long term then, this plan sinks or swims on whether the assets that are these securities are based upon are actually worth what they say they are, or are, in fact, worth much less. Now recall that not long ago I was writing about how the model the mortgage-backed securities were based on assumed unlimited housing price growth as extrapolated from the last ten years-worth of housing boom, and that the housing prices themselves were inflated due to the fantastically shit-storm-creating feedback loop of the securities themselves. So let's just say that the prices may have been a bit skewed towards the high-end.

In the short term, there is also a good chance of fucked-up-ness. These auction will be interesting to see. Because if the banks sell their 'toxic' assets off for less then they are currently valuing them on their books, then they will have lost significant chunks of cash which they will then need to recoup somehow, either from the still largely frozen credit markets, or more likely from the government again. AIG in particular seems to be essentially insolvent, so even the smallest of losses could set of a serious chain reaction.

Really, just nationalize the fucking banks already.