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Strategies & Market Trends : The Residential Real Estate Crash Index
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To: patron_anejo_por_favor who wrote (151150)9/27/2008 9:51:42 AM
From: mutuluRead Replies (1) of 306849
 
For comparison, here's a good explanation from the FT of how the H. Paulson plan is intended to work:

The whole point of the plan was to buy assets at more than the current distressed market price. In doing so the government would establish a new set of observed market prices, stemming the wave of mark-to-market losses and potentially allowing some banks to write back capital, easing the credit squeeze.

The Fed chairman argued that it was a fundamental mistake to think of an asset as having only one market price. The unwanted mortgage-backed securities had at least two different prices: a "firesale price" and a cashflow based "hold-to-maturity" price.

A well-designed government programme could exploit the difference between these two prices to help recapitalise the banking sector at little if any cost to the taxpayer, exploiting mark-to-market accounting rules to create a virtuous rather than a vicious cycle.

Mr Bernanke said the $700bn plan would establish the price at which non-distressed sellers would sell their assets to a buyer who did not have to worry about liquidity risk and general market risk-aversion: the government.

This price would be higher than the current firesale price - leading to a remarking of assets that would strengthen the financial system - but lower than the expected cashflow value of the securities, ensuring that the taxpayer was well protected. Amid a political backlash, the Fed chief was forced to clarify that he was not suggesting the government should overpay for these securities. But this did not change his logic at all, since the market price that would exist once the $700bn fund was in operation would be higher than the firesale price that exists in current conditions, where distressed sellers transact with only private buyers constrained by risk-aversion and access to liquidity.

If the plan works, the US government buying would create information about asset prices and catalyse buying from those private sector entities that do have capital to deploy, since they would no longer have an incentive to wait for further forced sales.
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