September 24, 2008
Paulson’s Gambit
Whatever you might think of Secretary of the Treasury Paulson and Fed Chairman Bernanke, you can see they aren’t dumb, especially when you see them alongside the Senators charged with overseeing their proposal. When you see the whole bunch of them on TV conducting a hearing, you tend to forget just how big a deal it is when one of these Senators comes to your Rotary Club meeting. Think of how slick and sophisticated they look and sound.
In the old days, the guy getting all the attention would have been Greenspan, but Bernanke hasn’t achieved that kind of stature. Paulson, The Treasury is taking up all the oxygen in the room, making the Chairman of the Fed and the head of the SEC look like dwarfs. He must be an awfully smart and impressive guy.
I also love his strategy, which didn’t occur to me when I was listening to him defend his plan but only later when I got out of the room into the air. The $700 billion to buy the bonds is only the beginning, and Paulson knows it. But he’s only going to take the heat for that part of the plan, because he knows the Democrats will automatically do the rest for him, and he’d just as soon let it be their idea. If he proposed it, they’d grill him over it, so why not let them force it on him and make it look like a bipartisan concession by the Administration.
The bonds value is based on the interest and principle received from the repayment of the mortgages. No repayment, no value. Which means the bonds go up in value every time somebody pays back his mortgage, and they go down in value everytime somebody defaults. When the homeowner defaults, the value depends on how much the home can be sold for. So the value will never be zero, and the plan will never cost all the money used to buy the bonds.
But the more help and support the homeowners receive, the more they continue making the payments, and the higher the value of the bond goes. Note this has nothing to do with market values of the bonds, it’s only about income received. Talking about these bonds as though they are stocks is silly. They aren’t trading vehicles. The fluctuations in value are supposed to be beside the point. They are supposed to be about income and return of principle. The uncertainty of repayment is causing the problem for the values. Every time you make the payments last longer and the return of principle more likely, the bonds rise in value. So the second part of the plan has to be the support of the homeowners. Of course, fewer defaults will stop putting more discounted homes on the market, raising the current selling price of all homes, making homeowners less upside-down, and more likely to continue payments, making the bonds more valuable again.
Now the gambit. The Democrats will fight bloody murder to tie mortgage payment support to the bill. The Administration will reluctantly agree to this bipartisan approach, and the bonds will automatically become more valuable, reducing the loss on the bonds. If Paulson buys the bonds at a price higher than the current fire sale, but less than the eventual value of the interest and principle, the whole exercise may cost nothing.
If we don’t get the plan approved, it will be because of sheer ignorance and fear, and as a free society, we will deserve what we get. An educated and informed populace wouldn’t have the problem. A kingdom would have done the deal last week. Paulson’s gambit will probably work. The Democrats will get to take credit for forcing the mortgage support for the regular people. The improved performance of the mortgages will make the bonds worth more money. Hurray for trickle-up economics. I personally bought more Goldman Sachs stock yesterday. I heard this morning that Warren Buffet bought a little of it, too. So how scared are you?
The Money Man Report
by Dan Frishberg
bizradio.com |
