Ten Questions For Henry PaulsonLiz Moyer, 09.19.08, 3:30 PM ET
http://www.forbes.com/business/2008/09/19/banking-bailout-paulson-biz-wall-cx_lm_0919questions.htmlTreasury Secretary Henry Paulson explained Friday that there's a "bold" plan afoot in Washington to relieve banks of their toxic assets, and details will get hashed out this weekend. Panicked stock markets fell in love instantly, even though the only certainty is that a plan will be expensive. Necessary, but expensive.
As Paulson & Co. hash out the details of the massive bailout, here's what we want to know. Do you have questions to add? Post them in the comments section below.
1. Who gets to participate? The outlines of the plan call for the creation of either a branch of the Treasury Department or an independent agency to buy or take on troubled assets, with the goal of either selling them at a profit later or working them off. In past iterations of this idea, like 1989's Resolution Trust Corp., failed institutions were the focus. The 1932 Reconstruction Finance Corp. lent $9 billion to ailing banks, thrifts, railroads, insurance companies and farm mortgage associations.
This time, it looks like the government will take on assets from otherwise healthy institutions. But Paulson hasn't detailed whether it would be available to all 7,200 commercial banks and 1,200 thrifts or to just a portion of them deemed to be "at risk,"--or where that "at risk" bar would be set. Also, would the program welcome assets from investment banks (perhaps even the estate of Lehman Brothers? Lehman Brothers), hedge funds and other funds that have exposures? What about the private equity funds that have been buying distressed debts or foreign banks or funds?
2. How much will individual companies be allowed to dump? Wachovia is said to be considering a "bad bank" for toxic assets, including some portion of a potentially lethal $122 billion portfolio of alt-A mortgages on its books. Citigroup is trying to work off $500 billion of its "legacy" assets. Paulson hasn't said what limits would be set for contributions from individual banks, if any. Does that mean a bank could unload absolutely everything, or would they be required to retain a portion for their own books?
3. How will the assets be priced? The new entity could buy the assets at a distressed price, but what would the price be? Collateralized debt obligations and mortgage-backed securities and their various iterations are sliced and repackaged so many times that one firms' holdings wouldn't necessarily match up with another's, making it impossible to just assign price marks per category.
Merrill Lynch, for example, sold its $30 billion CDO portfolio in July for 22 cents on the dollar. That didn't spark a wave of CDO portfolio selling. Last year, E*Trade sold its $3 billion portfolio of asset-backed securities for 27 cents on the dollar, and ditto--no mass selling elsewhere. Another thought is that the government could run an auction, which would force banks themselves to price their assets.
4. How open will the books be? Herbert Hoover's Reconstruction Finance Corp. kept its books open, listing the names of the banks that borrowed money and the amount they borrowed. It slowed bankruptcies down a bit, but the mere appearance on the list threatened a run on deposits, an erosion of confidence that was exactly the opposite of the agency's mission.
Still, one of the problems of the current crisis is the lack of information about bank exposures. If the goal is to restore confidence and the efficient workings of the banking system, perhaps making the entity's portfolio an open book wouldn't be such a bad thing. Asset valuation information might even lead to a more robust secondary market to take some of these assets off the government's hands.
5. Who will run it? There are plenty of bankers and finance types out of jobs these days. A few seasoned executives have landed at companies on shaky ground. That includes Robert Steel, who left the Treasury Department for Wachovia earlier this summer, Edward Liddy, this week named chief executive officer of American International Group, David Moffett, named head of Freddie Mac last month, and Herb Allison, named head of Fannie Mae.
John Thain might be looking for a job after selling Merrill Lynch to Bank of America. Does Alan Greenspan need a hobby? There are no shortage of policy wonks and former and current regulators in the Beltway who could take on the task.
6. How long will this thing be around? The RTC lasted six years: from 1989 until 1995, when its authority was transferred to the Federal Deposit Insurance Corp. During its life, the RTC closed or resolved 747 thrifts with total assets of $394 billion. The Reconstruction Finance Corp. lasted 21 years; after the 1930s, much of that was dedicated to the war effort. It was abolished as an independent agency in 1953. One of its affiliated entities, the FDIC, had its 75th anniversary this year. FDIC chairman Sheila Bair was in New York Friday, ringing the opening bell at the New York Stock Exchange.
7. How much will a new agency cost taxpayers? Paulson says it would need "hundreds of billions" to make a real impact, and as everyone knows no initial government estimate is ever what the ultimate cost turns out to be. The RTC, initially funded with $50 billion, ended up costing taxpayers $160 billion. The Treasury has already pledged to inject $200 billion into Fannie and Freddie and $200 billion into AIG, plus a smattering of other spending. (It'll buy back more mortgage-backed securities from banks, it said Friday, for example). The out-of-the-gate cost of all these bailouts seems to be $1 trillion.
8. Doesn't this make it hard to say no to other bailouts? Paulson refused to step in and save Lehman, insisting that just a week after seizing Fannie and Freddie, the government was no longer in the bailout business. Then a day later, the Treasury and the Fed were all over AIG--and now this. It doesn't take a great leap of imagination to assume the ailing U.S. auto industry might go and demand equal treatment. Homebuilders are hurting. Hey, how about homeowners? Paulson's plan is bound to be criticized for helping rich bankers out of a quagmire of their own making, while leaving average Americans to pick up the tab.
9. What happens next week in Congress? Paulson said he will work over the weekend with the Fed and members of Congress to hammer out a draft of legislation and hoped to have that draft submitted by next week. Lawmakers said Friday they hoped to move swiftly. The legislation will inevitably prompt a flurry of hearings, which will make for a busy season on Capitol Hill. Hearings are already planned to probe the downfall of Lehman, and there are calls for hearings on evidence of manipulative stock trading.
10. Will this end the credit crisis? Stock investors certainly seemed enthusiastic about the plan Friday, driving the markets to erase all of their losses for the week. That may be the bounce in confidence Paulson was looking for, but there are more dark days ahead. Banks still face mounting loan losses, and the new entity isn't going to get off the ground quick enough to prevent more write-downs.
In the longer term, the creation of the entity will be accompanied by regulatory reforms and a likely reshaping of the way financial companies are regulated. Banks are reducing leverage and shying away from risk, which will restore stability but lower profits. Eventually, though, someone will innovate another product that will become the hottest thing on Wall Street. The only question at that point: Will regulators have enough determination to keep it in check?
