Treasury Deal via Podcast

A call held by the Treasury Department from over the weekend has appeared as a podcast. Interesting features of the bailout deal:

• Participating Banks will face executive compensation restrictions, and Treasury isn't bashful about imposing them, and may impose additional limitations on executive contracts as a condition of participation;
• Pricing of impaired assets isn't known;
• Institutions that want to sell over $100 billion in assets to the Treasury-managed fund will have to part with a significant equity stake, to ensure a taxpayer upside -- Treasury repeatedly invoked the huge equity positions taken in Fannie and Freddie to give people an idea what the plan would look like;
• Treasury's contracts to buy impaired assets will involve one-off negotiations on an institution-by-institution basis;
• Institutions electing the insurance option rather than the straight-up purchase of impaired assets still face Treasury as a new equity owner, if they cross the $100 billion threshold;
• Purchases would be delayed a few weeks following legislation while asset managers are hired to conduct valuation and purchase, but it will be prompt;
• The objective of promoting lending isn't backed by specific language requiring re-lending of funds obtained from the Treasury fund (The Jaded Consumer views this as a potential positive; requiring relending might promote loans being made with a rapidity that exceeds the supply of quality borrower demand, leading to more bad loans).
  

The big question seems to be how to price the assets. One questioner asked about different institutions' valuation of similar assets, and their relative motivation to participate based on whether the clearing price is above or below the last-reported asset price. This question and its answer illuminate two things: valuation of impaired, illiquid assets remains so speculative that similar assets might appear on the books of different institutions at materially different prices; Treasury doesn't yet have a fixed model for valuing the assets, either.

The fact that the mortgage market is full of hard-to-price assets in the hands of institutions that face significant consequences for trying to sell an excessive amount of poor debt creates a potential buying opportunity for firms with liquidity and patience. Although many firms may have little appetite for home mortgage instruments just now, their fire-sale prices imply a default rate that appears materially worse than the observed default rate, indicating that (a) a buyer might get a good deal, and (b) when Treasury takes an equity stake atop this deal, it stands to do quite well in institutions that are otherwise sound.

I noticed Deutche Bank on the conference call, with a question. I wonder if there's any limitation against investing in non-U.S. institutions that are holding U.S. home mortgage instruments on their books. Might Treasury end up with a large, diversified, global equity portfolio of major lenders?

I ordinarily expect the federal government to squander money at the geratest maximum rate -- hence its appetite to enter cost-plus contracts as the buyer -- but this may be a deal that could work. The interesting thing is that the deal wasn't done last week by the Democratic majorities in both houses of Congress: if the Democrats wanted to do the deal on any particular terms it wanted, they could present a bill to the President for signature or veto -- but they haven't. The conclusion is simple: more important to Congress than getting some specific language in the deal to satisfy policy concerns is avoidance of potentially being alone to catch blame for one's party in a future election cycle lest it go down the toilet. The only reason anyone cares what House Republicans think is that they want House Republicans to share the blame for whatever materializes later.

Of course, with both parties' vote, both parties will clamor to take credit for anything that works, and The Jaded Consumer predicts here that in a few years we will see politicians campaigning with promises of how they will spend Treasury bailout profits. Yes, they will utterly ignore the towering net national debt to pretend there's found-money to spend on some pet project.

Just wait.