Henry Paulson’s plan to salvage U.S. bank assets is a good concept that had a bad sales job but may even suffer from worse execution. The reason: It is out of control.
First Treasury was supposed to buy toxic mortgage-backed securities. Then commercial paper was added. Then equity positions in banks themselves. Now it will be equity positions in other companies. Where does it stop for the new economic czar?
There’s no market for sub-prime mortgage backed securities. And that’s the only thing Treasury should focus on. The effort should be similar to the Resolution Trust Corp.’s handling of savings and loan assets.
And it shouldn’t be called a bailout, because here’s how it will really work.
Suppose the Treasury announced it will buy $50 billion of fixed rate mortgages (mortgage backed securities, or MBSs) with an average maturity of 2028 and an average term of 30 years. The term is important because it’s the basis for how much principal and interest will be generated.
Additionally, let’s say that the only coupons that will be accepted in this batch are between 6% and 6.25%.
After stringent prequalification, banks bid to sell their mortgage backed securities based on a discount to the coupon. Bids starts at 4.25%, and the highest that Treasury will accept is 5.75%. Only certain pricing increments are accepted, starting with the lowest bids in the Dutch auction process.
If a holder of MBSs doesn’t like the terms, fine. They don’t bid. Ditto if they want to hold out for the least amount of discount off of the coupon. The $50 billion might fill up without some bids getting hit.
And by the way, the next auction for similar products starts at 4% and ends at 5.5%. Announcements and results get posted on the Internet.
What does this mean for you, Mr. Biofuels Plant Developer? These auctions would be a proxy for the cost of capital. Securitization got the U.S. into the mess, and should be used to get the country out. – David Givens
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