The Bush Paulson $700 Billion Bailout Plan
What Are Wall Street’s Toxic Securities Worth?
Sep 30, 2008
Surrounded by Wall Street bailouts and corporate handouts the American people have heard little about how the government will value the noxious products the taxpayer is asked to buy. With bipartisan and bicameral support, politicians, economists, commentators and reporters are proliferating news of a failing economy on the national airways. Dire predictions are made of a deep countrywide recession, rampant unemployment, massive retirement plan failures, widespread corporate bankruptcies, and an economic “Pearl Harbor” should the Bush-Paulson bailout plan fail to survive the scrutiny of congress and the American people.
In the midst of the media’s blitz a fundamental question has failed to receive significant discussion. How will the government place a proper value on these financial instruments? While issues of who is to blame, what went wrong and where does America go from here still exist, these important valuation questions will determine the ultimate cost of any plan.
Government Asset Valuation
What are these toxic securities actually worth? The value of any item is directly proportional to the desirability of that item. Vikas Bajaj reported on September 25th in the International Herald Tribune that former Treasury Secretary Lawrence Summers suggested; “an institution could have securities on its books at $60, but the current market price might only be $30.” Bajaj quotes former SEC chairman Richard Breeden as saying; “Sometimes, because of fear or extreme uncertainty in the markets, you get in a situation in which there are no bids at all….”
By definition, worthless means an item has a worth lower than the worth of some other item or its own worth at some other time. When individuals do not want something at any price it has no worth. Neil Irwin of the Washington Post wrote on September 23rd “…investors have been unwilling to buy these exotic securities at any price.” Yet this crisis is seeing the Treasury Department buying financial instruments that no one wants. Taxpayers purchase worthless securities!
As a result the valuation, how much the government should pay for the financial instruments, is extremely important. It appears the government is favoring one or two methods.
- The instruments will be classified based upon the value the holder of the security has on their books. The Tribune argued, “Treasury officials will…buy the troubled investments near the values at which the banks hold them on their books. That would help minimize losses for financial institutions.”
- The instruments will be valued based upon the maturity value. Bajaj reported, “Ben Bernanke, the chairman of the Federal Reserve Board, told Congress…the government should avoid paying a fire-sale price, and pay what he called the "hold-to-maturity price," or the price that investors would bid if they expected to keep the bond till it was paid off.” This means that if a bank loaned $100k for 30 years at 5.5% interest, the borrower would repay $204k principle and interest. The maturity value of this asset (that may be in default) would be $204k and the government would purchase the asset at that value.
Whatever valuation the government eventually uses, one fact is certain as stated by Neil Irwin, “…the more effective the plan, the more expensive it will ultimately be.”
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