Bank Bailout

Big news out of the Obama administration yesterday. The Treasury announced the bank bailout details. I've always had mixed feeling on bailing out banks. Its important that banks don't seal themselves in and protect against more losses by not lending, a fluid credit market is super important.

This is the plan. Banks will offer the assets (risky home loans) they don't want up for auction. Assume that the loans were worth a million dollars if there was no risk. The collection of assets will go to auction where asset management companies can bid on them.
The banks only want to clear the riskiest assets so the assets will be worth considerably less than the million dollars because of the high risk of default. Let say the bidding reaches $100,000. The government will pay over 90% the whole cost of the loan while the private company assumes only minimal risk.

Now I don't know all the details, but I assume the asset management company would be allowed to renegotiate the terms of the loans the acquire.

Now if the assets turn out well and they end up collecting 200,000 on the loans. The government and private company split the 200,000 evenly. Everyone goes home happy especially the asset managers, they invested less than 10,000 of their money and were able to collect 100,000. If the assets fall in value, the government (taxpayers) takes a pretty big hit.

Now the plan is obviously very controversial. Here are the positives: It takes the bad assets off the banks balance sheets and hopefully frees them up to loan more money. It leaves the asset management to professionals and keeps open the possibility the government can make a profit.

The cons: If the plan fails, it falls hard and the taxpayers bite the bullet yet again. The government is buying the riskiest assets and though auctions are usually the best way to accurately price something, the fact that the government is footing the bill will inflate prices because the companies know they are assuming minimal risk.

I'm still very so-so on the plan. The banks with the bad assets have an incentive to work directly with the lendees to work out a plan without the need for government intervention. However, if your number one priority is to get banks lending, the plan will accomplish that.

This is another arm of the Obama's overall strategy for the economy, we'll all have to see together if it works.

Another opinion