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Banks May Say 'Thanks, But No Thanks' To That New $700 Billion

from the hello-adverse-selection... dept

Last week, in that big post about the financial crisis, one thing I mentioned is that despite all the talk of "moral hazard" -- the bigger fear might be moral hazard's sister problem: adverse selection. That is, it would only be those with truly awful assets and no other options that would take the government up on its offer to buy its "toxic" assets. That may be happening. Reports are coming out that some on Wall Street are considering saying "thanks, but no thanks" to the new ~$700 billion that the Treasury Secretary has been given. The article paints the issue as being about the strings that come attached to it, such as limits on executive pay and golden parachutes. That almost certainly could be a part of the reasoning, but a much bigger part may simply be that these banks recognize that the assets they have aren't quite as toxic as they're being made out to be.

Yes, there are bundles of highly questionable mortgages, but contrary to what the media tells you, plenty of the people who possess those mortgages are still paying -- and even if they're not, the property and houses they represent still do have some value on the market -- or will someday. Thus, it may be that the only banks that really take up Paulson on a buyout offer, are those with really toxic assets that aren't likely to appreciate in value. That's not good for anyone. The more you look at this bailout, the worse it seems. It also makes you wonder why there isn't more of a focus on using a so-called "stock injection" plan, whereby the gov't becomes an investor in the banks, rather than just buying out certain questionable assets. That would, in theory, help avoid sticking the taxpayers with only the worst of the worst assets.

Filed Under: $700 billion, adverse selection, bailout


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  1. icon
    the_dukeman (profile), 6 Oct 2008 @ 12:02pm

    property values

    After looking at the 1980's S&L bailout, this current mortgage situation could well be fallout from that. Until the early 1980's property values slowly and steadily rose, making real estate a sound investment. By the time the S&L bailout occurred, they were out of control. Since the bailout was in no small part based on hoping these values would gain again after the inevitable slump from the financial institution failures with bad mortgages, they fulfilled their own prophecy by soon escalating the property values again for no other reason than to try to make their money back from buying the toxic assets. When investors saw how much the prices were inflated, and that folks were willing to pay those escalating prices, an investment price spiral ensued.

    So in a way, the bailout plan from the S&L debacle directly set up this current situation by causing the property values to be propped up instead of allowing them to devalue to the proper price point and steady the market. Estimates of the S&L bailout plan having a 5-10 year economy impact are in fact false. It continues to this day.

    Thinking on Capitol Hill is that the government will make their (our) money back by selling the toxic assets at a later time. But they will inevitably prop up the property values again instead of allowing them to return to the levels that will ensure good growth in the future. The analysts hope that a 5-10% drop in prices will be sufficient. I suggest that they really need to drop 70% to put them back to the growth rate before the S&L bailout and the 5 preceding years.

    Now is the best time for that price adjustment so the real estate market can have a bright and steady growth prospect. Otherwise the same thing happens again in 15 years, if the economy doesn't collapse anyway in the next year due to marginalized price adjustments in the real estate market. They should take their medicine now and force the economy heal itself instead of just using a band-aid. Because the real estate prices were so inflated, investment vehicles in all sectors relied on those false values to make their profits. And so goes the self-fulfilling prophecy.

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