September 25, 2008
A safe haven for capital...
I don't know enough to know if the numbers really work, but this WSJ article by Andy Kessler, The Paulson Plan Will Make Money For Taxpayers, is quite intriguing....Firms will haggle, but eventually cave -- they need the cash. I am figuring Mr. Paulson could wind up buying more than $2 trillion in notional value loans and home equity and CDOs for his $700 billion.
So the U.S. will be stuck with a portfolio in the trillions of dollars in bad loans and last-to-be-paid derivatives. Where is the trade in that?
Well, unlike Mr. Buffett or any hedge fund, the Treasury and the Federal Reserve get to cheat. It's not without risk, but the Feds, with lots of levers, can and will pump capital into the U.S. economy to get it moving again. Future heads of Treasury and the Federal Reserve will be growth advocates -- in effect, "talking their book." While normally this creates a threat of inflation and a run on the dollar, and we may see dollar exchange rates turn south near term, don't expect it to last.
First, with Goldman Sachs and Morgan Stanley now operating as low-leverage bank holding companies, a dollar injected into the economy will most likely turn into $10 in capital (instead of $30 when they were investment banks). This is a huge change. Plus, a stronger U.S. economy, with its financial players having clean balance sheets, will become a safe haven for capital.
Europe is threatened by an angry Russian bear. The Far East, especially China, has its own post-Olympic banking house of cards of non-performing loans to deal with. Interest rates will tick up as the economy expands -- a plus for the dollar. Finally, a stronger economy driven by industry instead of financials means more jobs, less foreclosures and higher held-to-maturity payouts on this Fed loan portfolio.
You can slice the numbers a lot of different ways. My calculations, which assume 50% impairment on subprime loans, suggest it is possible, all in, for this portfolio to generate between $1 trillion and $2.2 trillion -- the greatest trade ever. Every hedge-fund manager will be jealous. Mr. Buffett is buying a small piece of the trade via his Goldman Sachs investment.
Over 10 years this could change the budget scenario in D.C., which can also strengthen the dollar. The next president gets a heck of a windfall. In the spirit of Secretary of State William Seward's purchase of Alaska for $7 million in 1867, this week may be remembered as Paulson's Folly.
Mr McCain was laughed at by lefty retards for suggesting that our economy is fundamentally sound. But it IS fundamentally sound. In fact, it's the wonder of the world, and has been since the Reagan tax cuts (With an assist from the Bush tax cuts.) Last quarter it grew at a 3.2% annual rate, even as the press was begging people to believe we are in a recession. Most European countries would kill to get their economies growing at 1%.
The financial sector has tied itself up in knots with derivatives, but the underlying asset is the USA. And to give you an example of how strong we are, our current military budget is about half the planet's total military military expenditure, and yet, as a % of GDP our defense budget is about half what it was in the Reagan years...
Posted by John Weidner at September 25, 2008 07:13 AMWell, I do know enough to know if the numbers work, and they do. Let’s take an example of something a little less exotic than a sub-prime CDO. Imagine just a large pool of mortgages (not insured by Fannie or Freddie) that is currently suffering from a relatively high level of delinquencies – say, 10% of the pool is 90 or more days past due on their monthly payment. Now let’s say that fully one half of the mortgages in the pool will eventually default – a number that far exceeds what just about anyone is predicting. That means half your money is good. But what about the other half? Well, eventually the house will be sold, likely at auction, and the proceeds of that sale go to…the holder of the mortgage. If the loss that is taken on the mortgages that do default is 50% (again higher than anyone is predicting and higher than we are presently seeing), then the mortgage holder has lost 50% of 50% or 25%. Thus, at the end of the day, the mortgage holder will get back 75 cents on the dollar.
I can tell you from personal experience that the mortgage described above may well be trading right now at 50 or 60 cents on the dollar, and if the government were to offer a bank 75 to 80 cents on the dollar for the mortgage pool, the bank would likely jump all over it with both feet.
But wait, the numbers get better. Remember that there is a monthly interest payment that the mortgage holder collects, so if I get 75 cents of the principal back, plus interest, then the thing has to ultimately be worth, if held to maturity, something north of 75. And this is all assuming truly depression era levels of default and loss severity.
So if all of that is true, and it’s that simple, why are the bonds trading at 50 or 60 cents in the first place? Why aren’t there buyers at 75. There is a very good answer to that question, but I’m afraid it’s at least as long as everything I’ve written so far.
The point is that Mr. Kessler’s numbers are correct. If done right (and the likes of Bill Gross have stepped up to say they’ll help to see that it is done right) the Paulson plan will not cost taxpayers money, and could in fact add to the treasury over the next several years. This all doesn’t mean that I’m thrilled with the plan. But I do believe it is the least bad option out there, and the cost, at least in dollar terms, will almost certainly be negligible.
