The nitty-gritty of pricing and buying troubled assets under the proposed U.S. government bailout of Wall Street would be left up to the Treasury Department, under draft legislation released Sunday.
In a key issue swirling around the $700 billion bailout since it was proposed on Sept. 20, broad discretion would be given to Treasury Secretary Henry Paulson and his successor to value, price, select and purchase distressed assets, mostly mortgage-backed bonds damaged by the real estate slump.
The draft leaves open the possibility of “direct purchases” from single institutions where no bidding or market prices are available, as well as “auctions or reverse auctions,” while requiring that assets be bought as cheaply as possible.
Eugene Ludwig, former Comptroller of the Currency in the Clinton administration, said the Treasury Department should know that it needs to get the best bargains possible.
“I’m certain the government is well aware that they have to be judicious, that this isn’t a big giveaway,” Ludwig said.
The bailout calls for spending a fortune in taxpayer money to buy up broken financial assets created by Wall Street banks when it looked like home prices had nowhere to go but up.
Now that the real estate bubble has popped, many homeowners are defaulting on over-aggressive mortgages. As a result, assets that rely on steady mortgage payment flows are no longer worth anywhere near what the banks thought they would be.
That has left many financial institutions sitting on a mountain of bad debts they cannot value or sell and the situation is locking up global capital markets.
The Bush administration is betting that buying up these broken assets and placing them into a vast government portfolio will unlock the markets and get capital flowing again, preventing wider damage to the economy.
Details of the financial rescue package were negotiated late into Saturday night, with Congress expected to move this week toward passage of a bill that still sheds little light on precisely how the asset purchases would occur.
“Passage of the plan is just step one. Step two is execution and there remains considerable uncertainty about how assets will be purchased,” said Michael Pond, Treasury strategist with Barclays Capital in New York.
GUIDELINES WITHIN 45 DAYS
Paulson would be required to publish implementation “guidelines” for the Troubled Asset Relief Program (TARP) within 45 days of its enactment, or two business days after the first asset purchase, whichever is sooner, says the draft.
Another provision would bar sale of assets to the TARP at a price higher than that originally paid by the owner, but this prohibition would not apply to assets acquired in a merger or acquisition, or bought from a financial institution in conservatorship or in Chapter 11 bankruptcy proceedings.
Treasury is also required to issue rules on handling conflicts of interest that might arise. To make the program transparent to the public, Treasury would have to disclose its purchases and prices paid within two days of making the deals.
Economists widely expect Treasury to use auctions and reverse auctions to price and buy up broken assets.
In a best-case scenario, banks burdened with bad debts would leap at the chance to unload them on the government, even at a discount. If Treasury could flex the government’s legal muscle to make these securities work again, perhaps by modifying the terms of their underlying mortgages, the securities could be resold later at a profit, break-even or a modest loss.
But analysts say much will depend on what price Treasury pays up front for the assets, which assets it buys and how widely the results of the purchase program are publicized and understood.
NERA Economic Consulting, a private consulting firm owned by Marsh & McLennan Cos Inc, issued a study Saturday saying Treasury faces challenges if it pursues auctions.
NERA suggested Treasury knows well how to be a seller at auctions, which it uses regularly for sales of government securities. But in the bailout program, it would be a buyer.
Moreover, the assets involved would not be standardized, widely traded government securities, but poorly understood asset-backed securities — no two exactly alike out of thousands of issues — and which are barely traded at all.
Factors such as the packaging of assets in the auctions and the number of bidding rounds will be crucial, NERA said.
“If successful, the auctions would effectively establish a market value for mortgage-related assets for which there is currently no market,” the firm said in its study.
The trick for Treasury, the study said, will be to maximize disclosure of both auction results and direct purchases.
“Auction results just might throw enough sunlight onto the valuation of mortgage-related products to jump-start the stalled over-the-counter markets, sparking them to get back to the business of price discovery,” NERA said.
“This might be the best of all possible outcomes, as it would conserve public cash once private markets began digesting the product that today no one can sell.”
(Additional reporting by Dan Wilchins, Walden Siew in New York; editing by Gary Crosse)
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