The main mechanism for buying these assets will be reverse auctions, using the same principles that govern auctions of electricity or the wireless spectrum. In this case, the government will issue an offer to buy a class of assets — for example, subprime mortgage-backed securities — with the final price being determined by how many banks are willing to sell.
The law stipulates that the government must prevent conflicts of interest in the hiring of firms, the decision of which assets to buy, the management of those assets and even the jobs held by employees after they leave the program. But it leaves the details to the Treasury, and its handling of the crisis so far does not inspire any confidence that it will do a good job managing these.
Finding the right price for these assets, many of which are not even traded in exchanges and others having no buyers and therefore illiquid, will be the biggest challenge. Overpaying would hurt the tax payers, while under-paying will be counter-productive as it would force the banks to book heavy losses, thereby further delay their recapitalization.
Another moral hazard inherent in the reverse auctions being proposed arises from the fact that hedge funds and other potential buyers would be participating in them, alongside the Treasury. By piggybacking on the Treasury and pushing for a much lower prices, they are hoping to knock away some of these assets at a bargain.
The management of the distressed assets purchased by the Treasury will be outsourced to professional asset management firms. This presents lucrative opportunities for fund managers, and also opens up dangers arising from conflicts of interest that these fund managers will encounter as they work both for their own clients’ interests — which could pay higher fees — and the interests of taxpayers. Further, with many of the junk loans and mortgage-backed securities having no market price at all because they have no potential buyers, the firms hired by the government will have enormous power to push the "market" price up or down as they choose. Inevitably, large asset management firms own, or are tied to banks that own, some of the same securities the government is seeking to sell.
Another important moral hazard concern arises from the fact that the Treasury which is effectively converting itself to a $700 bn asset management firm, is headed by a former Wall Street executive, Hank Paulson. To add to the problems is the fact that he has cobbled up a team dominated by ex-Goldman Sachs employees, many of whom may have strong conflicts of interests with the firms whose assets are purchased.
While bailing out the financial institutions and their investors and lenders, the bill does not contain anything for homeowners facing foreclosures orfalling prices. It does not include the one provision that consumer advocacy groups and some Democrats had initially been pushing for — giving bankruptcy judges the power to modify troubled borrowers’ mortgages on their primary residences. The law is only expected to provide indirect assistance to consumers, by seeking to stabilize the nation’s financial institutions, reopen the credit spigot and prevent a deeper economic slowdown.
Update 1
Daniel Gross calls the bailout plan a Universal Hedge Fund
Update 2
Gary Becker has this list of moral hazards unleashed by the bailouts. The moral hazards include - a bias toward financing enterprise by bonds rather than by stock because the government's bailouts have entirely protected bondholders and other creditors while the equity holders have been wiped out; extending government insurance of deposits to money market funds will only incentivize investment bankers who use them to take greater risks; impede hedge funds by forbidding short selling, which enables the funds to hedge their risks; reduce information about stock values (another consequence of forbidding short selling); increase regulation of financial markets, which will carry with it the usual heavy costs of heavy-handed regulation; and blur the role of the Federal Reserve Board by increasing its powers and duties.
No comments:
Post a Comment