September 25, 2008

SURE, WE'D MAKE MONEY OFF THE DEAL...:

What's the True Cost? (Robert J. Samuelson, September 25, 2008, Washington Post)

Love it or hate it, the true cost of Treasury Secretary Hank Paulson's proposed rescue of the financial system is not the sticker price of $700 billion. Conceivably, the government could make money; with glum assumptions, the losses would probably be less than $250 billion. No one knows the correct answer -- not Paulson, not Federal Reserve Chairman Ben Bernanke nor anyone else -- but here's how to think about the problem.

Under Paulson's proposal, the Treasury could buy distressed mortgage-backed securities. Consider a batch of hypothetical securities originally worth $100 million and paying an interest rate of 6 percent. They're no longer worth $100 million because half of the homeowners have stopped making their monthly payments. Suppose, then, that the government buys the mortgages for $50 million. It earns 6 percent on its $50 million, and if it borrowed money at 4 percent to buy the securities, it would make a tidy profit. If the government holds the securities until maturity and all the remaining homeowners repay their mortgages, the government would come out ahead.


...but it's just as bad an idea for the government to own such instruments in the longer term as it would have been for Bill Clinton to buy stocks with the SS Trust Fund. As a simple business proposition, snapping up this discounted debt is a no-brainer for the American tax-payers, but government oughtn't be in business. It would be acquiring too much power.

Posted by Orrin Judd at September 25, 2008 7:47 AM
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