Bailout Report Card – The Results Might Surprise You
by David Fessler, Advisory Panelist, The Oxford Club
Editor’s Note: A couple of days ago, our colleagues over at The Oxford Club put out their thoughts on the Federal bailout. And from the sounds of it, our readers haven’t been entirely pleased with the grade. Most have given the Feds an “unsatisfactory” in their use of the funds and the expected results. Remember that sometimes citizen needs and national needs are different. We both want the same thing, just not always in the same fashion. We’ve excerpted the article below for your convenience, so you can make your own judgment of the fed’s progress.
So how’s the bailout plan, or TARP (Troubled Assets Relief Program), working? You might be surprised.
But first, let’s first review what TARP is, and what it’s supposed to accomplish.
TARP was born on October 3, 2008 and is managed by the newly created “Office of Financial Stability.”
It gives the Treasury the power to purchase illiquid, or otherwise impossible-to-value, assets (primarily securities backed by subprime mortgages) from banks and other financial institutions. If they deem it necessary, the Treasury can choose to make direct investments in a given institution by purchasing its common or preferred stock.
These securities were created when investment banks mixed both prime and subprime mortgages into pools that could be sold to investors, piecemeal. Like other securities, they were rated by major ratings agencies, sold like bonds, and paid from cash flows generated by the mortgage payments.
At first, everything worked fine. But when people stopped making their mortgage payments, the house of cards began to fall.
In the last two years, prime mortgage default rates have doubled and subprime default rates have quadrupled. Both have occurred at rates that are much higher than the banks and mortgage companies expected, or had reserves set aside for.
Analysts shot first and asked questions later. They were quick to downgrade everything in a given pool, even though some of the mortgages were fine.
Making matters worse, mark-to-market accounting rules forced banks to write down the value of these assets all the way to zero (in most cases), which, in effect, destroyed their balance sheets and sent stock prices through the floor.
At this point, the government decided it needed to intervene and created TARP. The Treasury has been using TARP funds to purchase these “toxic” assets, allowing banks and other financial companies to stabilize their balance sheets, reduce or eliminate further losses, and begin lending to homeowners and business owners again.
One thing it doesn’t do, however, is allow banks to recover prior losses. Treasury officials are banking – no pun intended here – on the fact that the value of these assets will eventually stabilize, and the trading of them will resume.
Hank Paulson: Financial Superman
Guess what? Early signs indicate that it’s working. In fact, considering the heat that Treasury Secretary Henry Paulson took for his hasty construction of TARP, he’s starting to look like a financial genius.
According to The Wall Street Journal, Paulson is getting a better return than most fund managers.
As of December 30, 2008 the Treasury invested $200 billion in banks and various other companies. According to New Hampshire Senator Judd Gregg, Paulson and his team are currently sitting on an $8 billion pile of gains accrued in the past three months.
That’s roughly a 4% return. Annualized, we’re talking a 16% return, which beats most hedge funds, mutual funds and private equity firms for all of 2008. And that’s on top of the main purpose of recapitalizing the country’s financial system.
Senator Gregg stated that, “With this type of stimulus, there will be little, if any, long-term increase in the debt.” And Paulson – more likely his successor – still has $350 billion left to shell out.
And who knows? In light of how well the Fed’s doing, other market players may look to piggyback its success. I can tell you that the 10 biggest private-equity funds have nearly $200 billion at their disposal. And Warren Buffett has another $106 billion cash pile to work with.
Clearly, both the Federal Reserve and the U.S. Treasury are treading carefully, as we’re breaking new ground. But Paulson is proving that his experience at Goldman Sachs is worth its weight in gold for American taxpayers.
The U.S. government might just turn out to be the new “smart money.” We’ll just have to wait and see. But for now, I’m giving the bailout a B+.
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