CNBC Today At 4:10 PM ET
Today, we’re going to be discussing the Obama stimulus package and the plank that contains “Buy American.” Here’s what I wrote earlier today:
Another example of this type of behavior stems from the stimulus plan. This is fertile ground, but let’s just focus on one populist aspect: Buy American. How can anyone with a minimal understanding of how our economy works insert this provision into a “stimulus” plan is beyond my level of comprehension. Can one say Smoot Hawley fast enough? Did anyone think to look at a company like Caterpillar and ask how much of their sales are derived from overseas?
Here’s the article that will be discussed and it expresses many of the themes I’ve been writing about:
http://seekingalpha.com/article/117656-buy-american-goodbye-global-friends?source=headline1
January 31st, 2009 at 7:22 pm
Dear Andrew,
I have a solution to the toxic assets problem that even school children can understand. It is based on the game of Monopoly.
The Problem:
Banks and other financial institutions (“Banks”) are insolvent if their toxic assets are valued at current market prices. Banks will naturally be reticent to provide transparency on the toxic assets they hold, exposing their insolvency. Banks, however, believe that when the housing market recovers, their toxic assets will also recover. Banks need a government solution that will allow them time for their toxic assets to recover. They also need to be able to get cash against the value of their toxic assets, in order to fund their current operations. They also need to be able to value the assets at more normal prices; otherwise they will be exposed as being insolvent. Meantime, markets are demanding transparency on the size, value and risk of these assets.
The Solution:
Suppose Banks “mortgage” their toxic assets to the government for a pre-defined term of say 7-10 years. The discounted mortgage value of these assets should be less than model value, so value them at market value. The government gives these banks cash for their assets valued at market value, while the mortgaged assets stay on the banks books. The assets are disclosed to the public (solving transparency), they are currently valued at market rates (solving how to value them), and the assets will be returned to the banks in 7 years when they have recovered in value. If investors believe that there will be considerable appreciation in the value of these assets at the end of the 7 years, they will consider this an investment and not punish the stock. At the end of 7 years, when the housing market has recovered, the banks have the right to reclaim (unmortgage) the assets and sell them on the open market. In order to redeem these appreciated assets, the banks must pay a standard “un-mortgage” fee, roughly in line with prevailing interest rates. During the 7-year term, the banks will be subject to certain financial covenants and restrictions and the government has the right to sell the toxic assets if the banks are in violation of the covenants. This solution uses the government’s balance sheet to buy time for the asset values to recover. By leaving ownership with the banks, the banks can continue to value them at “model value”, with the understanding that at the end of the holding period, their values will substantially recover. This is consistent with the argument that the banks have been making that these assets are held as long-term investments and shouldn’t be valued at today’s crisis-level prices.
This solution is much like the game of Monopoly. Suppose you own Boardwalk, but not Parkplace and need to raise money to stay in the game. You believe that one day Boardwalk will have increased value, so you mortgage Boardwalk back to the bank at a value less than the purchase price. You retain title to Boardwalk, the bank gives you money to stay in the game, and you can redeem the mortgage at a later date when your fortunes have improved and when the value of Boardwalk has increased (say perhaps when you or someone else purchases Parkplace). When the time comes for you to un-mortgage Boardwalk, you pay a “un-mortgage” fee to the bank for its troubles. If you go bankrupt, the bank keeps the mortgaged asset. By retaining the title to Boardwalk, you retain the value of future worth of the assets, allowing you to assign value to the asset that is over and above the current market value.
What do you think ?
February 2nd, 2009 at 12:12 pm
Interesting idea. This is what we call a swap and your idea has merit. The question of these assets coming back in value down the road and that the government can hang on to them gets to the heart of the mark-to-market question.
However, I don’t think Geithner is going to be this creative when he presents his plan next week.
It’ll look a lot like Barney Frank’s idea for TARP.
Ultimately, poorly run banks will be closed down or forced to merge with healthy banks just like they did in the 1930s.
ab
February 3rd, 2009 at 1:33 pm
this is a very interesting blog. One of the questions that are a lot of folks are asking me is this. “What if the US Govt gave each American 5 Million dollars of cash and asked them to spend it in the manner they deemed fit’- will this not create a significant spurt in demand for all products and improve the state of the housing market immediately besides being a lot cheaper than the bail out plan. Agreed this is not a usual way to do business- but should they?? what is the downside?? atleast it gets to the common consumer and drives demand doesnt it??
sankar
Sankar Krishnan
Managing Director
Adventity Global Services
444, Park Avenue South, #1202
NY 10016
sankar.krishnan@adventity.com