Sunday, September 28, 2008

Bailout can WORSEN things: top US budget director.

The Washington Post reported the following a few days ago.

A financial bailout could worsen the crisis, be insufficient to restore trust and cost ‘a few’ billion dollars a year to administer said Peter R Orszag, US Congressional Budget Office Director, in his testimony before the House Budget Committee. The key question he said what “What are we buying and what are we paying for it?" Orszag feared that the bailout as it stands might reveal that the large financial corporations are inflating prices of assets on their books. “Suppose a company has Asset X, whose value is recorded on the books as $100. Because of the current economic decline, Asset X's real value has dropped to $50. If the company takes part in the government bailout and sells Asset X for $50, the company has to report a $50 loss on its books. On a scale of millions of dollars, such write-downs could ruin a company.” Such corporations "look solvent today only because it's kind of hidden” [but they] “actually are insolvent".

Here's what I don't understand: Because short-term lending by the banks had almost completely shut down Treasury is acting as a go-between in short-term lending between banks. "Instead of Bank A lending directly to Bank B, as is customary, Bank A [purportedly] no longer had confidence that Bank B could repay the loan. So Bank A would give the money to the Treasury, which issued a security that was put into the Federal Reserve, which then issued the cash to Bank B." [That action implies that the US Government is already guaranteeing the debt of insolvent firms; already bailing them out. Is that correct?]

Bailout Could Deepen Crisis, CBO Chief Says
Asset Sales May Lead to Write-Downs, Insolvencies, Orszag Tells Congress
By Frank Ahrens, Washington Post Staff Writer. Thursday, September 25, 2008; D04
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/24/AR2008092402799_pf.html


3 comments:

Anonymous said...

So instead of drowning government, they decided to poison it instead.

With cat food from China, basically.

davod said...

The valuation issue may lie up with something I heard on the radio yesterday. The financial advisor said that a portion of Sarbanes Oxley, which came into force in November, 2007, means that these companies have to value their assets every day. They have to do this based upon what the market is doing that day. No buying, no value. I do not know whether this is correct but it seems a silly way to do business.

Anonymous said...

davod, some who-knows-how-large portion of these assets are not marked to market but marked to model, in which case what they are worth, as a function of the models' assumptions, may be very different than what would now or later be paid for them on an arms length basis.

If govt pays less than the mark to model price, firms could experience balance sheet problems; if govt pays at mark to model it may well be overpaying.


Brenda; "the US Government is already guaranteeing the debt of insolvent firms; already bailing them out. Is that correct?"

yes and in the process govt weakens its own 'balance sheet' -- treasury default risk remains low but much higher than last year's average.

btw, i've been busy so have not had chance to respond to your excellent earlier response.