The Fighting 29th

All about New York's 29th Congressional District

Reader Vincent sends the text [pdf] of the Senate version of the bailout. Senator Chris Dodd is the chairman of the Finance Committee, where this bill originated.

The media seems to be focusing on the Democrats' demands for executive pay limits, but the real news as far as I can tell is that the Dodd bill requires banks to provide "contingent shares" in return for the Treasury buying their mortgage-backed securities. Those contingent shares are activated if the Treasury sells the securities acquired at a loss.

In other words, taxpayers get something for their money. That's huge.

The proposed bailout does a simple thing: it authorizes the Secretary of the Treasury to buy $700 billion worth of mortgage-backed securities at a price he sets. The bill is being peddled as the only solution for a crisis that may bring down our financial system.

I agree that the crisis may bring down our financial system. I think we all need to be skeptical about the idea that this is the only fix.

The reason this crisis may bring down the financial system is that most of the major banks have billions of dollars of mortgage-backed securities on their balance sheet. Those securities are probably valued at a price much higher than their actual value. Right now, those securities can't be traded because nobody wants to sell them -- there's no market in them.

Once someone starts selling mortgage-backed securities on the market, and once it's apparent that the real value of those securities is pennies on the dollar, banks holding those securities will have to "mark them to market". In doing so, those banks will acknowledge that their assets have shrunk. Some banks' assets will have shrunk so much that their debt-to-asset ratios will fall below the regulatory minimums. In other words, some banks will become insolvent and fail.

To avoid this, Hank Paulson proposes to buy those securities at a price he sets. Presumably his price will be high enough that banks will stay solvent.

Think of it this way: you bought a house with a $100K mortgage. The house is now worth $40K and you must sell because you can't afford the mortgage. But you only have $20K in the bank. You're bankrupt, since you owe the bank $40K if you sell the house. But wait! Rich Uncle Hank agrees to buy the house for $80K. You lose some money on the deal, but you're not broke.

Rich Uncle Hank isn't concerned about the real value of the house -- he only cares that you will walk away intact. Hank might sell your house for $80K someday, but that's unlikely. It's more likely that he'll take a loss, and he's certainly assuming a big risk. Shouldn't Rich Uncle Hank expect something in return for doing you this favor? Wouldn't he at least expect you to change your ways so you don't make a bad investment like that again?

In the bill currently being proposed, Hank gets nothing in return for assuming $700 billion in debt. This bill is an extremely generous solution to a real problem. Here are some questions Congress should be asking before they expect taxpayers to shoulder this burden:

Why isn't this bailout coupled with legislation to regulate or eliminate mortgage-backed securities? Isn't it clear by now that they were a bad deal for everyone?

What about the rating agencies that rated those securities as "AAA", which allowed banks to buy this junk? Shouldn't the hammer be falling on them?

How about the executives who took home huge bonuses for selling mortgage-backed securities?

And, in my mind the most important question: Why not let the market work, and create a backstop instead of a savior? In other words, let the banks fail, but announce that the Treasury will insure that no bank customer loses any money. This is what happened with the S&L bailout in the late 80's and early 90's. The S&L's failed, and were operated in receivership. If we're going to do it again, do we need to be more generous this time?

Read the whole thing, but don't miss these highlights:

Sec. 6. Maximum Amount of Authorized Purchases.

The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

This act makes Hank Paulson the $700 billion King of Wall Street.

WENY has a story on Eric Massa's new farm plan [pdf], which was announced today.

In that story, Randy Kuhl's chief of staff says this:

“[Randy] is sitting on the House Ag Committee, he's not just a wannabe…Kuhl fought for New York farmers and against the Bush Administration's farm bill….Kuhl knows the issues better than anyone in this race, hands down.”

I'll point out the obvious: if Massa is elected and he wants to be on the Ag Committee, he'll be on the Ag Committee. The Democratic majority in the House will be very interested in retaining this seat, and Massa will have his pick of committees.

The Capitol newspaper has a nice 29th race profile story online.