The Bailout Plan

People have asked me about the "Bailout Plan" and I wanted to describe what is really going on.

The issue with the “financial crisis” is simply this – banks are insolvent and lying about the price of the assets they hold on their books.

Credit is created by banks lending back and forth to one another. Banks know that other banks are lying about their assets and are afraid that if they lend to another bank, they may not get their money back. So banks aren’t lending to each other right now. They are hording US Treasuries.

The Paulson Plan
How does the Paulson Plan fix things?
The goal of the Paulson Plan is to give the US Treasury a $700 billion pool with which to buy securities. They want this power so that they can fix prices at artificially high levels.

Why?
Say Bank A has a $1 Billion Mortgage Backed Security. Say that this bank is pricing that asset at 20 cents on the Dollar, or $200 million in paper value. Other banks know that the bond is really worth something like 6 cents on the Dollar, or $60 million in paper value. The US Treasury wants to be able to go to that bank and buy a small portion of their holdings in this bond at some fantasy price well in excess of the current “price" or actual value of the bond, say 40 cents on the Dollar.

That will allow Bank A to increase the value of the bond on their balance sheet and declare a $200 million PROFIT for the quarter! This “repricing” will result in banks becoming flush with “capital” and they will be able to start lending again.

That’s the Paulson Plan. Buy overpriced assets with taxpayer money so that the banks can lie about the value of their holdings. Does that sound like a good plan? It sounds highly illegal and unethical to me.

Plan B
When the Congress voted No to the Paulson Plan, the SEC (Securities and Exchange Commission) decided to investigate a Plan B for how to artificially inflate prices of the holdings on the balance sheets of banks.

The SEC Plan
The day after the Paulson was voted down, the SEC went to FASB and asked them to change the rules for how bonds are priced. The role of FASB (http://www.fasb.org/) is to develop the Generally Accepted Accounting Practices (GAAP) within the United States.

FASB 157 is the rule for determining how corporations price the assets they hold. The intent of the rule is to have prices set based on the actual prices being paid in the market for the security or for a security of similar quality and maturity.

The SEC asked the FASB to change the rule, so that companies could now price their assets based not on the current going price, but on some fantasy estimate of the hypothetical maturity value of the security.

At this point I just throw my hand up in the air. The SEC is supposed to enforce the laws to protect the public from transgressions by companies which hurt the public.

The SEC is now instructing companies to lie about the value of their holdings
The credit markets are now frozen because nobody trusts the guy on the other side of the trade
US Treasuries are being horded at the expense of new corporate debt creation
The stock market is imploding because nobody wants to hold rigged assets
The US Government wants to give $700 billion to the US Treasury to further rig the prices of bonds

We are in deep doo doo.