Calculated Risk on the Bailout

from calculatedrisk.blogspot.com

Friday, September 19, 2008
The Price of the Bailout
by CalculatedRisk

Secretary Paulson said: "We're talking hundreds of billions."The NY Times DealBook has other estimates: Putting a Price Tag on a Government Bailout

“It’s probably $500 [billion] to a trillion dollars, and that’s going to visit the taxpayers sooner or later,” [Sen. Richard Shelby] said. “It’s either going to be a debt charged to all of us or to all our children.”...Bloomberg News ... reported that the government is considering establishing an $800 billion fund to purchase so-called failed assets and a separate $400 billion pool at the Federal Deposit Insurance Corporation to insure investors in money-market funds.

However buying the assets isn't enough. These asset sales will lead to substantial write-downs, and that will reduce the regulatory capital at the banks. So how do the banks recapitalize?The hope is that by making the assets transparent, and selling off the toxic waste, that will rebuild confidence with investors. Maybe.

But the U.S. Government might also have to help recapitalize the banks to keep them lending (like the Reconstruction Finance Corporation (RFC) did during the Depression). Either way, it appears the current shareholders face massive dilution.

Also - as an aside - when the banks make their assets transparent (should be a requirement for participation), we will discover if any executives misrepresented their assets and filed false reports with the SEC. That could be prosecuted under Sarbanes-Oxley, and perhaps a few executives spending time in jail might help with the moral hazard issues.

I am not sure I would want to be a long term shareholder of some Financial firms with large Tier 3 assets.