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FINANCIAL CRISIS: PROSPECTS

Could the plan turn a profit?

Federal officials aren't promising anything, but economists say the U.S. could make money from the deal.

September 28, 2008|Michael A. Hiltzik | Times Staff Writer

Here's the $700-billion question in the financial bailout that Congress is expected to announce today: Could the American taxpayer actually make a profit on the deal?

Treasury Secretary Henry M. Paulson and Federal Reserve Chairman Ben S. Bernanke haven't made any promises on that score. The furthest they've been willing to go in appearances before Congress last week is that not all of the proposed $700-billion commitment would be needed.

But some economists say that the mortgage-backed securities the Treasury proposes to buy from crippled banks have been so beaten down in price that taxpayers could actually profit once the market for these securities -- now virtually nonexistent -- unfreezes.

"It's entirely within the realm of possibility that we'll make money on this deal," says J. Bradford DeLong, professor of economics at UC Berkeley.

For The Record
Los Angeles Times Tuesday, September 30, 2008 Home Edition Main News Part A Page 2 National Desk 2 inches; 73 words Type of Material: Correction
U.S. rescue package: An article in Section A on Sunday about the prospects of the federal government turning a profit from a bailout deal used the term "reserve auction" to describe the government's purchase of mortgage bonds. The correct term is reverse auction: Each bank hoping to sell mortgage bonds to the government would state the lowest price it would accept and the government would buy first from banks offering the lowest price.

DeLong observes that several government bailouts of the past have ended up in the black, including the 1994 rescue of the Mexican peso. The U.S. government eventually recorded a $500-million profit on its share of Mexico's $50-billion international loan package.

Of more immediate relevance, the government's takeover of stricken insurance company American International Group may have already produced a paper profit, and could produce more gains as AIG's asset portfolio is sold off or recovers its value.

"Very senior people in charge of asset portfolios on Wall Street have said they are envious of the terms the government imposed on AIG," DeLong says. "They think the Fed's going to make a fortune." He conjectures that the $700-billion bank bailout could yield somewhere between a $100-billion loss and a $100-billion gain.

Paulson has also endorsed requiring banks that sell troubled assets to the government to give some sort of equity warrant, so that taxpayers can share in profits once those institutions recover financially.

But questions about the ultimate bill to taxpayers continue to drive alternative proposals to contain the credit crisis roiling international markets. House Republicans proposed one such plan last Thursday based on a published paper by economists Laurence Kotlikoff of Boston University and Perry Mehrling of Barnard College.

Their proposal is for the government to sell insurance policies to struggling banks to backstop their holdings of questionable mortgage securities. "We think the public may feel better about selling insurance to the banks rather than buying the assets," Kotlikoff said in an interview. The insurance and asset-purchase ideas could coexist in the same rescue plan, he said, adding that he thought it was possible that the asset purchases would be profitable in the future.

"If we pay somewhat above the market price today, that doesn't mean that the market won't move," he said.

Congressional negotiators were reported Saturday to have added the insurance proposal to the draft bailout bill as an option to be considered by the Treasury.

Also weighing in on the bailout last week was William M. Isaac, former chairman of the Federal Deposit Insurance Corp., who pronounced Congress' rush to spend $700 billion on questionable assets "disheartening."

Isaac proposes revisiting a 1980s-vintage FDIC program that buoyed problem savings and loan associations by issuing them promissory notes they could use to shore up their capital base, allowing them to start lending to worthy borrowers again.

He also says the banks should get relief from an onerous accounting requirement known as the "mark-to-market" rule, which forces them to declare values on mortgage security holdings that reflect only their short-term worth, which in a troubled market may be far below their real value. The markdowns, he argues, have contributed heavily to major banks' huge reported losses, sapping investor confidence.

Meanwhile, 170 academic economists issued an open letter to congressional leaders last week questioning the fairness of the bailout and the lack of concrete terms for the asset purchases.

"It's opaque how the Treasury would set a price" for its asset purchases, says Lee Ohanian, a UCLA economics professor who signed the document. Any deal should be structured to make money for the taxpayer, he says, "but in its current form the deal gives the Treasury Department too much leeway."

Congressional negotiators said late last week that they would take steps in the bailout bill to ensure that taxpayers received a fair price.

The warnings of impending catastrophe sounded by Paulson and Bernanke and their calls for hasty action have left little room for alternative approaches to gain a hearing on Capitol Hill. There is some disagreement among economists and financial professionals over whether prospects are as bleak as the officials say -- and whether the proposed bailout would prove as much of a remedy for the year-long credit crisis as they suggest.

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