"I think both the doom and gloom and the optimism have been oversold," says Isaac, suggesting that taking time for a more considered analysis of all possible solutions would lead to a better outcome.
No one is yet sure how the Treasury Department intends to set a price for its asset purchases, assuming Congress grants its request for $700 billion in buying power. Treasury officials have said only that the price might be set in a so-called reserve auction, in which 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 the banks offering the lowest price.
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.
"The devil is in the details," says Sandeep Dahiya, a finance professor at Georgetown University. "The government would pay something between the current market price, which is effectively zero, and the full fair value. But we've heard very little about how the auction would work out."
The goal is to find a sweet spot between two extremes.
The lower the purchase price, the better the chance of minimizing taxpayers' potential losses and maximizing potential gains. But such a "fire sale" price would force the selling banks to record large losses, hampering stability.
Overpaying for the assets, on the other hand, would be seen as a handout to imprudent bankers.
"This is where this would acquire the whiff of bailout," says Dahiya.
"That would be a very hard sell to the public at large."
Paulson has suggested allowing Wall Street traders to conduct the auction, notwithstanding the bad odor that mortgage traders currently emit on Main Street.
Given proper incentives, however -- such as a percentage of the profits their trading eventually nets taxpayers -- professional traders may produce the best results for taxpayers.
One uncertain question is whether the government purchases will entice private investors to start bidding again for mortgage securities, creating an active market that could relieve the Treasury of the need to spend its entire fund.
"Having one available buyer gives other buyers the courage to look at the asset class again," argues William Satchell, a corporate finance attorney in the Washington office of O'Melveny & Myers. "I'd be surprised if the Treasury didn't have to go through a big chunk [of the $700 billion]. But I think you'll see a lot of other entrants" to the market.
That may not be a sure thing, says Kjerstin Hatch, portfolio director for Madison Capital Management, an investment firm specializing in distressed assets.
"We haven't been at all tempted," she said, even though institutions such as Merrill Lynch & Co. have sold their mortgage-backed securities for as little as 22 cents on the dollar.
"They're probably a decent buy at that level, but we're choosing to spend our money on other paper that's attractive and not as risky."
She notes that the government has the unique power to make policies that would enhance the value of mortgage securities -- by instituting a homeowner bailout that cuts down on defaults and foreclosures, for example.
"So the Treasury may really be the most appropriate owner of that paper," she says.
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michael.hiltzik@latimes.com
