Moon of Alabama
September 23, 2008
The Mother of All Bailouts plan gives the Treasury not only authority to buy and sell Mortgage Backed Securities, but allows it to deal in any financial instruments including leveraged derivatives.
This evolved over the various versions.
The original Paulson proposal said:
Sec. 2. Purchases of Mortgage-Related Assets.
(a) Authority to Purchase.– The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.
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Sec. 12. Definitions.(1) Mortgage-Related Assets.–The term “mortgage-related assets” means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.
All media reports and blogs I have read about this assume that the Treasury under this plan would only buy Mortgage Backed Securities, i.e. bonds backed my mortgage payments.
But the above language also includes Credit Default Swaps. Insurance contracts or derivatives, that guarantee the recoverability of MBS and change their value in relation to an MBS’ value.
The language in the Treasury Fact Sheed on the proposal is even wider:
Treasury will have authority to issue up to $700 billion of Treasury securities to finance the purchase of troubled assets. The purchases are intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. The Secretary will have the discretion, in consultation with the Chairman of the Federal Reserve, to purchase other assets, as deemed necessary to effectively stabilize financial markets.
It seems like the fact sheed exceeds the breadth of the released proposal.
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Oh, you say, the Democrats in Congress will prevent the Treasury from morphing into a investment bank backed by $700 billion of taxpayer capital?
Here is Senator Dodd’s expanded proposal of the Paulson plan. The language is even worse than in the original:
SEC. 2. AUTHORITY TO PURCHASE TROUBLED ASSETS.
(a) OFFICES; AUTHORITY.—
(1) AUTHORITY.—The Secretary is authorized to establish a program to purchase, and to make and fund commitments to purchase troubled assets from any financial institution, on such terms and conditions as are determined by the Secretary, and in accordance with policies and procedures developed by the Secretary.
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SEC. 21. DEFINITIONS.(7) TROUBLED ASSETS.—The term ‘‘troubled assets’’ means—
(A) residential or commercial mortgages, and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case were originated or issued on or before March 14, 2008; and
(B) upon the determination of the Secretary, in consultation with the Chairman of the Board of Governors of the Federal Reserve System, any other financial instrument, as the Secretary determines necessary to promote financial market stability.
The Dodd version gets lauded by Krugman, DeLong and other ‘liberal’ luminaries.
This while the bailout language morphed from "mortgage related assets" to "any financial instrument."
The Dodd version added some nice little extras for a homeowners in distress and some oversight provision. But it also extended the scope of the Paulson plan far beyond housing and mortgages towards an all encompassing bailout for any financial issue.
Since 2003 Dodd collected over $4 million in contributions from Securities and Investment companies. His top five doners include Citibank, SAC Capital Partners and Royal Bank of Scotland. That may well be the reason why he does not want to keep the bill restricted to mortgage related assets but wants to include any financial instrument.
If this becomes law, Paulson and whoever replaces him in January will have the authority to buy Asset Backed Securities from car loans and credit card loans. He will be able to buy and sell derivatives based on ABS that have build in leverage effects. The Treasury may even deal in synthetic Collateral Debt Obligations and derivatives base on those. It can buy and sell shares of public dealt companies, precious metals, future contracts on these and it can speculate on interest moves of Russian government bonds.
Are there any big long future positions on the Canadian dollar the U.S. president does not like? Just get the Treasury buy them up. Congress is giving it the right to do so.
With a capital of $700 billion and the authority to buy and sell any highly leveraged financial instruments, the Treasury will become one gigantic hedge fund that can and may well act to move multi-trillions.
If such an entity makes one wrong move, it can bankrupt its owners within a few hours. The Treasury is too knowledgeable to make such mistakes? So were two Nobel Price winners at LTCM.
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