To Splurge Or Not To Splurge

I went to bed with the news that McCain wasn’t sure if he would support the splurge. Not that anyone needs my vote on this thing, but I woke up trying to figure out if I am in favor of it. So I’ll read (links) and think outloud and hopefully get somewhere.

My friend Tom Evslin, a conservative in the best sense of the word, posted his thoughts titled Just Say No. He argues the splurge is a short term fix and we should invest the capital in long term solutions to our economic problems instead.

My friend Roger Ehrenberg, a wall street guy who made the leap to startups and VC a few years back, thinks we must do something:

Bottom line, I think the system would remain too jammed for too long
simply letting things play out on their own. Now I am a free markets
guy. I grew up in the markets. Love the markets. Believe in the
markets. But this market is badly broken, and it needs a bridge loan to
begin the healing process. And this can and must be structured in a
manner that achieves the objectives without unfair and inappropriate
bailouts. The devil is in the details. But to toss aside the call for
action is, in my opinion, playing a dangerous and unnecessary game.

Mohamed El-Eria, Co-CEO of the huge bond fund PIMCO, wrote this in the FT yesterday:

As is now widely recognised, left to their own devices, US financial
markets simply could not accommodate the large and simultaneous
shrinkage of multiple balance sheets without major damage to
institutions and, critically, the system. Last week, the damage had
migrated to the essential component of any financial system – the
smooth functioning of cash, collateral and counterparty risk management.

would think all this would be too arcane for the politicians to take
notice until it was too late. Yet they did because disruptions affected
money market funds and, as such, became a real and present danger to
the average American. In these circumstances, the authorities had no
option but to act urgently. They did so by coming up with a bold and
targeted multifaceted approach. In the process they made two
transitions that are key to successful crisis management: most
importantly, move away from piecemeal measures and towards a
comprehensive and self-reinforcing policy programme; and see internal
measures supported by some action by other countries.

I am persuaded by Roger and Mohamed’s arguments that there is just not enough liquidity in the system and it needs a "bridge" and the lender of last resort is all of us, the US taxpayer.

But when a venture backed company runs into trouble and needs a "bailout" from its investors, the investors who step up generally get all the upside (with a generous carveout for the management team that will take the company forward). And when they are done right, these "recaps" (or "cramdowns") can be very profitable for the investor of last resort.

Look at what Buffett did with Goldman Sachs. He got a $5bn investment at what looks like an attractive valuation, he got preferred stock so his money gets out before any other equity holder, he gets a 10% interest rate, and 100% warrant coverage in the money. That’s the kind of deal the investor of last resort gets.

I do believe that the "splurge", as I’ve been calling it, can be structured as an investment of the taxpayer’s money into the fragile banking and brokerage system. And I am thrilled to see that someone on capital hill is smart enough to tranche the money as we would do in the venture business. Why invest $700bn when you can start with a couple hundred billion and see how its going?

What I want to know is what our upside is on this deal? We’ve been talking about $700bn which is what we call "the total capital requirements" or the $250bn which is what we call "the first round". At $700bn, that is $2300 for every citizen of the US, a huge sum for most people.

What I have not seen is a probability adjusted set of outcomes and an expected value of the gains on this investment we are being asked to make. If this money is not coming back, then its an expenditure and we should not do it.

If the probability adjusted return on this investment is $1.5tn then we should do it in a nanosecond. We would not approve any investment without doing this work and neither should our government. If I were Bush, McCain, or Obama (all three of them ideally) I’d send Paulson and Bernake to their cubicile and tell them to do the numbers and come back with the return projections before voting on this.

That’s my two cents for what it’s worth.

UPDATE: The comment thread on this post is what all comment threads should be, an informed honest tough conversation about this issue. I highly recommend it and want to thank everyone who has weighed in so far.

Reblog this post [with Zemanta]

Comments (Archived):

  1. AndyFinkle

    The more I have been thinking about it, the more I believe the splurge will not come in time. If anyone can mess something up, it’s congress. We need a shorter term solution. We should stop the FASB “mark to market” rule immediately. Almost everyone agrees that these CDS’s will be worth something in the future. Any bank wanting to “mark to future” should then be immediately required to hold the asset till it’s

    1. Nick Molnar

      This seems like a vastly cheaper way to solve the problem. We can call it the untervention, because it actually reduces government involvement in the markets. A lot of the present problems can be seen to be the result of a mismatch of regulations, like the dangers of mark-to-market accounting in volatile – highly regulated – markets.

  2. McLarty

    I don’t know about the real probabilities probabilities, but my made-up-odds-I’d-be-willing-to-wager on adjusted returns say it’s somewhere around $30B +/ – $10B PER YEAR, from that $700B investment. Best case, it’s ~$52.5B / year….for a few years…or so I’ve heard.

  3. stanley

    I’m 22 and I only mildly understand the financial system (as it was taught to me through my economics degree at Unv. Michigan), but I can’t help thinking this is something I should have read about in my history book. Over the past 5 years I’ve wondered about the US’s place in the world (ecsp comared to BRIC) and whether it would take a huge downfall. I can’t help but think this is the beginning…of possibly the end. I have a lot of faith in Americans and believe we can overcome just about anything…but this still wories me more than any other economic crisis I’ve eperienced/read about.

  4. howardlindzon

    I am still not sure. Can the system be purged without complete panic? Is America tough enough anymore? Can we turn off the TV’s long enough to effect real change?The stock market is give way to much credit. It’s a mood ring and that’s all.Now the bond market….

  5. McLarty

    Can you even add up the probabilities of systemic/counterparty risk? I mean, w.r.t to the up/downside for the country? i’m talking tax revenues from employees, banks, …and what’s the product of the intrinsic value to keep a person employed – you think the government can multiply the present value of THAT, by a probability the place where he works will fail from liquidity?

  6. S.t…( ever hear the story about how Janet Reno was gonna charge the lenders with ‘racial profiling’ if they didn’t make it easier for unqualified borrowers to get loans even though those borrowers wouldn’t be able to afford the payments?)

    1. andyswan

      No question. Mohamed could not be more wrong in his premise that markets were “left to their own devices”.This is the flu that the country gets from a socialist-program sneeze.

  7. Wallen

    Agree that this “investment” should be structured in such a way that the US taxpayer gets the upside of the direct returns. But the return on this “investment” is not only the potential direct outcome in a few years time. More critically, it’s avoiding the cost on the “real” economy today of a potential meltdown of the US financial system by cleaning-up the balance sheets of banks. The latter (and maybe the US economy in general) need to reduce their leverage which in turn will affect growth rates. Mind you it does not guarantee that the financial crisis does not spread in other areas but lower the probability at least. See post I wrote on this:

  8. alan shimel

    Fred- do you mean 1.5 trillion or 1.5 billion as the return on this investment? I think the 700b should yield 1.5t, in that case we should do it for sure. Hey at these kinds of levels it is easy to confuse a billion with a trillion I guess 😉

    1. fredwilson

      Typo, ughPosting in the early morning has its issuesI will fix asap, thanks!!!

  9. jasonkolb

    Fred -What everyone needs to realize is that ANY hope of ANYONE making money off of the so-called “assets” (so-called because when there is no bid for something it is worth ZERO), is that they are predicated on housing going back to 2006 price levels.2006 housing price levels are UNSUSTAINABLE. They were based on incredibly bad underwriting standards and a massively inflated credit bubble. Historically, house prices MUST be at around 3x income. There is pretty close to a snowball’s chance in hell that anyone ever makes money off this garbage. This entire “Splurge” exercise is about who has to eat the loss: the banks that made the bad bets, or us, the taxpayers?The real issue here is NOT liquidity. It is TRUST. The credit market is locked up because there is absolutely no transparency. We have laws on the books to enforce transparency, but Cox and SEC refuse to enforce them. They refuse to enforce them because they’re hoping that it can be offloaded onto the taxpayers so that the banks don’t have to book a loss.There is an easy solution to this problem, which is to force all the dirty laundry out into the open. Once people can see what they’re buying, liquidity (for GOOD assets) ceases to be a problem. BAD assets are bad, and the people who bought them in the first place need to take their medicine rather than trying to steal money from our wallets.I would encourage everyone to read more about this and the TRUE solution to this problem here:,Jason

    1. howardlindzon

      really good point that no one is talking about lately. Housing is a commodity and one needs to look no further than the semiconductor index $smh and see what happens at the end of a commodity bubble.Housing is f#$#ked for three to 5 years

      1. JLM

        I think that the issue is really a notch more subtle than just looking at real estate values. It has to do with the value of “shelter” — right up there with safety and sex in man’s hierarchy of needs.Even if the underlying value of the real estate securing a mortgage declines by 20%, a borrower still has a requirement for shelter.If the bailout has a provision for lenders to renegotiate the payments with a borrower (which is exactly what a new investor will do if they come into possession of the mortgage at a discount), then the borrower will meet his need for “shelter” by staying in his home at a reduced payment rate even if he has to share the equity at some future date with the new lender.Remember defaulting on a mortgage has consequences including the creation of a legally collectable deficiency judgment as well as a very negative impact on personal credit.I suspect that many borrowers cannot afford $100 a month but can afford $75 per month. They will also be willing to share the upside in order to prevent the deficiency judgment against them while avoiding the necessity to move.

        1. fredwilson

          JLM ­ you are the master of this issue on this blogWe are all hoping that people like you get involved in solving this messasap

    2. fredwilson

      JasonYou can’t make money buying mortgages at face value but you sure can at 20% of face valueThe plan is for the gov’t to pay a fair price for this paper which may in fact be 20% of face

      1. jasonkolb

        Problem is, Paulson refuses to say how they’re going to value all of this stuff. Not sure if you watched the hearings the other day, but he basically answered that question (“How will you value the assets?”) by completely dodging it. “These are very complex instruments, we’ll need to handle them on a case by case basis”, “We’re bringing in experts”, etc. They were trying to pin him down on this very important point and he refused to answer.

        1. Damon

          Do you really think more than a handful of people on wall street would understand what he was talking about if he did? They are complex instruments, and you can’t attribute their value in a sound bite. It would take volumes to describe how these securities are valued.If the taxpayer gets too good a deal, the bailout doesn’t work. If it’s not good enough, Wall St. just robbed the entire US. It’s a balancing act, and a tricky one at that. We (the taxpayers) may gain, or we may lose in that optimal case. But that gain/loss needs to be compared to the alternative (potential meltdown), not zero.

          1. jasonkolb

            I understand the instruments he’s talking about. And while I spent a great deal of time educating myself to understand them, they are NOWHERE near as complex as he makes them out to be.The fact is, he was in a CONGRESSIONAL HEARING to debate these EXACT TOPICS, and he dodged the questions. He could have easily summarized the mechanisms he would use to clear these assets, but he intentionally dodged the question, multiple times.”Trust me this is too complex for your simple brain to grok” is NOT an acceptable answer when you’re talking about almost a TRILLION dollars.

          2. qwang

            I wouldn’t underestimate the complexity of these securities, especially as an outsider to the industry.. And congress is most certainly unable to understand the valuation mechanics, as are 99.99% of the population, so no, he could not have “easily” summarized anything.

          3. jasonkolb

            As someone who does understand it, I respectfully disagree.

        2. JLM

          Actually the instruments are not really all that complex.

          1. Nick Molnar

            That’s mostly because bankers have put on their TV faces and oversimplified the story a bit…when they go back to talking to bankers the complexities come back out. They are very idiosyncratic securities.As much as I think the plan is a bad idea, I don’t think Paulson was dodging the question so much as protecting his negotiating position with the banks. It’s much harder to generalize when you are going to be held accountable for it an a negotiation later.

    3. ispivey

      Jason, I’d think that by definition, when you take hundreds of mortgages, package them together and slice them into tranches, the senior tranches will retain a substantial portion of their value unless you anticipate a majority of the mortgages being valueless.But the junior tranches (sub, junior sub, sub sub, junior junior, whatever the creative folks in securitization named them) of many vintages will undoubdtedly be worthless. And I take issue with the idea that we should be buying these assets at “hold-to-maturity” value. As Yves points out, “hold-to-maturity” is the new “mark-to-myth”.If these assets have any value, start shopping them around — dump the underlying mortgage info into spreadsheets for each vintage and let everyone have a look. Hold auctions. It would take a while, but they’d get valued at their “hold-to-maturity” value, accounting for each potential buyer’s view of the likely default rate. I know some banks are doing this with some assets (there have definitely been block MBS sales in the past 6mos); doesn’t this suggest that assets that aren’t being shopped are being held back because they’re worthless? Why should the taxpayers buy these at mark-to-myth valuations?

      1. jasonkolb

        Agreed. Problem is, until they allow the market to clear itself by letting worthless assets go to zero, the market can’t decide on a price for the assets that are actually worth something.Ben & Hank & Chris are unintentionally (?) killing the markets by not enforcing regulations and forcing the market to clear itself.

        1. ispivey

          It seems what really blew up the market was the realization that afterLEH went bankrupt and opened its books, theyhad a $110bn hole in the balance sheet. Not only were they lyingto the market about their solvency (perhaps unintentionally), it was amassive lie.If you apply that to the rest of the market players, it’s reasonableto expect that the reason no one is willing to let their worthlessassets go to zero is that they would become waaay insolvent. So…the “splurge” plan is to plug the balance sheet by buying some assetsat above-market prices (injecting cash, increasing equity value) andthereby also increasing the “market value” of other worthless assets.Voila! Solvent balance sheet, but again based on myth. The splurge’svalue is in reducing the size of the balance sheet holes byartificially inflating asset prices!The splurge would be less painful/costly than only injecting equity,which (because it would still require the market to price assetsfairly) would not inflate prices. But it would sure be a lot lesshonest, and I think it would set us up for a longer period of economichardship as the asset prices continue to decline to their true value.

          1. JLM

            The hole in Lehman’s balance sheet was caused, in part, by two different things:The difference in value between the underlying mortgages and the sum of the securitized tranches. I would call this the “promote;” and,The drop in value of the underlying mortgages compounded by the drop in the real estate which secures the mortgages.The “promote” is gone forever while the drop in value of the underlying mortgages may eventually recover. Time wil ltell.In any event, Lehman was lying to itself before it lied to the rest of the world.It gets down to a simple truth: “One cannot make chicken salad out of chicken excrement even if you are a Master of the Universe.”

    4. JLM

      A horse that does not attract a bid at a livestock auction is not worth zero. It becomes dog food. Somebody will buy every financial asset that has a piece of dirt attached to it. Some are just tougher to price than others and some will, in fact, become dog food.Real estate values will absolutely recover. Remember we have 4MM new Americans born every single year. Dampen the supply for 18 months and you will wish you could buy a home at 2006 prices.The first things the SEC needs to do is get rid of “stupid” policies — naked short selling is crazy. Public stock exchanges exist to allow the many to own companies of the few. They are not casinos where you can simply bet on outcomes. They are about ownership.

      1. jasonkolb

        A dead horse is worth zero.Seriously, go look at Detroit. Many, many houses that they can’t give away because the neighborhoods are decomposing. The houses actually have NEGATIVE value, because they must be torn down at this point. They will not recover.

      2. qwang

        Only the issuing of stock is about ownership and raising money and capitalization. Every trade post listing is partly (often mostly) speculative by nature, and naked shorts both adds liquidity to markets and validate markets as a powerful signaler of truth.

        1. JLM

          I run a public company and own a substantial amount of its stock. I bought into it as a turn around opportunity. I am iintimately familiar with Nasdaq, OTC-BB, Boston (now defunct) exchanges. I speak only of common stock and simple preferred stock.Any public company has its stock listed on stock exchanges subject to rules promulgated by the exchanges which have evolved based upon a very simple concept — allowing the shareholders of the company to trade the company’s shares among themselves and prospective shareholders in an efficient manner with full exposure of the bids and asks. This is simply an objective third party auction in which the company allows others to set the price of a trade and agrees to enter on its books the transfer of its stock among folks who have used the appropriate markets to buy and sell its stock. The company has made the decision to provide this service by deciding to be a “public” company.No company is served by the selling of “naked” shorts — which by their very nature are not even “shares” but some mythology created by traders. No company should be required to enter on its books the transfer of ownership of something which does not even exist.The mangement of a public company has a fiduciary obligation to its shareholders to act in the best interest of its shareholders including in protecting the value of shares both through diligence in the management of the enterprise but also in the administration of its records. To facilitate the selling of shares which do not exist and which serve to dampen the price of the shareholders’ shares is contrary to that obligation.”Adding liquidy to markets” and “signaling truth” are not benefits which are conveyed upon investors by deciding to purchase shares in a company.

  10. Rowan

    I think you’re on the right track. Simply giving the banks $700B with no strings attached stinks. But can you comprehend not evening trying to do something? That’ll just lead to further anarchy next week.A mature bipartisan plan needs to be worked out over the next few days that restores some trust/faith in the system and ensures the tax payer isn’t given a raw deal.It’s a pretty simple equation really — if tax payer money means that a big bank doesn’t fail and goes on to make profits in the future, then it stands to reason that the tax payer should be rewarded for their investment.At the end of the day it might not stop the collapse of the financial system… but you’ve got to try.

    1. Nick Molnar

      This assumes there are only two options: splurge or not.In fact, the government has a variety of options beyond the subtle differences between bailout packages.1. Force banks to raise capital by going to existing investors and/or selling some MBSes at the (crappy) current market rate2. Negotiate with sovereign wealth funds to split up the risk on buying some of these banks3. Let the banks fail and use some of the 700B to increase deposit protection and mortgage insurance4. Change the mark-to-market accounting rules so that every bump in the road doesn’t send banks into a collapse.I think all of those count as trying…and they’re all relatively cheap.

  11. Phanio

    Who knows what tomorrow will bring and if we will see any return from this so called investment. My question is, if there is a return (any amount) who gets it? Will it be returned to the people or will congress just earn mark it for their other pet projects.

    1. Brett Topche

      This has actually been one of my bigger concerns for a while. In the hypothetical case that Fred gave where we roughly double our money on this (and I say “we” and “our” as a US taxpayer), what becomes of the proceeds? I have a huge problem with this plan if it doesn’t include anything on the back end about paying down all of this extra debt the government is issuing and lowering the debt ceiling back to something a bit more sane. Unfortunately, I have minimal confidence that the money, when returned to the treasury, will be used to pay down debt or returned to the taxpayers. Faced with a windfall, the one thing we can be sure is that Congress (whether it is controlled at the time by Donkeys or Elephants) will find a way to spend it.

  12. MassMan

    Here’s how I see it:Point 1:The economic situation in the United States is going from poor to catastrophic. Data set after data set point to an acceleration to the downside. No matter where you look the story is the same (eg, unemployment stats, retail sales and housing prices, commercial real estate and autos are all terrible and getting worse). The Main Street locomotive is heading towards a cliff.Point 2:This economy was built on a mountain of debt and nobody (and I mean nobody) wants to see that mountain collapse. Once the Paradox of Deleveraging morphs into the Paradox of Thrift, the game is over. And the final score would be grim not only for the US but for the world.Conclusion:Should we support a $700 billion blank check bailout? The answer is NO! Our money says “In God We Trust” not “In Government We Trust.” Should set in place the mechanism to raise $700 billion? The answer has to be yes. ~$35 billion per year in interest expense is a tiny bill to pay to avert a global depression. However, with this authorization, Congress needs to put in place safeguards, oversight, audit and supervision before a single penny is spent. A little sanity can go a long way.Speed is of the essence. The clock is ticking and zero hour is approaching.I hope the politicians and bureaucrats do what’s right (for once). We The People are depending on it.

    1. Phanio

      Instead of a bailout of these large conglomerates, would the $700 Billion or $35 Billion in annual interest expense be better off funding something else that will rebuild the economic foundation of this country. These large organizations knew the risks they were taking. They reaped the up side when it was there. Now they should deal with the down side. We are in for a very hard time economically in the short-term no matter what. Why throw good money after bad?Take the $700 Billion and invest in the small and medium businesses of our country. Businesses that create the majority of the jobs (not off shore them) and businesses that can revitalize our economy from the ground up. Invest in innovation not speculation.

      1. fredwilson

        The banking and brokerage systems is the “roads and bridges” of the capital flows in our country. It’s like if there the trucks couldn’t get the food to the market. That’s what’s going on.Everyone focuses on the “rich guys are getting bailed out”In fact, their investments in their firms are being wiped outBut if we don’t keep the “roads and bridges” of our financial system working, we’ll be in big trouble

        1. Phanio

          You wrote “But if we don’t keep the “roads and bridges” of our financial system working, we’ll be in big trouble.” – Seems like we are already in big trouble!My problem is that I am tried of driving these same old roads and bridges. I say we build new ones. This is the time to do so. And, I feel in a few years, we will look back (hindsight) and say, that this was the perfect time to effect real change on the foundation and direction of this country. We always wait until it is too late and then try to piece meal fix it. Let start over – now is as good as any.I would rather invest in new businesses that innovate new banking and brokerage systems, new companies that are developing long-term renewalable energy solutions, and new companies that are innovating a better tomorrow. I’m not taking about funding new conglomerates but funding thousands – even millions – of new, growing companies that will bring change today. Companies that will compete against each other, creating better products and service, companies that will not need bailouts because if one fails, the others will fill the gap. I don’t mind driving off road for awhile or going around a river or chasm. I am just trying to think about a better tomorrow and if that takes pain today – I am OK with it.

          1. MassMan

            I think you are focusing too much on the long-term. I agree that the government should redirect more of its spending towards infrastructure related projects (the electric grid is in desperate need of an overhaul, roads, bridges, a functioning rail system, public transportation etc…etc…) and primary research. Unfortunately, it won’t happen overnight. This situation has to be dealt with now. The credit markets are frozen and if they don’t start working soon, the system will collapse.Moreover, I think people are focusing too much on whether this bailout will show a positive ROI. Assume it won’t. Capital needs to be injected into the system. In all likelihood the government will overpay but by doing so it will hopefully keep the financial system afloat and functioning. To demand a positive ROI at this juncture is akin to cutting off your nose to spite your face.Finally, nobody feels good about this. It’s something we are all going to have to suffer through. Hopefully, we’ll learn our lesson and put measures in place to keep this from happening again (or at least in our generation). Remember, it took us 70 years to forget the lessons of the Great Depression.

          2. Phanio

            Good article showing the abilities of the smaller guys : http://www.washingtonpost.c…Demonstrate that while the Interstate system of our financial markets may be in disarray the local roads and state roads are still providing the services needed to keep the system afloat.

        2. jasonkolb

          Our roads and bridges are built on a foundation of trust, which has eroded to the point of collapse.There are still solvent firms out there, but nobody knows who they are because the financials have been obfuscated beyond recognition. The roads and bridges that still work are out there, but nobody knows which ones will collapse when they step on them. That’s the real issue here.Insolvent institutions SHOULD be shut down and replaced with functioning ones.

        3. Tom Evslin

          The banking system we have today is financial infrastructure similar to the old phone networks in preInternet days – it’s way too centralized and too many tolls are paid as the flow goes through the money centers.Interestingly the $100,000 limit on FDIC insurance is encouraging people to move their assets out of the money centers and directly into regional and local banks.The pain of transition to a less centralized and less intermediated financial system will be great but hopefully less than the cost – not only in funds now but efficiency later – of keeping the old infrastructure in place.

          1. fredwilson

            This comment thread has now spawned two reblogs in less than two hours. It is possibly one of the best conversations I have ever seen in a blog comments thread. Thank you everyone for taking the time to share your thoughts. Tom – I reblogged this on the main AVC page. it’s so right.

          2. howardlindzon

            i absolutley agree. this is the smartest conversation i have ever watched unfold on a blog

          3. fredwilson

            It sure beats the lashing I got when I posted about community organizers!

          4. Satish

            Proves that blogging like any other profession is a “what have you done for me today?” world. When you bring forward thought provoking topics people respond with great stuff, and when you start a negative thread we are all more than capable of taking it down the gutter. 🙂

        4. bernard lunn

          Fred, you say “In fact, their investments in their firms are being wiped out”. Is that true? It is not the deal for AIG AFAIK? Equity should be wiped in a bailout. The issue is the banks are “playing chicken” with the economy, saying “Ok, don’t bail us out then”. If their equity is going to be wiped out they don’t care either way I guess.

  13. andyswan

    Why would the returns of the investment be returned evenly among the population?If taxpayers are chipping in on the “investment”, then $420 billion of it (60%) would be made by the top 5% of earners.The bottom 50% of earners would chip in 3% ($21 billion)The only way I support this splurge is if the money is put into a separate institution which keeps track of the involuntary investment amount made by EACH taxpayer and is obligated to send any returns or remaining capital back to those individual taxpayers in the same proportion which they invested within 6 years.Otherwise this is just another big-government scheme where the productive in this country are making “investments” (risk) with no hope of recovering their outlay.THAT is exactly how we got into this situation.

    1. Logic First

      Smart. This is the best way to punch through the “investment” talking points of the left. If this is really an investment, wouldn’t each individual contributor expect the same rate of return? Thanks.

  14. greenskeptic

    Smart, well-reasoned analysis, Fred. How realistic is a probability adjusted return of $1.5bn? And over what time-frame and, most importantly, who gets the gains? The taxpayer? Goldman Sachs? Warren Buffett?I can’t help thinking this is just a Band-Aid, short-term fix, and that the bleeding will continue. What I’d like to see is a corresponding investment of capital in longer term, systemic solutions. If we can mobilize $700bn, why can’t we tranche it as you suggest and take another slice of it and apply it to the real infrastructure needs faced by our country, such as fixing and transforming the power grid, making sure bridges and highways are safe, or creating a “Green Jobs Corp” to put Americans back to work?Tomorrow, people all over the country will be mobilizing around Green Jobs Now: A National Day of Action to Build a New Economy. Would be great to kick it off with a commitment to jumpstart the New Green Economy.

    1. fredwilson

      That’s Obama’s economic plan (invest in America) so vote for him and you’ll probably get what you are looking for splurge or no splurge

      1. andyswan

        I thought Obama was waiting until after the bailouts to reveal his economic plan? Is it out yet?

        1. fredwilson

          Read this and you’ll know everything you need to know’s also for eliminating cap gains on startupsI am not for that, but I would bet you are

          1. andyswan

            Thanks, read it.Obama sees the role of Federal Tax as a means towards income redistribution and income “equality”, not simply a means towards capturing revenue for the government.How can anyone argue against the “tax cuts for the rich” knowing that 5 years later, the top 1% are paying 40% of all taxes (up from 33% pre-cut), and tax revenues are now at all-time highs?”Tax cut for rich” = Rich paying more tax AND a greater % of the total tax. IS THAT NOT THE GOAL?That eliminates him from contention in my book.And yes, I’m for eliminating cap gains tax on startups, because I’m for eliminating cap gains tax PERIOD.

          2. fredwilson

            I’m with Buffet and Obama on this one AndyLet me make the money without intervention and then take a good piece of it to educate the poor and immigrants who need the education, provide health care, and rebuild our roads bridges internet energy etc etc

          3. andyswan

            If I wanted our hospitals to be as effective as our public schools, I’d agree :)I guess my main point is….since the tax cuts, the government is taking a larger share of what it wants from the “rich”….so why do we care that their rate is lower than it was?

          4. tom

            Obama said it was an issue of fairness. It’s not fair that rich people get to make more money than poor people. Government needs to tax in order to equal the playing field.

          5. andyswan

            Wow. Socialism…..a wonderful system to keep people from working and innovating!

          6. kareem

            A socialist democracy is a very successful ideological model for running a great country, andy. No need to resort to black and white straw men like socialism / capitalism, cuz nobody lives there in the real world anyways.Denmark has the happies populace of any country (the true measure of success imho. here, we often use money as a proxy for happiness, so why not just measure happiness instead?)Denmark is the least corrupt country in the worldDenmark is also the best country in the world for businessWe could also take note of how Sweden dealt with its own bank crisis in the 90s

          7. JLM

            Denmark does not guarantee the safety of Europe, North America and southeast asia. Denmark was overrun by the Nazis in about 30 hours in WWII.. Classic micro-macro error of logic.

          8. vineet

            Fred,Any particular reason for not eliminating cap gains on startups?As far as I am concerned it is one of the best forms of increasing innovations and pushing them out to the public, so I can’t be anything but happy for something promoting startups.Vineet

          9. fredwilson

            I don’t think its necessaryCap gains rates on startups are very low nowIf anything there is too much capital chasing startups not too little

          10. vrikhter

            Fred, is the rate on startups the same as the capital gains tax rate for basic investments? i.e. is it 15% at the top income bracket? Or is this a separate rate altogether?

          11. fredwilson

            It’s the same except there is also a rollover of gains exemption

          12. vrikhter

            cool, thanks!

  15. davidu

    As usual, Kessler lays it out clearly:…You can slice the numbers a lot of different ways. My calculations, which assume 50% impairment on subprime loans, suggest it is possible, all in, for this portfolio to generate between $1 trillion and $2.2 trillion — the greatest trade ever. Every hedge-fund manager will be jealous. Perhaps Mr. Buffett is buying a small piece of the trade via his Goldman Sachs investment.

    1. fredwilson

      If this is true, and I respect Andy, then it’s a huge mistake for Paulson and Bernake to pitch this as a bailout and focus on the upfront investment without talking about the potential returns

      1. infoarbitrage

        I totally agree. The messaging has been all wrong. There needs to be acknowledgment that many people screwed up to get us in this mess, but that there is a real opportunity for the U.S. taxpayer to be far better off 5-7 years down the line, as well as in the short run. This is getting lost in all the petty fighting among democrats and republicans.

      2. jasonkolb

        Do you really believe that housing will return to 2006 prices? You must remember that that is the basis that they are using for prices when they talk about ANY potential to create a return on investment.If so, you should be buying real estate hand over fist right now.

        1. davidu

          In the article Kessler thinks it’s an Everest-sized win even if we take a 50% markdown on current housing prices.And yes, I think people with a lot of money who can go long will be buying the 10-20 cents on the dollar real-estate right now. Look at Buffet.

      3. davidu

        It’s hard to say if it’s a mistake. You and I might understand the dynamics, but it can come out wrong.Perhaps Paulson and Bernanke fear that if they talk about the upside people will crucify them for trying to make lemonade out of lemons. The media works on soundbites and that soundbite doesn’t sound very good; it’s the exact soundbite that politicians and pundits love to pounce on, even if it is the best plan for everyone, including the homeowners.

  16. John Caddell

    I just wanted to say thanks to all for the most common-sensical, lucid explanation of the situation and debate about the remedies that I’ve read anywhere. I think the plan should go through if the lousy loans can be purchased at the right price and the owners of said loans feel enough pain.regards, John

  17. ispivey

    We had a conversation about this on Albert’s blog a couple days ago!I agreed then, and agree now, that investors should be getting terms like Buffet’s getting. Otherwise this is a clear value transfer from taxpayers to equity-holders of the institutions selling assets at above-market prices.Something I have not heard developed in detail by smart people (which may mean it’s a stupid idea) is a system for large-scale mortgage modification. Isn’t one of the biggest costs of a big crash the friction that results from foreclosures? People will be forced to leave their homes, rent, banks will spend a long time trying to unload these houses at ever-falling prices, and eventually prices will fall (and personal savings will recover) to the point where many people will be moving back into the homes that sat vacant for so long?Isn’t it more efficient to set up an industry-sponsored, federally-coordinated clearinghouse to offer modifications to allow homeowners to stay in their homes, avoiding the friction caused by defaults and confirming the value of mortgages underlying MBS at the same time? Of course you’ll mistakenly modify some mortgages of people who don’t need the help and are applying fraudulently. But doesn’t this still help us to a soft landing instead of a hard one?

    1. fredwilson

      I believe congress has been working on something like that for a while but now this splurge debate has taken over

      1. Brian

        What you are forgetting is that the MBS are backed by the cash flows on those mortgages. So, if you modify the mortgages, you lower the cash flows and thereby lower the potential ROI of buying the RMBS. I agree that it’s really tricky and interconnected, though. What that tells me is that we’re in for a good deal of pain regardless of the action taken.Also, cramdowns (mortgage mods) are potentially included in the ‘Hanke-Panke’ Bailout plan. John Carney at Clusterstock has a good recap. He and Blodget actually have great coverage of this thing, IMHO.

      2. Nick Molnar

        The splurge took over the conversation of doing a lot of other, sensible, solutions to the crisis. It has the political advantage of APPEARING to be decisive action by Congress, even if they have no idea what the plan will entail as they vote on it. This is an election year, after all, and everyone wants to be able to go home to the district and say ‘I fixed it’.

    2. smikolay

      Just a thought here, be curious for some other views on this: by purchasing the “toxic” assets, does the government not become the owner of the underlying mortgages (yes, I realize that all tranches would need to be purchased, but at $700bn it seems possible that this could happen)? If the government then owns the mortgage, foreclosure is left up to its discretion. Another alternative would be to help the homeowners and restructure the mortgages, allowing them to keep their home, propping up home values, and start to reverse the trend.Interestingly, Buffett’s investment costs Goldman up to 17%, meaning this could be used to offset the restructuring costs, and by propping up home prices would result in a benefit for all, solving the “redistribution” question.

    3. JLM

      Buffet is investing the best company left on Wall Street. The rest of the firms are not as high quality. The new money should be getting a deal substantially better than Buffet’s deal. Remember he is in it for the long, long term while the rest of the bunch will be in it for about 5 years. I bet Buffet could have cut even a better deal today.

  18. Andrew Watson

    Fred, re your suggestion that Bush “send Paulson and Bernake to their cubicile and tell them to do the numbers and come back with the return projections…”I don’t think that P&B would do that. I think it’s more likely that they would tell their staff the result of the calculation, and have their staff build the assumptions and equations to obtain that result.

    1. fredwilson

      I know. It was a rhetorical gesture.

    2. andyswan

      Bush stopped caring as soon as he beat Kerry….he wouldn’t even put the effort in 🙂

  19. Tom Evslin

    Turns out that Buffett’s own buyout is contingent on the bailout. From the WSJ: “If Congress fails to approve the bailout, Mr. Buffett says, all bets are off. His investment in Goldman will “get killed, and so will all our other investments.””So right now this is structured to give Buffett the upside from our bailout because he is frontrunning it.I still think we can’t let ourselves be panicked; we’ll be stronger if we take the pain. Government investments belong in infrastructure – $700B would go a long way – not in banks.Today’s rant at

    1. Karen E

      I agree most with this statement. If we are going to get stronger as a nation, we have to go through the pain.

  20. Koz

    The reality is that it’s the pricing mechanism that I think is *most* important here, and it’s receiving no discussion at all. There were vague points about buying it somewhere in between ‘firesale’ and ‘hold to maturity value’.If the treasury can pick these up at steep discounts (think 30c on the dollar, not 80c) then I’m sure they’ll make a killing in the long term. But at 80c or even 50c the fall in house prices will likely eat up any future returns leaving the tax payers with a large bill.The discussions so far lead me to believe the banks will get a sweetheart deal with assets purchased at a discount to the par value, not the current market-clearing value.For once I’m glad I pay tax in New Zealand rather than the US…

  21. vruz

    The biggest problem of all is confidence, not financial.You could still play the game a little making fixes progressively if you had a president, or equivalent leader to tell you what’s going on, *when* it’s going on.People wouldn’t be requiring liquidity, they would be confident things are going to be resolved, and they wouldn’t be causing bank runs… moreover, I’m sure most people are well-natured and they would voluntarily pay those $2300 in cash to rescue their country, if they had a real assesment of what’s really going on.Now it’s too late for fixes, you don’t have a president: you have three.One of them is a totally inept and inoperant puppet, another one is totally out of his mind stalling the due process of democracy for personal gain and phyrric heroicism, and the other…. the lesser of three evils, there’s not much he can do in in the coming weeks, until election day and possibly not much afterwards either.You can’t wait for them to do anything, the American people should be solving this.

  22. bernard lunn

    Fred, right on the money. Rescue is needed. But rescues come at a price. Any investor knows this. Buffet got a deal and that was for the best asset on the Street. I have heard coffee shop conversations way, way off Wall Street (up in the boonies where I live) that tell me that American people understand this. “Give us a better deal” is all people ask. Who is negotiating on the taxpayer’s behalf? Preferential shares +++, all the usual VC term sheet stuff in a Series D when cash is burning and venture is about to hit the wall. Bernard

  23. jrh

    The US is profoundly over-invested in housing. Assets were mistakenly trusted to buyers and investors, who destroyed hundreds of billions of dollars of value.Why is the solution to put more public funds into housing? Why channel public money to people who already squandered private money?A lot of counter-intuitive things turn out to be true. But on the face of it, I just can’t see how the bailout/splurge could possibly be the best solution. It seems like we should be channeling money somewhere else, and to other people, who will use it to build value and grow the economy.I’ve heard a lot of assertions that doing nothing will lead to disaster. But I’ve yet to hear a compelling description of how this actually happens, with numbers to back up the argument. A few leading indicators that point to recession are not enough to justify a program like this. The fact that the government might make money is also not terribly germane — there are plenty of profitable investments that I don’t want to see the government involved in.I don’t claim to be right, or to have a better plan. I’m open to being convinced. But so far, I don’t think the case has been made for the splurge — and it needs to be a damn good case to justify the price tag.

    1. Nick Molnar

      I agree, to an extent: the disaster stories seem to have very little data to back them up. While interbank lending is clearly having troubles over the last month, consumer lending (including real estate loans) is still running near 2007 levels. There are flights to quality in lending, but the aggregate amounts do not seem to be moving much. It also seems much of the growth in asset backed securities was used to buy more asset backed securities, which points to some level of containment in the system.Alex Tabarrok has written a couple of interesting articles about this phenomenon. I read another one that quotes the figures for Sep1. ’07 v. ’08, but I can’t find it now.

    1. jrh

      I understand the basic argument — everyone is deleveraging, so if the government doesn’t step in and leverage up, then things will continue to spiral downward.But look how coy Buffett is with the data. He won’t say who’s going down, won’t say how bad it will be. You’re just supposed to trust him. Oh, and by the way, he’s got a lot of money at stake in the bailout going forward. Buffett is a useful data point, but there should be a lot more going on.To get $700bn from Congress, you should have some real numbers. You should have to lay out the alternatives to the public, and the public (via Congress) gets to decide. It shouldn’t be like a bad startup powerpoint, where a miracle happens in the out-years.Paulson has been wrong pretty much every step of the way down in this crisis. If he wants us to believe him now, he should make a better case. I’m happy to support him if he can convince me. But the onus is on him if he wants my money.

    2. Cameron Corda

      Here is what Buffett said in the CNBC interview:”[T]hey shouldn’t buy these debt instruments at what the institutions paid. They shouldn’t buy them at what they’re carrying, what the carrying value is, necessarily. They should buy them at the kind of prices that are available in the market. People who are buying these instruments in the market are expecting to make 15 to 20 percent on those instruments. If the government makes anything over its cost of borrowing, this deal will come out with a profit. And I would bet it will come out with a profit, actually.”As CalculatedRisk points out however:”Unfortunately the plan is to buy the assets at a premium to market prices and probably at prices close to, or even above, the carrying value.”Paulson has been especially dodgy on the issue of price, which is a pretty key ingredient to determining whether the taxpayer makes money. He wants to overpay for assets, otherwise the plan doesn’t do anything for bank balance sheets.If you’re going to overpay for assets (compared to market), it’s a backdoor giveaway designed to improve capital ratios. Why not just inject capital directly, get preferreds in exchange, and call a spade a spade?

  24. Guest

    Unfortunately I think everyone is responsible. Americans voted in this regulation-averse administration. Banks were too lenient with loans. Private equity fueled the loans. Ratings agencies whored themselves. Homeowners who weren’t duped by predatory lenders duped themselves. Hedge funds did God-knows-what without anyone knowing. And now the whole system is collapsing. We’re really facing a bail-out of ourselves, a necessary and all-too-common step that hopefully will be righted by future changes.

  25. JLM

    Sometimes a bit of historic perspective is useful in trying to deal with TODAY. Remember that quote about being doomed to relive the history we ignore? Well we are not being very thoughtful about this. We have actually seen this movie before though maybe it was a shorter version.Remember the S & L crisis and the Resolution Trust Corp? I do because I hit a very, very good lick in purchasing distressed properties from the RTC, pension funds, insurance companies, banks and S & Ls. I bought them for $0.20-0.30 on the dollar of replacement cost, fixed them up, owned them for about 5-7 years, had the numbers audited annually and sold them all to institutions in 3 transactions in 1995 — 6,000 apartments, 100 warehouses, 7.5 MM sf of offices.My partners were the likes of GE Capital (for whom I also fixed up some of their problems), Fidelity and private foreign investors. BTW, GE Capital is the smartest bunch of real estate folks I ever met and the best risk takers a partner could ever have hoped for. And they made a ton of money in the deal while conducting themselves like perfect partners and gentlemen. Private money jumped in big time!I trooped around Wall Street trying to raise money for a long, long time and shared my contrarian investment strategy (and believe me the folks were looking for the lobotomy scars all the time) with the likes of KKR, Odyssey, Bear Stearns, Allen & Co, Leon Black — the usual suspects. And guess what? They never gave me any money but they all went into the business themselves. Capitalism was alive and well.Here’s the bottom line: If the RTC had held every property and just injected a bit of management they would have recovered every penny of principal, every penny of interest at the default rate and they would have firmed up the national commercial real estate markets more quickly.This is not some mythical academic theoretical tale. This is something that a bunch of guys did the last time the markets crashed (then it was more commercial than residential) and the government stepped in to bail out the transgressors. This is reality.BTW, the final price tag on the RTC was about $200B last time around. How much would that be in today’s dollars? Oh, about $700B maybe?Here’s a suggestion based upon what was learned the last time around —Let all the originators of the problem fail. Suck their capital dry. Punish them like a VC would punish the first round guys.Don’t use a penny of government money. If pressed, use government loan guarantees only. The only entity left with real credit is the US government. Use it. This will make the markets tell us what this crap is really worth. Right now the issue is the pricing.Fix the problems that created this mess quick and do it publicly. No 100% mortgages even for Warren Buffet. No low doc mortgages. No financing of closing costs in mortgages. Make all borrowers have skin in the game. No leveraging capital 30-40 times for any financial instititions. No mortgage based derivatives of any kind — why? Cause you cannot collect mortgage payments when the mortgage is “embedded” and “divided” by securitization. Teach the guys with mousse in their hair how to collect a past due payment. No extraordinary compensation for investment guys who are primarily salary men — let them take a piece of their own deal if they want an equity style upside. No naked short selling. Ban short selling for 24 months. Then reinstate the uptick rule. Bring all hedge funds out of the woods and under the regulatory umbrella. If you want American markets, tax laws, securities laws, etc, then you have to be regulated. Lower the capital gains rate to 0% for five years — because that’s how long it will take to work this through. The private capital will come to that lowered capital gains rate like a moth to a flame and it will be immediate. Merge Freddie and Fannie and obtain meaningful merger efficiencies.Stop the foreclosure process on residential real estate which can be salvaged. If a borrower can pay anything — owes $100 per month but can pay $70 — keep him in the house because real estate plummets in value the second it is empty and every foreclosure ever sold has been sold at a deeper discount than the foreclosure price. Make a trade. Rework the mortgage in return for a 50% equity slice above the mortgage amount. There is a certain irony in allowing the public to solve their own problems rather than just sending them the bill. It shortcuts the flow of money and it has a social benefit. Can every deal be reworked? No, but many can be and should be.Oh, yeah, get rid of Barney Frank, Chris Dodd and Chris Cox.

    1. fredwilson

      This is great – JLM, we need you down in Washington right now!

      1. dcostolo

        agreed. JLM’s two comments here are my favorite comments in a sea of great discussion. Paging JLM. ….JLM to the ER, please.

    2. Peter Fleckenstein

      JLM – Why don’t you and Fred head down to DC. By the way I need to talk with you. [email protected]

  26. Alexander Muse

    I looked into the $2300 number and found it a little misleading. Most Americans (i.e. half of taxpayers and those who do not pay taxes as they don’t earn enough) will pay far less $0 to $350 each. Of course, those in the top 25% of taxpayers will pay far more, between $17K and 170K. Here are the details: http://www.texasstartupblog

  27. Gabe

    typo -Mohamed El-EriaN

  28. Cameron

    “If the probability adjusted return on this investment is $1.5tn then we should do it in a nanosecond.”It’s not, otherwise private money would be going in….

  29. Paul

    I think it may be a mistake to focus on trying to determine the expected value of the gains on this investment and the uncertainty surrounding the true value of the mortgage securities in question is not going to be solved by any auction process.An auction can provide a best estimate of value based on information available today, but will not solve the problem of lack of information about the future. So, why not have a purchase mechanism that doesn’t rely just on the information available today?If the securities end up being worth more than the government purchases them for, a predetermined share of the profit can be returned to the financial institution that sold them. If, on the other hand, the securities end up being worth less, the government can be reimbursed by the financial institution through debt or warrants.This kind of symmetrical arrangement would be fair to all and makes it much less important to get the original sale price right today. In effect, it defers the price determination until later when there’s more information. It gives the government the best chance of a return on its investment while at the same time letting the selling firms recoup any financial windfall should the securities be worth more than anticipated today. By eliminating the uncertainty problem, this proposal should be attractive both to taxpayers and financial institutions.

  30. D. Lambert

    This topic came up around dinner and drinks last night, and someone asked, “why not just buy the houses?”Sounds like a pretty good question to me. We’re talking about stopping the bleeding at a macro level by bailing out the financial institutions that are responsible for all of these houses, and hoping that that’s going to get money flowing again so people can start buying homes again, thus stabilizing the housing market and acting like a big shot of Prozac for the rest of the financial markets. I think this will help, but how much, and how soon? I’m not sure.But why not just start buying houses?We’re in a downward spiral in housing. As subprime borrowers began defaulting on loans, homes were injected into the market in greater numbers than the market could sustain, so prices began to fall. It turns out that there are lots more borrowers in trouble than we were aware of, and there’s a hell of a lot of houses coming on the market as these borrowers default.But falling home prices are making more defaulters than we’d have if prices were anywhere near stable. Normally, we’d expect borrowers to sell their homes if they got in trouble, and go find an apartment. In most cases, I think this would be punishment enough for these people that they’d never buy a home they couldn’t afford again.In this market, though, most of these people just can’t afford to unload their houses. Prices have fallen enough to put people upside down on their mortgages, so these homeowners can’t do the right thing even if they wanted to. At this point, there are even people who *can* make their payments that are walking away from their homes because they’re so far upside down. The homeowners who stay put see eroding prices eating into their biggest asset, and even if it’s only a paper loss, it fuels buying behavior.The other market anomoly is the knot created by the securitization of all these debts. The issue here, of course, is transparency. As far as I know, there’s no way to really break these securities down into individual loans, so there’s no way to know how many bad loans, exactly, are wrapped into each security, and the market price freefall is putting the rest of the loans in jeopardy, too. Since there’s no good way to price these, they stop trading, and credit becomes even tighter for the few people who have any interest in buying a home.What a mess.So do you really start at the top, or do you start by buying up some homes? You could start taking foreclosures and short-sales off the market. These are the homes that are putting the most downward pricing pressure on local markets (and after all, all real estate markets are local). You’d obviously have to figure out what to do with them, right? If they sit unmaintained, they’re going to continue to depress the market by being eyesores, so you’d have to hire some local managers to keep them in order.Or how about buying homes from people and turning around and re-renting to them? Find the people who have incomes and want to stay in their homes, but can’t because they overextended themselves. Set the rent at a point they can afford, and set a schedule to get the rent rationalized to market rates in five years or so. I know this sounds like another ARM, but ARMs work great if you can get out of them when you need to.I don’t think we’d have to buy anywhere near all of the houses – just enough to re-establish solid market conditions. Once that happens, they government could ease back into selling these assets, probably at close to face value, and slowly enough not to torpedo the market again.The bailout money would thus be injected much closer to the source of the bleeding, and I think the impact in the market stands to be a whole lot more direct.I think the biggest risks here are that we wouldn’t, in fact, be able to buy enough homes with several hundred $B (gulp), and that we’d need an agency to administer and manage all the assets they’d buy, and I don’t know if we’d be able to put this in place quickly enough to save anyone. Politically, though, I’d think there’s some appeal in helping the people that need help, rather than the big banks, who are full of smart people whose jobs are to know better than to get into this sort of mess.Commence firing.

    1. J.D. Falk

      Sounds like a good idea to me. I’ve been wondering about something similar, though maybe not as good as your idea: if We the People are (via our government) buying all those mortgages for cheap, why not let the mortgage-holders pay off their loan at the same price that We the People paid to buy their debt?In other words: Joe Dohn owes $100,000 on his mortgage. We the People bail out a big bank by buying his mortgage for $1,000 (I have no idea if that’s the ratio; this is just an example.) Let Joe pay an extra $1,000 in taxes this year — or more, maybe — and forgive his debt.The financial sector wins because they got bailed out. Joe wins because he gets to keep his house, and rather than spending the rest of his life under crushing debt he can be a productive member of society. We the People win because we get paid back, and the Government which represents us wins because they don’t have to deal with the overhead of harassing Joe until he declares bankruptcy because he’ll never be able to pay off the full $100,000 anyway (which is why it’s a “bad” debt in the first place.)I know why this won’t happen. But why can’t it happen? Is my math wrong?

  31. alan p

    Nice one – these are exactly the things I as an investor would want to know. I wrote a similar, though more irreverent, piece here on my blog yesterday:

  32. kidmercury

    as all forms of government spending are a tax, either directly or through inflation, an ideal solution would be to shift spending from one area of the economy (i.e. public education that doesn’t work, BATF filled with criminals, intelligence agencies that have tripled in size during the bush admin, the unjustified war in Iraq, etc) to the bailout.of course, you won’t hear any of the puppets mention that, because everything is designed to make problems and then propose more government as the solution. only the truth sets us free.

  33. awilensky

    I hope we go back to the old system after the splurge: You write loan, you hold the paper.

  34. Mike Su

    Ok, I haven’t had time to read through the rest of the comments below, but I’ve made it this far, which has to count for something.So this is where I lose all trust in this proposal. Everyone’s focused on getting this done fast, and everyone’s focused on the upfront. The problem is, assuming markets recover, and eventually the gov’t sells what they buy – what price are they selling at? Who do they sell to? Open market? What are the rules and oversight? I can’t help but wonder who the Haliburton of this crisis is. Seems like we’re all focused on oversight for the purchasing of assets, but nobody’s looking after the eventual sale of these assets. Seems like the system is fraught with the potential for sweetheart deals when the markets recover (companies that Bush and Cheney or whoever are on the board of). I obviously don’t know the details, but haven’t heard any concerns in the news about this aspect of the proposal. If we assume this is something that has to be done, it seems to me that this is the most important aspect of the proposal because it determines whether we the tax payers ever make anything back on this. And anytime Bush gets on TV and pushes for something, I immediately kick into conspiracy theory mode to try to figure out how he’s going to benefit from our disaster.As for the House Republican’s proposal – while having Wall Street save themselves sounds great, doesn’t the elimination of capital gains tax essentially cost tax payers anyway? Seems to me in THAT scenario, the gov’t loses out on taxes they normally get (from the rich, btw), and taxpayers DEFINITELY will see no upside. Am I missing something?

  35. Michael Rattner

    I just read an interesting comment on Steve Conover’s blog:…To quote:Today (Friday, 9/26/08) will be an important day in American history. The credibility of the US dollar is at stake, which in turn depends on worldwide confidence in the US economy’s future. [Note to gold bugs: see the end note.]Almost everything I’ve written about at this blog for the last four years (regarding how bright the future just might be) depends on one huge but intangible asset on the balance sheet: worldwide confidence in the dollar. Accountants would liken it to an asset called “goodwill”; I roughly estimate the brand name “US dollar” to be worth around fifty to a hundred trillion dollars in present value. If we destroyed that asset, it would be like destroying the most powerful brand name in economic history.

  36. Brian

    There is a good alternative suggested by another Paulson in today’s Wall Street journal that I think matches Fred’s approach.…I like the sound of this better than what I have heard about the Treasury’s bailout proposal. I also believe we should start slow and stop once the markets start moving again.

  37. Peter Fleckenstein

    Fred,FTW???!!!! Your blog here is incredibly fantastic! My biggest question is – Why can’t I find one person with your thought patterns on the Hill? From either side!!!So – my question to you – When can you be ready for DC to go teach these wonks how it is done properly?Again – The best blog post I have seen on the web about this – bar none.Thank you.

  38. G-man

    I realize that Ben and Hank are very smart guys, but I also know that there are some extremely smart, talented, and experienced guys in industry right now who could provide input to the process. Some are right here on this blog and many others. Why is the government and Treasury and no calling these guys and getting them on the phone or in a room together to brainstorm and cull together the best of the best ideas out there? They’re the one’s who are going to have to by into it in the end, so why not use them? Maybe they are and we just don’t see it. But what I see is a bunch of politicians and somewhat removed government officials making decisions that will affect the rest of the country and possibly the rest of the world. That scare me a little.

  39. Mike Su

    oh, and by the way, the IQ level in this discussion is WAAAAY too high and is skewing the numbers for the rest of the internet. i feel like it’s my duty to throw in a “fred – you SUCK!” and “this post is gay”. ahh…now it feels more like a normal blog discussion thread.

    1. fredwilson

      David Karp (tumblr founder) says that this blog’s comments are the exceptionto the rule that all comments suckI’m not sure about that, but I am sure that this blog’s comments areawesome, way better than the posts that generate them

  40. gpjudge

    The Paulson plan will work, and it should produce a healthy profit for the public. The banks in this country can’t sell these mortgage bundles to anyone for even 50 cents on the dollar, even when in most cases the “value” is probably 65 or 70 cents. As a result they can’t lend money beyond drips. therefore, greatly fewer new mortgages, car loans, business loans, student loans, and the economy grinds to a halt. And most importantly the values of all homes continues to drop. And the banks can’t raise new capital as a result of the uncertainty of the value of these assets. The solution is for the US gov’t who can borrow at 3% to buy up these mortgage bundles at 50-65 cents on the dollar, the banks get the assets, that can’t otherwise be sold, off the books and fresh cash on their balance sheets. then they can make good mortgage loans, car loans, small biz loans and the economy moves again. At the end of the day confidence in our banks rise, the govt most likely makes a profit, the economy picks up and tax dollars rise.Do nothing and we likely sink into a depression.

  41. @christinelu

    This is an international crisis, why do we keep discussing this like it’s a domestic issue. How many Americans are aware of the role China is going to play behind the scenes in bailing us out? After all, only two places in the world with liquidity right now Asia and the Middle East.

    1. fredwilson

      Russia and India have a lot of cash too

  42. jackson

    Damn, where’d all these chickens come from? Full house at the roost these days.

  43. CADbloke

    I see 700 000 000 000 examples of how Wall St has pwnd Washington. If we prop this system up then these fat cats keep their power and your elected government retains its lack of control over then engine room of your country. This system of individual and corporate greed and exploitation needs to fall.The world will still turn and the sun will still shine. It will be rough for a while no matter what is done at this stage. $700bn can buy all sorts of eventual outcomes – which one do you want?

  44. JLM

    I agree with you completely as it relates to Detroit. I was referring to market values in 2006. I suspect that the Detroit market was just as troubled in 2006 as it is today. I doubt any new mortgages were originated in Detroit’s worst areas in 2006 so they are not really part of the current problem.Even having said that I would opine that even the Detroit situation is not hopeless — very, very difficult but not hopeless. They are not making any more land these days. It would take some extraordinary vision and leadership to make that happen and I suspect many would think it to be pragmatically worthless.One of the encouraging things about the current problem is that many of the troubled mortgages are in great markets. I looked up foreclosed properties on the Fannie and Freddie websites the other day and I was very surprised to see so many in “hot” markets (e.g. Austin, TX). In these instances, there is a great market for the properties and the only challenge is pricing. I suspect that places like Las Vegas where both the price of the real estate and the core business of the market[;svr are under pressure may present more difficult problems.

  45. guest

    Well – even if there is a sizable upside, who will actually get it? The fundamental problem here is a form of corruption, that is, decision-makers who are not being held accountable for their decisions. If there is an upside under the control of a finance czar, it is likely that a large percentage of it will be distributed thru favors and cronies. The average taxpayer understands the system better than we are given credit for, and it does not require a degree in finance.