Saturday, October 04, 2008

A Simple View of Government Purchase of Structured Finance Instruments

Michelle Caruso-Cabrera and Rick Santelli made a stunningly simple but important point about the proposed Treasury purchase of distressed structured financial instruments earlier this week on CNBC.

Amid the usual on-air drivel of various co-anchors and guests which has been gushing for the past week, Caruso Cabrera asked the question, paraphrased, below

'If there's such profit opportunity in buying these assets that the taxpayer should fund doing so, why aren't private investors doing so already?'

Santelli immediately chimed in with his agreement. I think they are right.

We've seen the reports on private equity funds being amassed for eventual purchase of these mortgage-backed instruments. We've seen the Merrill Lynch deal with the Texas investment group for 22 cents on the dollar, with recourse.

But if no significant purchases are being made by those who don't have unlimited credit, why should taxpayers believe that Treasury purchases of the same securities will be profitable?

Even Bill Seidman, one-time head of the RTC, allowed that, if skilled private investors were buying and managing these portfolios, money might be made. But not in government hands.

To me, that's a very important missing signal. If savvy private investors don't feel they know enough about the value of these instruments, regardless of mark to market issues, about which they, and the Federal government, do not need to be concerned, why should we believe that Treasury knows at what prices its purchases will yield profit, while simultaneously recapitalizing the current owners of those securities.

As I wrote here last week, If the Federal government is aiming to rescue banks, it can't pay low prices. If it's aiming to profit, it can't pay high prices.

Which will it be? If private investors aren't even bidding low prices, or banks aren't hitting those bids, that tells you something about how unprofitable this expensive plunge by Treasury into structured securities is likely to become.

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