The Housing Chronicles Blog: Could taxpayers make money on the federal bailout?

Sunday, September 28, 2008

Could taxpayers make money on the federal bailout?

Could taxpayers actually make money on the federal bailout of distressed assets when the market unfreezes? An L.A. Times story asks the question:

...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.

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...

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.

"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."...

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.

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