[Peace-discuss] A better bailout plan

[Barbara kessel]

Thank you, Carl. This one is tough going in spots, but everything you have
put out this past week has been extremely helpful,  and a compass for
staying upright in the "economic shock therapy" that we are getting from the
top. Very appreciative. BBK

On Wed, Sep 24, 2008 at 5:11 PM, C. G. Estabrook <galliher at uiuc.edu> wrote:

> [Here's the best analysis and counter-proposal to Paulson's plan that I've
> seen.  It comes from a DC-area lawyer of my acquaintance.  --CGE]
>
>
> A Better Bailout Plan ~~ Taxpayers receive preferred stock and collateral
> from a bank borrowing from the Taxpayers, both in the full amount of the
> loan sought by the bank.  In other words, stock plus collateral in double
> the amount of the loan. Taxpayers profit from a bailout before anyone else
> does.
>
> Thanks to Warren Buffett and Goldman Sachs for the heads-up by disclosing
> the terms of their deal, which should be the low water mark for any Taxpayer
> bailout.  A higher water mark would be the terms suggested above, which are
> not uncommon in private equity deals and chapter 11 bailouts.
>
>        ***
>
> Explanation ~~ Paulson's plan calls for him to buy assets of an unknown but
> admittedly low value, at an inflated book value, for cash, from the member
> institutions of his own industry, with other folks' money (ours).  He sees
> his industry and its member institutions as too important to fail.  With all
> due respect, Paulson cannot claim to be objective or disinterested.
>
> Paulson's plan pays in cash the price on the bank's books for the subprime
> mortgage-based assets.  The book value is probably a high percentage of the
> total balances owed on the underlying mortgages.
>
> Paulson's price for the subprime mortgage-based assets is favorable to the
> banks. If Paulson's price for the subprime mortgage-based assets was not
> favorable to the banks, the banks would not sell.
>
> Neither Paulson nor the banks have presented any rationale, much less a
> convincing argument, for the proposition that the US is on the brink of
> financial chaos.  They have declared it to be so.  If you believe them, the
> banks are on the brink of failure without a bailout. If you believe them.
> One of the benefits of the better plan is to put that proposition to the
> test.  To accept the terms of the better plan, the banks will have to be on
> the brink of failure.  Otherwise they will not seek a loan, and a new equity
> participant, under the terms of the better plan that will enable them to
> survive.
>
> Does the banks' condition put the US on the brink?  What, because the banks
> won't lend without a bailout?  I don't believe so.  The banks remind me of
> the Sheriff in Blazing Saddles who takes himself hostage.  The banks commit
> suicide by not lending.  The banks won't lend without a bailout? Fine. Don't
> lend, banks. Don't lend starting now.  You already have?  Huh.  Most banks
> in the DC area are advertising that they are not holding subprime
> mortgage-based assets and open for business to make loans.
>
> If the banks won't lend and there is money to be made lending, someone else
> will lend, like the banks that are advertising.  That's the free market, and
> the creative destruction should start now. If things are so bad that banks
> won't lend, the Taxpayers would be stupid to do so without the substantial
> potential for profit that the better plan provides.  Paulson's plan provides
> only certainty, the certainty of losses.  Why would anyone buy high for the
> certainty of selling low?
>
> Hidden in the courts is another problem.  The banks own securities. The
> value of the securities is based on subprime mortgages.  The banks do not
> hold the subprime mortgages, or the notes secured by the subprime mortgages;
> they hold securities.  A trustee for the issuer or the underwriter holds the
> notes and the equitable interest in the mortgages.  Independent trustees
> hold the legal interest in the mortgages and the power to foreclose. The
> mortgages for any particular issue of securities were assembled -- without
> much forethought -- from all over the country.  How many mortgages were
> bundled to offer one issue of the securities?  Lots.  Securitizing a whole
> bunch of mortgages at once reduced the relative amount of the soft costs
> necessary to pay the lawyers, underwriters, accountants and auditors
> necessary for the issue of the securities. There are many different issues
> of subprime mortgaged-based securities.
>
> So for each issue of subprime mortgage-based securities, here's the cast of
> characters and their problems:  the banks (from all over the country)
> holding a particular issue of securities, the issuer and the underwriter in
> say, NY, the issuer's or underwriter's trustee in say, DE, and the numerous
> trustees on the individual mortgages (from all around the country where the
> individual mortgaged properties are located) are difficult to assemble
> anywhere, and if assembled might fill the Yale Bowl, especially if the
> meeting is open to the homeowners. Many of the trustees for the issuers and
> underwriters did not receive the original notes at closing, and many of the
> original notes can't be found.  Banks have attempted to foreclose on the
> mortgages and sue homeowners for deficiencies after foreclosure, only to be
> turned away by the courts for lack of standing because they don't hold the
> mortgages and cannot produce the original mortgage notes in court.  The
> trustees won't act for lack of clear authority from anyone to tell them what
> to do.  Courts, banks, issuers, underwriters, holders, trustees,
> homeowner-mortgagors and mortgagees, oh my.
>
> Paulson's plan, with Taxpayers' money, makes a fool's bet, "Heads you win
> tales I lose," with no upside for the foolish Taxpayers.  No one is
> guaranteeing that any recovery can be made on the subprime mortgage-based
> assets (in excess of the cost of collection), no one is guaranteeing that
> the banks will lend after a bailout, and nobody is even suggesting that this
> bailout, the one currently proposed, is the only one that will be necessary.
>  The precedent for others will be set by this one.  What about the
> securitized commercial mortgages of say, shopping centers in neighborhoods
> decimated by foreclosures?  What about the securitized asset-based lending
> of say, department stores' inventories that can't be sold because consumers
> are paying their variable rate mortgages instead of buying new washing
> machines?  What about the securitized credit cards that consumers are not
> paying to pay their mortgages instead, after maxing out their credit cards
> to pay the mortgage? Tune into call-in shows on radio or TV and hear the
> financial experts tell consumers to not pay credit cards and mortgages in
> order to feed their families.  I have.  The owners of securitized variable
> rate secured debt in any form (guess who?) are all out there, awaiting the
> denouement of the current drama and preparing their own play for the same
> treatment.  The banks will be back again for more bailouts after this one.
>  By definition, Paulson's plan creates a moral hazard, and the speculative
> trading of the subprime mortgage-based assets and securitized variable rate
> secured debt has already begun.
>
> The better plan calls for the Taxpayers to receive a first priority lien on
> fairly appraised collateral, along with an equity kicker.  After the
> Taxpayers receive the preferred stock interest valued at their investment,
> the subprime mortgage-based assets could be the collateral at their
> appraised value for the loan.   The value of the subprime mortgage-based
> assets as collateral is their appraised value, which may be ten or twenty
> times the total balances remaining on the underlying mortgages and is not
> likely to be the value of the assets carried on the bank's books.
> Understand that the loan and the investment are the same money in the better
> plan, and if the bank is able to repay the loan, the Taxpayers could double
> their money because they will still own the equity kicker. If the bank can't
> repay the loan, Taxpayers recover on their collateral and share, as the most
> favored shareholder, in the liquidating dividend.  BTW, where are the
> government's bank examiners requiring the write-down of the value of the
> banks' books of the subprime mortgage-based assets? I think they work for
> Paulson.  Seriously, I do.
>
> No more private profit at Taxpayers' risk.  Under Paulson's plan, we are
> about to nationalize the almost certain losses incurred in running the banks
> badly, and at the same time we leave the banks, without their losses, with
> more money, in the hands of the folks who ran them badly.  The only thing we
> have socialized in this country, after the bailout, will be the (mostly)
> unrecoverable losses of banks, acquired for cash at book value.  Somebody
> else already got the profit and the fees from making the subprime mortgage
> loans and from issuing the securities.  After the bailout, the banks will
> have shed their private losses, and received a premium of public cash for
> doing so. Private profit, public losses, all around.
> A bank seeking the Taxpayers' loan is not an admitting bankruptcy; the
> terms are merely a recognition of the risk in the loan that requires a
> private equity kicker to attract the lender (us).  Private equity is not
> bankruptcy.  The terms would be appropriate, for example, if I approached
> you to purchase an apartment building, me being broke.  You would put up the
> money for a first trust and a preferred ownership position for receipt of
> income, get paid in full first with interest, and end up with 50% of the
> apartment building and its appreciation, all your money paid back with
> interest, and half the income stream.  I would have 50% of the apartment
> building and its appreciation and share in the income stream once you are
> paid off in full with interest.  I have represented clients in similar
> leveraged deals where the financier (you, in my example) gets first payout
> on cash loaned (not contributed) and 50% of the equity in the deal.
>
> For example, the financier in one deal (which involved a third party 80%
> first mortgage for the purchase of a real estate portfolio appraised at
> $70M) put up $14M, was paid back in full with interest in five (5) years,
> and retained a 50% interest in a real estate portfolio and its appreciation
> and income stream.  14M up, 14M with interest back plus 35M with
> appreciation and half the income stream off 70M.  At ten percent interest on
> the loan and a market appreciation of 1% on the portfolio, my client's deal
> paid the financier, on a $14M loan (in simplistic terms), $1.4M per year in
> interest, $350K per year in appreciation, and $14M on the fifth anniversary,
> a total payout of $22,750,000 in five years, with an equity kicker of a $35M
> interest in a real estate portfolio, the income stream it creates and its
> appreciation.    The bank does not have to borrow from the Taxpayers if they
> don't like our terms.
>
> Buffett is not paying book value in cash for subprime mortgage-based
> assets, with no equity kicker or even a loan structure.  Buffett is buying
> into value. Goldman Sachs has an international name with the best talent to
> run a highly leveraged portfolio and assets to match his buy-in twelve times
> over.  GS is poised to convert to a money center bank, among other options
> open to it, and would likely survive were there no bailout and no Buffett.
>  Buffett is not buying subprime mortgage-based assets, or even lending
> money. He is buying a preferred class of stock issued for him, which has
> first priority above all other owners.  In other words, Buffett is secured
> by all of GS assets, including the money he is paying in, if anything goes
> wrong, before any other owner gets paid.  If things go right, he receives a
> 10% annual dividend before anyone else on the equity side gets paid plus the
> value of his preferred stock. If the Taxpayers have a chance to take
> Buffett's deal with Goldman Sachs they should take it.  Investing in Goldman
> Sachs preferred stock is not the same as investing in or lending to a bank
> with subprime mortgage based assets, much less buying the subprime
> mortgage-based assets at book value without an interest in the bank or a
> note from the bank to pay the money back.
>
>        ###
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