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September 24, 2008

Clarification on Bailout: It Won't Cost 700 Billion, Ultimately

In all likelihood, it will cost far less. It's possible (not even unlikely) that the government will actually make money on the deal.

The key is remembering these assets are not worthless. It's property. It's houses. It's mortgages. It's derivatives, um, derived therefrom. These things have intrinsic value that never approaches zero, ever.

Because of the panic/crisis, these assets are "frozen" because no one can sell them, because no one will buy them.

There is therefore currently no "market maker." (Which, from what I remember from securities law, is a basic requirement to creating a market -- someone must agree to be a market maker for any stock, any commodity.)

Currently these assets are temporarily worthless as no one will buy them. But as soon as a functioning market returns, they'll be worth something.

How much? Who knows. That's part of the problem; no one can currently say what they're worth. But once a normal market returns, they'll be worth something -- a solid fraction of their prior value. Maybe 3/5ths, maybe 3/4ths.

The government's play, as I understand it, is to begin buying these assets at deeply discounted prices, due this being a distressed sale and all. Doing so will cause Wall Street and others to lose money and take big losses, but not so much as to knock most of them into bankruptcy.

Once the government does this, however, the market returns, and these assets rise in value. The idea will be to unload them quickly back to private buyers once the situation stabilizes and people start trading again. Ideally, the government would at least get back what they paid for each asset, plus a percentage based on them essentially "floating a loan" for a period of time.

For many parcels, they will realize an actual profit.

Now perhaps this is best-case scenario, but assuming the government agrees to buy these junk (but by no means worthless) assets at low prices, and then is able to sell them in a year or two and for a more realistic higher price, this bailout can actually add funds to the treasury.

Got this from the Brit Hume panel today.

This is not likely to be $700 billion just tossed in the fireplace. The government isn't buying worthless notes. They'd be buying, temporarily, real assets with real value which are currently unsalable and thus are freezing the entire financial industry. It will, at worst, end up costing us $300 billion, and at best, could actually make the government a couple hundred billion.

It should be noted that the very controversial Mexican bailout in the Clinton Administration was a net moneymaker for the government. The S&L bailout -- the last time we faced this sort of full meltdown possibility (though today's crisis appears more serious) -- either only cost $124 billion or actually broke even/made a small amount of money over outlay, depending on one's accounting.

Something to keep in mind. The government will not be getting into this business forever, nor is it simply throwing money away.

Outstanding Piece by Dafyyd: I feel like a smarty pants for having just read the first half.

It's long, but it brings you up to speed on exactly what is going on.

Bonus: If you read the whole thing, you will know approximately 40 times as much about this crisis as the average person, and 500 times as much about it as 95% of the media.

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posted by Ace at 08:36 PM

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