Friday, September 26, 2008

What Are They Doing?!

I just realized that I have talked a lot about the current problems in the financial system but have not talked about the proposed solution.

Remember the problem is that firms have all those mortgage backed securities that no one knows the value of. Paulson, the U. S. Secretary of the Treasury, recommends that taxpayer money be used to buy up those devalued mortgage backed securities. That way the questionable securities will be taken out of the market, removing the uncertainty that has shaken the market.

No, taxpayers would not have to hand over $700 billion today. The U. S. debt would increase by that amount.

What will the government do with those securities? As long as the government holds the securities, it will earn money from them, offsetting their cost somewhat. Eventually the government would sell them, possibly for more than they bought them, so that in the long run taxpayers might not end up any worse off. However, taxpayers could end up worse off if the securities sell for less than the government buys them for.

On balance, I am not opposed to the Paulson plan. I view the securities as a poison that the U. S. government brewed up with the Community Reinvestment Act in the laboratories of Fannie and Freddie and poured into the financial system. I am OK with the government removing that poison, especially since the cost may be substantially lower than the $700 Billion.

But, then, I am in favor of sellling Fannie and Freddie to the private sector and scrapping the Community Reinvestment Act. We should aim for long-run health.

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