I have been reading a bunch of commentary lately about the rescue bill being discussed in Washington. Most of the economist are very negative on it.
The Theory seems fairly simple, in fact I reached the "buy the distressed assets" conclusion a year ago in one of my very first blogs as I started covering this. While the theory is simple the practice isn't.
Remember that this mess we are in, can be characterized as a illiquid market (for mortgage securities in the beginning)with a strong downtrend. If your asset goes down, below what you think it is worth then you hold. No one buys and you have thin trading. The problem with thin trading is that price discovery is not thorough. No one knows what stuff is really worth as "bid/ask" spreads increase. To compound the problem, thin trading can lead to low prices that reflect poorly on mark to market accounting. The situation deteriorates with selling of more assets to meet regulation requirements for example further bringing the price down. Markets in these conditions are in a negative reinforcing spiral where nothing moves.
I call it "a constipation". The market is holding a lot of shit and it is not clearing out. Pardon my crass description, but I do believe it is truly accurate. The plan as explained by Bernanke is effectively a laxative. The scholar of past financial crisis, knows that a SETTING THE PRICE is the first step to unlocking the markets. You obviously want to set it higher than the current market, which will recapitalize the banking system somewhat, but you don't want to set so high that you giving a deal to Wall Street. This is what was done during the LTCM crisis and the Resolution Trust Company, which auctioned off the distressed assets.
Once you buy the assets, a lot of the prices will be reset, the mark to market accounting will kick in and ease or increase the pain on balance sheets. Those that have mark to market will see a plus, those that have mark to model will see a minus, but we will have a benchmark, a clarity of price on a large pool of assets ($700B?). other side of the loop, where it feedback positively. The debt mortgage market is $10T so we are talking about a 7% rescue. It is both a lot and not much. A lot of US Govt and not much compared to the overall size of the market. Will it be enough to get that "release shit"?
The way Bernanke talks about it, he wants to change a negative death spiral into a positive spiral, to stabilize the market. Their actions seem targeted at removing negative feedback loops (like the ban on short trading for example) so as to not completely overshoot on the way down.
Some critics are afraid that there is little way for the Treasury to get the money back, much less turn a profit on it. Further high level criticism is the debt amount taken on which will contaminate the Treasuries. Dollar down, oil up.