Monday, September 22, 2008

USA Trading Corp., LLC

From WSJ:
Sen. Dodd's plan wouldn't allow the Treasury Department to purchase any assets "unless the Secretary receives contingent shares in the financial institution from which such assets are to be purchased equal in value to the purchase price of the assets to be purchased."

Although this idea seems both fair and reasonable, it also happens to defeat the core purpose of the proposed action. The whole idea is to take assets so toxic that they run the risk of sinking otherwise large, well financed companies; if the government takes the assets and equivalent equity they may as well allow the assets to fail, as it is said assets causing failure risk in the first place. If the companies had enough money to finance these assets, they would not be toxic and would not require government intervention.

UPDATE: I was unwittingly making an argument similar to one posted earlier on Naked Capitalism.

UPDATE II: Paul Krugman does a nice job of simplifying the (il)logic involved here:
...the prices of many assets, not just those the Treasury proposes to buy, are under pressure. And even if the vicious circle is limited, the financial system will still be crippled by inadequate capital.Or rather, it will be crippled by inadequate capital unless the federal government hugely overpays for the assets it buys, giving financial firms — and their stockholders and executives — a giant windfall at taxpayer expense.
UPDATE III: George Will asks:
The political left always aims to expand the permeation of economic life by politics. Today, the efficient means to that end is government control of capital. So, is not McCain's party now conducting the most leftist administration in American history?


  1. OK, Justin: help me out, here. I don't understand your terminology, such as companies having enough money to "finance these assets." Do you mean, to "pay their (maturing) debts?"
    If the government buys the assets and also takes "equity" equal in value to the assets, what is the bookkeeping entry? That is, the debits and the credits have to equal one another, right? So if the debit (from the Company recipient's point of view) is the cash infusion, it has to be equalled by the total of (1) the equity that it issues to the government, plus (2) the value of the (crappy) assets the government also takes --removing them from the Company's books is a credit entry.

    It is this item (2) that seems to be where the problem lies: what is that number? Has it already been written down? By how much, and how much more of a writedown is required to state it at fair value? With a jammed up system in which no transactions are taking place, I think it will be very hard to get that number right. But the loss on the Company's books is not costing it any cash, any more than writing it down but keeping it would.
    I don't really understand your statement that the assets are "so toxic that they run the risk of sinking otherwise large, well-financed companies." If an asset is toxic, then flush it. Are you then "large, well financed?" If not, why not?

    I submit it is not that the assets themselves are toxic --they are not infecting the assets around them--, but rather that the liabilities are way too large for the asset (or equity) base to liquidate them in an orderly fashion. If I am right, then why isn't the solution simply to have the government buy equity in the Company, and leave the assets where they are? Now the Company has cash, and equity: voila, a stronger balance sheet. Let them nurse the impaired assets along, as they now have the cash to service their liabilities. After all, the job of any company is to convert its equity investment to assets, and the assets to (more) equity. If you do a bad job in converting equity to assets, and utilizing the assets properly, then you need more equity, so you can try it again. You should still have to recognize the loss. Having a sugar daddy come in and say, "we'll pretend that these crappy assets are really okay, and I'll buy them" won't help. Who owns the company should not matter to the process of adding value by efficiently converting equity to assets, and assets to greater equity (in the form of profits), if you have competent managers.

  2. "Company's books is not costing it any cash, any more than writing it down but keeping it would."

    I think this is where the misunderstanding may lie. The debts don't simply lay there, but must be serviced in two ways, one, the company with the debt on its books likely borrowed the money to buy the debt, and two, is servicing that debt continuously with protections payments (CDS, most likely). So, there are ongoing costs associated with the debt: repayment to the lender and payment of the insurance premiums (there is likely to be some nitpicking here, because the protections are usually purchased with the debt as per the swap arrangement and are therefore already paid, but this one-time payment is actually many payments over the course of the life of the instrument priced in upon origination).

    The original formulations provided enough cash flows to cover these expenses, and are no longer being covered as a result of a failure of those flows. As a result of this triple whammy, the combined debts and servicing costs may actually be greater than the market capitalization of the firm, and as a result, receiving the effectively valueless "equity" and the crappy debt instrument in exchange for some over-valued amount of cash is not exactly the best bargaining chip to make this deal any more fair or just.

    The idea here should not be to keep these firms in business, but to re-establish an environment for sound lending. It may in fact be necessary to purchase these bad debts to make that happen, but we'd only purchase them at inflated prices if we had an interest in keeping the companies alive.

    We should not have such an interest. Wiping out the companies and purchasing the debts at rock-bottom prices may have a significantly better result for tax payers than leaving the companies in tact, receiving equity in them and knowingly over-paying for bad debt instruments.


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