One way the agency reportedly under discussion could work is by setting up bulk auctions to buy mortgage debt from financial institutions. The auctions would be for set dollar amount purchases. Companies that want to offload the hard-to-sell assets from their balance sheets bid to sell to the government at a huge discount. The company willing to take the biggest haircut wins.
Let's see if I get this straight. There are a whole bunch of mortgage-backed securities, the value of which is not known, because nobody knows what the default rates on the underlying mortgages are likely to be. A government agency, Bailie Mae, is going to put up, say, a billion dollars. Companies will make offers. It might go like this:
Shake-E Bancorp offers to sell securities with a face amount of $1.4 billion for $700 million. 50 cents on the dollar.
Shift-E Investments offers to sell securities with a face amount of $1.2 billion for $720 million. 60 cents on the dollar.
Slime-E Insurance offers to sell securities with a face amount of $1.0 billion for $900 million. 90 cents on the dollar.
Bailie Mae then buys $700 million from Shake-E (the entire $1.4 billion face amount), $300 million from Shift-E, and leaves Slime-E to pound sand.
It sounds to me as though Bailie Mae is going to be wearing a big sign around its neck saying, "Adversely Select Against Me." For all we know, Slime-E's offer was the best deal. Recall that we stipulated that we don't know what the securities are really worth. That's what makes "hard-to-sell assets," you know, hard to sell.
Once upon a time, Bailie Mae was supposedly going to help home owners. I guess when push comes to shove, the real bailout money goes to financial institutions, not individuals.
The agency and auction facility is one that House Financial Services Chairman Barney Frank, D-Mass., and Senate Banking Committee Chairman have supported as recently as this week.