Bryan Caplan  

Will the Paulson Plan Turn a Profit? Let's Bet

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Bush says that the Paulson Plan might turn a profit:

The government is the one institution with the patience and resources to buy these assets at their current low prices and hold them until markets return to normal. And when that happens, money will flow back to the Treasury as these assets are sold. And we expect that much, if not all, of the tax dollars we invest will be paid back.
Does anyone want to make an even-odds bet that the Paulson Plan turns a profit during the next ten years? (I want to bet No, of course).

P.S. If you'd like to refine the bet, I'm listening.


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shayne writes:

I'll not only bet no, but I'll put up double odds that whatever bailout is authorized will fail in its intent and the Fed/Treasury will be back at the public trough inside of 6 months. One stipulation: I put up U.S. dollars, but I want the bet taken in Euros at todays exchange rate. (basically, the same hedge Goldman Sachs is probably making right now.)

Alex J. writes:

If Bush is right here, that means this could be a profitable investment. If no one else has the resources, the gov't could spend its money as matching funds to get enough capital. The Bush family has a decent amount of money. If he really believes what he said, he could put up a stake.

I'm still struggling to think of a good reason to regard the government as uniquely patient.

Maniakes writes:

Betting yes is equivilent to betting that mortgage-based securities are undervalued. If I wanted to bet that MBSs are undervalued, I could do so by buying bond funds that invest in MBSs.

Bi writes:

Clinton says the taxpayers made a profit from the S&L bailout. Was that true?

8 writes:

Adjusted for inflation?

Gabriel writes:

I'll bet you that the final taxpayer burden will be lower than 700 bln. Zero? No. But less than advertised.

Bryan Caplan writes:
Gabriel writes:

I'll bet you that the final taxpayer burden will be lower than 700 bln. Zero? No. But less than advertised.

You'll be right unless the government manages to spend $700B on assets worth nothing. Thanks for the offer, but no thanks. :-)

Here's an alternative: Name your over/under bet for how much of the $700B the taxpayers will recoup in the next ten years. I'd guess $500B, but I'd want to learn a bit more before I put money on that.

H man writes:

My bet is a flat no.

For discusstion, here is one of the better solutions I've seen to pricing the MSB's.

As William Goldman famously said of movies, nobody knows anything when it comes to predicting what a movie will earn when it finally reaches the market. I showed in my book, Hollywood Economics, that the way to solve the problem of unpredictable results is to set the price later when you do know. How is that done? Well, to use the movies as an example, you make contingent contracts that pay based on the revenues a movie earns after it is released. Virtually all the industry’s contracts follow this principle, which I call the Option Principle. Designing option-like contracts lets you pay when you do know.

www.arthurdevany.com

for the rest of the article.

pcs writes:

Well, if Bush and Paulson think that bailout will be profitable, I say we let them make a killing on it. We should allow them to pitch in their considerable personal fortunes in to the TARP program. So, if for example the plan makes 20% return, they should get their money back, plus 20%. If the plan is a looser, well, they loose their money too. Are they ready to “boost the confidence” in their Plan by following with the real action on their words?

Brian Goff writes:

Bryan, while I generally agree with your thesis, govt is a bad bet when it comes to making a profit, I would be interested in comments from you or Arnold on the details (not generics) in Andy Kessler's piece in today's WSJ. He's the one to make your bet with, if you can agree on terms. In his piece, he suggests that Buffet is essentially putting himself in the same position as Paulson, just a smaller stake, $5B rather than $700B.

Bob Knaus writes:

Andy Kessler does indeed nail it in his WSJ piece:

Well, unlike Mr. Buffett or any hedge fund, the Treasury and the Federal Reserve get to cheat.

He thinks the risk of inflation from the bail-out is small. I'm not so sure. Ben & Hank (and their sucessors) get to set the nominal value of the money used to measure the outcome of the bail-out. If you get to grade your own papers, of course you will pass the course.

Bryan, if you want a bet your wife will approve of, invest in TIPS. They should pay off nicely relative to other fixed investments if we do have to inflate to pay off the bail-out.

shayne writes:

To Bob Knaus:

Andy Kessler nailed nothing other than his own coffin lid. Yes, the Fed/Treasury can 'cheat' or 'grade their own papers' or whatever you want to call it. But we're in a GLOBAL, not a closed economy. The folks who trade their goods (petroleum, toys, cars .....) for our currency right now, are going to know its artificial.

Ross Williams writes:

I see a problem with any type of bet. Sen. Clinton will be trying very hard to use this for political reason to get mortgages written down, wiping out any chance at profitability. Your bet would need a nullification clause in case Clinton and crew screws stuff up

Dave writes:

It's too bad you and Barry Ritholtz want the same position, or else you could make a $1M bet.

aaron writes:

Bailout Plan has been drafted.

Looks OK to me, but I think 3c. "Directs a percentage of future profits to the Affordable Housing Fund and the Capital Magnet Fund to meet America’s housing needs," is sketchy.

Jonathan Walz writes:

I will accept the bet. The government will make a profit.

You will certainly lose this bet because the same entity that shall decide the outcome of this bet will be the same government that decides arbitrarily not only the value but also the meaning of asset and debt on a daily basis.

I'm afraid I have already won (I'm so thrilled!)
Sorry Bryan.
Perhaps a sabbatical to Vegas (or Washington for that matter,) you will quickly learn that you cannot beat the house.

Grant writes:

Can someone explain, in clear terms, why these assets aren't being bought if rational people think they are going to be worth more than their current market value?

Methinks writes:

No, I will not take the bet.

Paulson's plan means that the U.S. government will become the largest distressed debt hedge fund in the world - with no incentive at all to make money. Government has no incentive to make sure that it is not taking too much risk for a given level of expected reward. In other words, there is no disincentive for entering into negative expectancy trades. In fact, there's every incentive to do so (and as politicized as this will become, it is an inevitability). The government will not avoid negative expectancy trades and even if they do (accidentally) win on some of them, you can be sure that the risk adjusted return will be terrible. We know this because there are no guidelines to prevent them from doing so and it's unlikely that Wall Street's best and brightest will be lured to manage this portfolio when there is so much more incentive to figure out how to skirt regulation.

I'm a seller of whatever they are buying.

Methinks writes:

Can someone explain, in clear terms, why these assets aren't being bought if rational people think they are going to be worth more than their current market value?

One explanation is that there aren't enough firms that are well capitalized enough to actually buy the securities - at any price. To some extent, this is probably true. In the past few months, arbitrage opportunities (a rarity) in fixed income securities have not been arbed. When riskless arbitrage is left on the table, it means there are serious capital constraints across Wall Street as leverage has been cut and people have become paralyzed.

However, I think there's more to it than that. Some private investors (hedge funds mostly) have bid for these assets. The institutions don't like the bids and are hoping to sell it to the government at much higher prices. It's like a game of poker and the government has tipped its hand and shown its panic. Unfortunately for us, the government must buy the assets from the banks at the lower prices the hedge funds are bidding to make money on them. So...we're cooked.

PrestoPundit writes:

I'd sure like to see Congress and the President make a bet like this, say, put there future pensions on the line: if the government makes money, they get their pensions, if the government loses money, they don't get their pensions.

Sub Specie AEternitatis writes:

Bush says:

And we expect that much, if not all, of the tax dollars we invest will be paid back.

Bryan says:

Name your over/under bet for how much of the $700B the taxpayers will recoup in the next ten years. I'd guess $500B, but I'd want to learn a bit more before I put money on that.

Looks to me like Bryan and Bush agree. (Unless you consider $500b/$700b = 71% not to be "much of").

(Not necessarily supporting the bailout, but annoyed at all the commentary which treats the $700b investment--a term just for once used correctly for government expenses!--as if it was the bottom line cost.)

Adam Ruth writes:

"I'll bet you that the final taxpayer burden will be lower than 700 bln. Zero? No. But less than advertised."

That may be true of direct costs, but the indirect costs of this sham of a bailout will be much more far reaching and devastating.

Grant writes:

Methinks,

One explanation is that there aren't enough firms that are well capitalized enough to actually buy the securities - at any price.

I understand this argument, but why couldn't the cash be raised? If its clear that these assets are undervalued, one would think we'd be seeing entrepreneurs raising funds to purchase them. I understand why the lack of availability of credit would be an issue, but one can invest without leverage.

Tom Hanna writes:

Is there an Intrade contract on this yet?

SheetWise writes:

If we're only considering the purchase of RMBS -- and if they're purchased at or below the current FMV of the the underlying collateral -- I'll take the bet.

My guess is that the government will convert all of these mortgages to fixed rate (so the coming inflation doesn't create a cascade of foreclosures), let inflation increase the asset value, season them for a few years, and sell them at a profit. I'm betting on inflation -- the loan to value on these mortgages should be pretty low within 10 years.

David writes:

Bryan, please ask Andy Kessler to bet with you. He must already have invested his money in MBS if he's so sure of the outcome.

Less Antman writes:

Tom,

Yes, a contract has been trading this week. It was as high as 95% at one time, but is down to 65/69 as I type this.

http://www.intrade.com/jsp/intrade/common/c_cd.jsp?conDetailID=644000&z=1222433172621

If these assets were undervalued (whatever that means), the government wouldn't have to be there to bail out anyone or to buy the assets. The fact is that the government is actually offering to buy the assets at a higher price than they are worth in this market. Cheep goods never have a hard time finding buyers.

I've vote "No" with you. For the very reason stated above.

aaron writes:

Sheetwise, I wouldn't be so sure. Inflation may not land on the houses. Just like now, if consumables go up in price while asset values don't, you get big default risk.

aaron writes:

To illustrate this futher, take me as an example. Last year I was able to save a little cash. I got a raise last fall plus a 3.5% pay increase to cover inflation. Despite making more money, this year I'm taking on debt. Last year I was also doing things like going out to eat and did a vacation in Italy, this year I'm not. But I'm not saving (sure, I bought a mountain bike and got braces, but that doesn't cover my raise).

Methinks writes:

I understand why the lack of availability of credit would be an issue, but one can invest without leverage.

Grant, here's the rub: without leverage, the assets may not generate enough of a return to justify the purchase. Without leverage, the price may be much lower than $0.25 (I don't know at what price above zero the expected return will exceed the discount rate or even if there is one). One reason everyone was so highly levered of late is to juice returns by levering the tiny credit spreads

Gil writes:

Les,

I think Tom was suggesting, as I was also thinking, that there should be an Intrade contract on the issue of the government turning a profit on the Paulson deal.

I guess it doesn't make sense unless the plan itself is approved and in effect. Once that happens, somebody should definitely create such a contract.

Good luck to them with specifying how to measure success, though.

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