Tuesday, September 23, 2008

The $700 Billion Question

Kashyap and Stein at the New York Times on what the bailout should look like:

First, the agency could act as a deep-pocketed private investor that sees a bargain buying opportunity — Warren Buffett on steroids.

[A] second job for the agency might be to restructure the mortgages it acquires. For example, it could reduce required interest payments so that fewer homeowners default on their loans. Done well, this could avoid costly foreclosures, thereby benefiting homeowners while also raising the value of the securities that the government has bought. This sort of restructuring has been difficult until now, because individual mortgages have been sliced and diced, and the pieces widely scattered. However, if the new agency winds up owning a majority of all problem mortgages, reconfiguring them so that interest payments are lower may become practical.

...These first two tasks are probably the easiest for skeptics of government intervention to embrace — or at least tolerate. Unfortunately, they may not be enough. The financial sector is now seriously undercapitalized ... a third job for the new agency might be to directly subsidize financial firms to increase their capital. One way to accomplish this would be the agency’s purposefully overpaying — relative to underlying fundamental values — for the mortgages it acquires.

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