I just read an article concerning the $700 Billion dollar bailout.  It talked about the complexities of placing a value on the MBS's and CDO's that Banks hold in there portfolios. And it went further and explained some of the difficulties in doing so.  It used Citigroup as an example and said they say there CDO's are worth 60 cents on the dollar because it does not have that many toxic type of loans then other Banks holdings were worth only 30 cents on the dollar.

It spoke of various ways to purchase them and maybe even trying a reverse auction. And how to value them, do they use a mark to market or maybe a value based on the life of the loan.

I can see the Feds getting screwed here and possibly paying more than what they are worth and not being able to unload them with out taking a loss.

Are we to believe what the Banks tell us what the portfolios are worth; now remember these are the same guys who over valued them in the first place so they could receive millions in executive bonus'.

Why can not the feds put together the smartest guys in the industry. Get some Bankers, Wall Street guys, Rep From the Credit Agencies, Someone from the Security Exchange Commission and some IT professionals and put there heads together and design a software program that would show a value that would be used by everyone.  And it would be fair to every one.

Or is it impossible because the Banks have no idea what type of paper they hold or the amount of toxic loans in the portfolios.

Lots of things at play here. I'm by no means an expert, but here's my thoughts:

I have only heard of it being handled as a reverse auction, which is the only way it makes any sense. A bank sets the price they feel the MBS are worth, and the treasury starts buying at the lowest levels moving up with their $700 billion checkbook. This encourages a bank in need to price low enough to get bought. It also stops, or at least limits a banks willingness to overstate values. Think of it this way, if you had a giant pile of garbage weighing down your company, and the ability to throw said garbage overboard, you aren't going to risk it not getting bought because you want to overstate the value. This is your get out of jail free card if you're a CEO. You don't throw it out with the bath water.

As for banks specifically knowing the true 'value'. Of course they don't. They are valued off of past models, and current performance, but if you've got a vintage of early 06 95-100% ARMs, who knows how they are going to react come adjustment time. Same thing with Option ARMs that aren't into recast. Someone could still basically be 'renting' a house that is upside down 30%, and when the recast comes, they walk if thats the case. Thing is, recast may not be for another 2,3, or 5 years. How can you properly value that? In order to value, you need a basis of performance. Its the same case as subprime MBS "performing" in 03, 04, 05 etc because when someone got in trouble they could simply refi. So while there was a bundle of pre-payment in the tranches (hence, the requirements of PPP, to safeguard investor returns), there weren't defaults. At least not to catastrophic levels, until the value well ran dry and people couldn't simply churn their loan when they got in trouble. You can't value loans that haven't hit the breaking point, because you are valuing them on a false pretense.

For me, if I'm a CEO, I get with my CFO, my accountants, and my board and say look, we've got X in MBS, port loans, CDO's etc that is either A.) Exotic, B.) ARMs yet to adjust, or C.) Lower credit quality than something we would approve today. On any of those packages I'm finding my pain point, to price as cheap as possible to get it off my books and move on. I don't think this is a perfect situation, but I think it's the smartest thing we've done so far to potentially fix the problem.

AC

I did not really understand how the reverse auction would work but how you explained it; it made perfect sense to do it that way.

So I would hope that say XXX Bank did not want to sell or thought there package was worth so much and bet wrong and a year from now they got in to trouble because they held on to there Securities then the fed's should just let them fail.

I was hoping to get Matt Graham's opinion here because as far as I am concerned he is the expert.

I'd say Matt's the expert too. Just sent him a message to come check this thread out. We'll get his .02.

AC

Antwon's got it covered actually.

Here's my .02.

Yes, the feds will overpay.  They will do this on purpose, not because the banks want to take advantage of them.  The banks will take whatever they can get.

The Fed's overpay because it's more stimulation for capital markets.  It's more alleviation of fear for investors.  It makes Asia buy MBS, it makes ma and pa investor take their money out from the cushions of their couch and give it to "some broker" down the street, who in turn puts it in a bond fund, who in turn buys MBS.  The more they pay, the more MBS improve.  And for every extra dollar in taxes the average 'merican pays, they will more than make back, NOT in the form of return on investment as some have suggested (although that's not out of the question), but rather in the avoidance of massive amounts of pain.

I'm going to write an op-ed on this shortly, so a more thorough answer will be there.

Also, buying these assets at the true value today would do absolutely nothing to help the situation either. There would be a huge influx of capital for the banks who participate, shareholders will be screwed, and the market will have not gained assurance of potential stability to come.

Very True, the more the government gets involved, the worse off we are.

Matthew Graham:

Here's my .02.

I wonder what we'd get for $1...

It's like they are in the middle of the desert and need water... the small gas station has it and it is overpriced but it's be better than waiting til we get to the next city.