Is a government-sponsored vehicle an ultimate solution?

From Bloomberg:

The U.S. government moved to cleanse banks of troubled assets and halt an exodus of investors from money markets in the biggest expansion of federal power over the financial system since the Great Depression.

"We’re talking hundreds of billions,” Treasury Secretary Henry Paulson said in a press conference. "This needs to be big enough to make a real difference and get to the heart of the problem.”

The Treasury is likely to run the program, which would involve auctions where the government buys devalued assets, said House Financial Services Committee Chairman Barney Frank. The plan is designed as a comprehensive approach after a series of individual rescues failed to stem the crisis.

Would this be an ultimate solution to the current market turmoil? The US Treasury and the Federal Reserve have been coming up various creative solutions in response to the credit crunch, which has been unfolding since last August. Despite some calm moments in this one year time, there have been occasional big crisis, like the fall of Bear Stearns, takeover of Fannie and Freddie by US government, and now the bankruptcy of Lehman Brothers, sale of Merrill Lynch, and takeover of AIG.

I somehow believe that a government-lead effort of buy all the toxic asset to be an effectively solution of the current crisis. The main problem of the current crisis, to me, is that these bad assets are something which every bank is trying to get rid of. When all the banks are trying to get rid of these, there would be no demand in the market while everyone is supplying these to the market. This will lead to the downward spiral of the market price of these assets. The sooner people want to get rid of, the faster the price is going down. As the price go down, banks have to write-down the assets and recognize the loss somewhere in their accounting statements, such that they have less and less capital. What they can do is to raise new capital, or sell other things. Note that the market price may not be the intrinsic value of that assets. I believe that under such an extreme situation, the market price of the asset might be lower than what it should worth for.

If the US government is going to buy all these assets, at lease it will halt further downward spiral in price. I believe the problem now is quite a political one, as this will certainly put taxpayer money at risk (although it is too early to say that taxpayer will be the loser). Also, we will expect the multiple rescue efforts by the Treasury and the Federal Reserve will make the government under pressure to issue more debt, which will drive up long-term interest rate.

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About Zarathustra

Zarathustra: Founder and Managing Editor of Also sprach Analyst. Once an analyst, now an investor and entrepreneur. Based in Hong Kong, but Londoner at heart.