Maybe Hank Paulson should hire Warren Buffet to manage the bailout?

If done right the American tax payers can end up making money on the current 700 billion bail out plan says Warren Buffet.

But first…  with all the current debate about the rescue plan being proposed in congress many Americans ask themselves: “How did we get into this mess?”

National Public Radio has an excellent one hour special called “The Giant Pool Of Money” that tells you in plain simple English the roots and causes of the current crisis.

You can listen to it on the web or download a 20 page transcript here if you prefer to read.

In a nutshell here is what happened:

1.  In the past decade the amount of money in the world has roughly doubled.  All this money had to be invested somewhere and preferable somewhere “safe”.

2.  Big pools of mortgages bundled together as “mortgage backed securities” and sold by Wall Street became more and more popular and in demand.

The problem?  There were not enough mortgages to sell.

The solution?  Relax the lending standards.

So in essence many borrowers applied for mortgages with no documentation and just a credit score.  Have a pulse?  You will get approved.  In the heydays of the mortgage boom many brokers did very few “full documentation” loans.  Why bother with all the paperwork when just a credit score was needed?

So people took out mortgages that they could not afford.  These mortgages were sold in bundles to Wall Street who sold them to institutions and foreign investors.   A huge problem was that these mortgages were marketed as “safe” and “secure” and often backed with a AAA credit rating (AAA is that US government debt is rated at).  Credit agencies have a lot to explain here I think.

When home prices started to fall people could not refinance their mortgages any more.
Foreclosures started to grow.  And these supposedly safe mortgages are not so safe anymore.  A lot of times they might only be worth 50-70% of what investors paid for them in aggregate  (no-one really knows).

So what the government is planning to do now in an essence is this:

1.  Since no-one want these mortgages and economy is in crisis with no-one lending any money to each other the tax payers will buy them up, hopefully at a good discount.

2.  When house prices re-bound in the next 5-10 years the Government will then repackage and sell these mortgages again and get some or all the money back.

This is one of the biggest misconceptions regarding the rescue plan.  It’s not 700 billion down the drain.  These homes will come back in value in the future.  We just don’t know when.  And it takes a government to be patient and hold these types of assets for a long time.  A good example from a decade ago was the bailout of all the banks in Sweden described here in the New York Times.

It was approximately the same size of bailout in terms of percentage of the economy that we’re talking about in the US.  And since the government got shares and equity in the banks pretty much all of the money came back to the tax payers over a 10-15 year period.

So is the rescue plan needed?  Yes.   Is it fair that responsible home owners and tax payers are rescuing irresponsible home owners and investment banks from a mess that could have been avoided?  No.  But there is not much of a choice if we don’t want our 401k’s to go down even further and our home values drop even more.

And hopefully we will make some money on it long-term.   Here is what Warren Buffet said on CNBC Television according to the Guardian newspaper in the UK:

“I bet they’ll make a profit,” said Buffett, who pointed out that hedge funds specialising in junk assets were already picking up mortgage-related securities with a view to making profits of 15% to 20%. He said a positive return was feasible if the government ignores the book value of instruments or the original cost to banks and instead pays the prevailing market rates for the bombed out assets.

“They’ll pay back the $700bn and make a considerable amount of money if they approach it like that,” said Buffett. “I would love to have $700bn at Treasury rates to buy fixed-income securities - there’s a lot of money to be made.”

Maybe Warren Buffet should be retained by treasury secretary Hank Paulson to help negotiate these buys?

-Ola Edvardsson