On one hand, the proposed Federal program may offer a more stable platform to restore confidence and to allow financial institutions to rebuild their balance sheets. At the same time, if the Fed is going to buy mortgage-based securities (but not derivatives) in an open, auction-style market at prices somewhere between 20-50% of fair market value, the sellers of those securities are still going to take a bath when they have to write down their assets to account for the discounted sale price. The only important difference I can glean is that it allows them to clean up their balance sheets with certainty, i.e., the losses are certain and there will be no more since the asset is sold, vs. taking additional writedowns which are NOT certain, i.e., the market doesn’t know if the writedown is sufficient because the financial institution is still holding the asset on its books.
We’ll learn more over the weekend. In the meantime, Joe Nocera’s column in the New York Times takes a much more negative view of the Fed actions this week and whether the government really has the answer. He doesn’t think so.