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Could the bailout actually make money for the Treasury?

Republican Senator Norman Coleman apparently is arguing that it could.

Theoretically speaking, Coleman actually is potentially right. The deleveraging theory that I've mentioned in earlier posts suggests that assets may end up having market values well below fundamental value in a temporary squeeze where there simply isn't enough money on the "long" side to compete away the windfalls suggested by the spread.

If Warren Buffett, say, indicated that he wants to buy the same bad loans that Secretary Paulson is talking about (supposing that he had enough money), and was willing to pay more than current market value, I would figure that this was indeed happening, and that Buffett might be quite likely to do well.

However, there are several key institutional differences between the hypothetical Buffett scenario and the actual one. The Treasury isn't deciding to go in for any such reason, would have no incentive to execute its buying strategy from a profit-making standpoint (even where socially optimal), and would probably be unable to do it competently even if it tried. Obviously, making money is not exactly at the heart of its institutional skill set.

Hence I would predict huge losses to the taxpayers even though the undervalued-assets scenario is by no means silly. Reinforcing the argument that Treasury's outlays ought to be fully financed under the assumption that they will recover zero, and probably, insofar as arbitrary stated measures matter to political behavior, ought to be included in the budget deficit.

Full post as published by Start Making Sense on September 23, 2008 (boomark / email).