Friday, September 26, 2008

Make that the second biggest

John Berry from Bloomberg contends that the Paulson Plan would be the biggest carry trade in history.
The government will get the $700 billion by selling a range of Treasury securities to the public with yields of 3 percent to 4 percent. With investors around the world clamoring to buy risk-free Treasuries, the market should be able to absorb the jump in supply without a significant increase in yields.

Contrast that with likely yields on the troubled assets for which there currently is no market. No one can be sure how big a haircut there will be on the assets Treasury buys, though if it's 50 percent or more, their yields should be 10 percent or higher.

That is, the government will be borrowing at 3 percent to 4 percent to buy assets yielding 10 percent or even 12 percent. Conservatively, that spread on an investment of $700 billion should generate income of $40 billion to $60 billion annually.
Got that -- since the US Government can currently borrow cheaply (3%), it will make money if it buys any asset that yields a higher interest rate. This is awesome -- the Government should buy ALL assets, make money off the carry, and then write checks to us, the taxpayers.

It also does something like this in the retail banking sector, where FDIC insurance means that the current system is indistinguishable from deposits sitting in a vault, and the banks borrowing directly from the Government (at 3%) and lending out at more (10%+). If we're to have fractional lending with a Government guarantee, we should really just have the Government make all loans.


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