An Idea on Pricing Bad Assets

One of the many points of worry about the bailout is the need to find a balance between buying enough mortgage backed securities to get the credit markets flowing again and relieve fears about bank collapses, while at the same time not massively overpaying and thus having the government take a bath in the process while rewarding people who bought junk (and deserve to take losses as a result.)

At first glance, I like this toss-out idea from Warren Buffet:

But Buffett described a plan he thought of Thursday morning on the way to the Summit that would allow Treasury and private investors to buy assets together. He said his proposal would quickly kickstart demand for mortgage-backed securities and help find a market price for these troubled assets.

"One easy way to do part of the program is to say to anybody - hedge fund operators, Wall Street firms, or anybody else - that the Treasury will lend you 80% of the purchase cost of a bunch of distressed assets," he said, explaining the concept of his proposal. The investors benefit from borrowing at lower rates, but Treasury would get first claim on the sale of those assets, which means it would get its loan back plus interest and possibly turn a profit.

"Now you have someone with 20% skin in the game," he explained. "Believe me, I won't be overpaying if I'm buying with that kind of leverage. And you have someone [the investors] to manage the assets to the extent they need to be managed."