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In an article in last month’s Barron’s, Jonathan R. Laing makes a compelling case in favor of the U.S. government’s $700 billion bailout plan.  Given the feelings of disgust and indignation on the part of some taxpayers towards this plan, it’s worth summarizing a few of Laing’s key points.

Most significantly, many of those distressed accounts (primarily mortgages and mortgage securities) that Uncle Sam is buying from banks, insurance companies, and credit unions aren’t as toxic as many people think.  Furthermore, these Treasury Department purchases will accomplish several things: freeing up credit markets, increasing home-loan backed security prices, and eventually slowing the trend of plummeting real-estate prices.

Mortgage fund TCW’s CIO Jeffrey Gundlach had this to say: “Essentially this secondary effect would do much to lift housing out of its funk and actually improve the performance of the securities that Treasury ends up buying…Thus, I think that there’s a good chance that the bailout plan will be a win-win for both the taxpayer and the financial system.”

Bill Gross, manager of Pimco bond fund, maintains a similarly sanguine outlook.  His estimation is that the distressed assets the Treasury will buy will be worth approximately 65 cents on the dollar.  When financed at 3% to 4% from the sale of Treasury debt, the Treasury can potentially earn a positive amount of 7% to 8% on its purchases.

Laing helpfully points out the irrationality inherent in Chicken Little thinking: “By most accounts, current losses on U.S. mortgage paper — the difference between face value and current fire-sale prices — stand at about a trillion dollars. In a sign of the distortions from panic selling, eventual losses on the underlying mortgages figure should be no greater than $250 billion. The market, irrationally, is assuming losses of four times that amount.”

Laing provides more insightful information, which we might address in future blogs.  Suffice to say, the sky is not falling.