US taxpayers to gain from $700 bln bailout-Barron's

NEW YORK, Sept 28 (Reuters) - U.S. taxpayers and their proxy, the U.S. Treasury Department, should turn a profit from the proposed $700 billion bailout of the country's financial services industry, Barron's said in its Monday edition.

The weekly business newspaper said the mortgages and mortgage securities that the government will buy back are not as toxic or as widespread as is commonly assumed.

Such purchases should help free up credit markets and boost the prices of securities backed by home loans, it said, helping to arrest a cycle where falling home prices spur more defaults and foreclosures, causing home prices to decline even more.

Bill Gross, who runs the world's largest bond fund PIMCO Total Return PTTRX.O, is even more upbeat, the newspaper said. He said Treasury may buy the securities at an average 65 cents on the dollar, and by financing it with the sale of Treasury debt at 3 percent to 4 percent should earn a yield spread of 7 percent to 8 percent, even assuming particularly severe default rates and recoveries in foreclosure.

The paper said a bailout may be a boon for taxpayers as the market corrects what is now a "yawning gulf" between current prices for mortgage securities and any value based on rational expectations. It said U.S. mortgage paper is now valued at $1 trillion below face value, but that the eventual losses should total no more than $250 billion.

According to the newspaper, the government could pocket $75 billion over two years if it spent $520 billion to buy $800 billion of troubled debt at 65 cents on the dollar, and then generated a 7 percent annual return from its holdings. If the markets open up, the government could sell the debt at more than 65 cents on the dollar and profit more, it said.

Barron's said Merrill Lynch & Co's MER.N sale in July of $31 billion of toxic debt to private equity firm Lone Star Funds for 22 cents on the dollar -- and its agreement to provide 75 percent financing, meaning Lone Star had only 5.5 cents on the dollar at risk -- is the type of fire sale pricing that has spawned the current liquidity panic. (Reporting by Jonathan Stempel; editing by Gary Crosse)