Preventing the Greatest Heist in History

There’s currently an idea to fix the financial system that’s getting quite a bit of traction: an RTC-type program whereby the government would buy $1 trillion of troubled assets from struggling U.S. banks, with the goal of restoring them to health so they can begin lending again, leading to an economic recovery.

The problem with this idea (let’s call it “New RTC”) is that either the government will pay market prices for the toxic assets – in which case, it will simply accelerate the collapse of our financial system – or pay above-market prices, in which case taxpayers will likely suffer big losses.

There is another option, however, which involves debt holders taking a share of the losses. If steps are not taken to ensure that this happens, the greatest heist in history will have occurred: at least $1 trillion will be transferred from taxpayers to debt holders of failed financial institutions. This must not be allowed to happen.

Mark-to-Market vs. Real Losses

To understand the government’s dilemma, one must realize that the great majority of the not-yet-recognized losses in our financial system are not short-term, mark-to-market losses that will someday be reversed, but permanent losses. This is a huge misunderstanding that many people, especially those in Washington, seem to be suffering from.

To understand why the losses are real, consider this simple example: imagine a bank that lent someone $750,000 via an Option ARM mortgage to buy a McMansion in California at the peak of the bubble less than two years ago. Virtually all homeowners with this type of loan will default, thanks to declining home prices, the structure of the loan, and the fact that 70-80% of Option ARMs were liar’s loans. If we assume the house is only worth $400,000 today, then there’s been an actual loss of $350,000. That money will never be recovered. If one considers the millions of toxic loans made during the bubble – subprime, Alt-A, Option ARM and second mortgages, home equity lines of credit, commercial real estate, leveraged loans, credit cards, etc. – it easily adds up to at least $1 trillion in additional, unrecognized very real losses.

Imagine that New RTC buys this loan for $400,000. In this case, it might not lose money, but then the bank (or the structured finance pool) holding the loan has to immediately realize the loss of $350,000 – and it is certain that the U.S. (and world) financial system has not even come close to marking these assets to what they’re really worth, which explains why they won’t lend, even when given new money. Thus, if New RTC buys these assets at fair value, then the financial institutions suffer the losses – but this would bankrupt many of them. Yet if New RTC pays the inflated prices they’re marked at today, then it (and taxpayers) will suffer huge losses.

Who Should Bear the Losses?

To save our financial system, somebody’s going to have bear these losses – the only question is, who? Some fraction of this will certainly have to be taxpayer money, but all of it needn’t be if the government would stop bailing out all of the debt holders.

Government policy has been all over the map. Among the large financial institutions that have run into trouble (in chronological order, Bear Stearns, IndyMac, Fannie & Freddie, Lehman, AIG, WaMu, Citigroup and Bank of America), in some cases the equity was somewhat protected, while in others was wiped out, and likewise with the debt. Most likely due to the chaos that ensued after Lehman filed for bankruptcy, the current policy, as reflected in the most recent cases of Citi and BofA, is to at least partially protect the shareholders and, incredibly, 100% protect all debt holders, even junior/unsecured/subordinated debt holders.

The result is at least a $1 trillion transfer of wealth from taxpayers to debt holders. This makes no sense from a financial, fairness or moral hazard perspective. While there’s an argument that the government should protect senior debt holders to preserve confidence in the system (even though they knowingly took risk – after all, they could have bought Treasuries), the junior debt holders got paid even higher interest in exchange for knowingly taking even more risk by being subordinate in the capital structure (of course, equity and preferred equity holders are the most junior). These investors made bad decisions, buying junior positions in highly leveraged companies that made bad decisions, so why should they be protected?

Moreover, the reckless behavior of debt investors was a major contributor to the bubble. It was low-cost debt with virtually no strings attached that allowed borrowers, especially the world’s major financial institutions, to become massively overleveraged, fueling the greatest asset bubble in history. This was not an equity bubble – unlike the internet bubble, for example, stock market valuations never got crazy – it was a debt bubble, so it would be particularly perverse and ironic if government bailouts allowed equity holders to take a beating, yet fully protected debt holders.

Case Study: Bank of America

Let’s look at Bank of America (BAC), which effectively went bankrupt last week (disclosure: we are short the stock). The cost to taxpayers of avoiding this outcome wasn’t the headline $20 billion, but far more – the government is going to take a bath on the $120 billion that it guaranteed – and it’s likely that this is just the beginning of the losses.

Consider this: as of the end of 2008, BofA had $1.82 trillion in assets ($1.72 trillion excluding goodwill and intangibles), supported by a mere $86.6 billion in tangible equity – 5.0% of tangible assets or 20:1 leverage – and $48.9 billion of tangible common equity – 2.8% of tangible assets or 35:1 leverage (common equity excludes the TARP injection of capital in the form of preferred stock, which has characteristics of both debt and equity). (All data from BofA’s earnings release on 1/16/09; note that these figures include Countrywide, but not Merrill Lynch)

At such leverage levels, it only takes tiny losses to plunge a company into insolvency. It’s impossible to know with precision what BofA’s ultimate losses will be, but among the company’s loans are many in areas of great stress including $342.8 billion of commercial loans ($6.5 billion of which is nonperforming, up from $2.2 billion a year earlier), $253.5 billion of residential mortgages ($7.0 billion of which is nonperforming, up from $2.0 billion a year earlier), $152.5 billion of home equity loans (HELOCs; about $33 billion of which were Countrywide’s), and $18.2 billion of Option ARMs (on top of the $253.5 billion of residential mortgages; all of which were from Countrywide, which reported that as of June 30, 2008, 72% were negatively amortizing and 83% had been underwritten with low or no doc).

BofA is acknowledging a significant increase in losses, but its reserving has actually become more aggressive over the past year. From the end of 2007 to the end of 2008, nonperforming assets more than tripled from $5.9 billion to $18.2 billion, yet the allowance for credit losses didn’t even double, from $12.1 billion to $23.5 billion. As a result, the allowance for loan and lease losses as a percentage of total nonperforming loans and leases declined from 207% to 141%.

So BofA had big problems on its own and then made two very ill-advised acquisitions, the result of which effectively wiped out the company, causing the government to come in and bail it out, at a huge cost to taxpayers. So what price is being paid? NONE! The architect of this debacle, Ken Lewis, is still in place, as is the board that approved everything he did. Ditto with Citi. These banks are just getting do-overs, with the management, boards and debt holders not being touched – the only losers are the common shareholders (to some extent) and taxpayers (to a huge extent).

Since big losses from Merrill Lynch triggered last week’s bailout of BofA, why are all of its debt holders ($5.3 billion of junior subordinated notes, $31.2 billion of short-term debt and $206.6 billion of long-term debt) being protected 100%, while taxpayers are taking a bath eating Merrill’s losses from its reckless, greedy behavior?! This is madness.

A Better Solution

So what’s a better solution? I’m not arguing that BofA (or Citi or WaMu or Fannie or Freddie or AIG or Bear) should have been allowed to go bankrupt – we all saw the chaos that ensued when Lehman went bankrupt. Rather, if a company blows up (and can’t find a buyer), the following things should happen:

1) The government seizes it and puts it into conservatorship (as Fannie, Freddie, IndyMac and AIG effectively were, to one degree or another);

2) Equity is wiped out (again, as with Fannie, Freddie, IndyMac and AIG);

3) However, unlike Fannie, Freddie, IndyMac and AIG (and certainly Citi and BofA), everything in the capital structure except maybe the senior debt is at risk and absorbs losses as they are realized; the government would only provide a backstop above a certain level. This is what happened in the RTC bailout;

4) Over time, in conservatorship, while the businesses continue to operate (no mass layoffs, distressed sales, etc.), the government disposes of the companies in a variety of ways (just as the RTC did via runoff, selling the entire company or piece-by-piece, etc.), depending on the circumstances (as it’s doing with AIG and IndyMac, for example – these are good examples, except that the debt holders were protected).

Counter-Arguments

One counter-argument to my proposal is that we don’t want the government to nationalize banks. I don’t like it either, but the alternative – inject hundreds of billions of dollars of taxpayer money and not take control – is even less palatable. There should certainly be urgency in disposing of the companies, but also the recognition that it could take years, as with the RTC.

Another counter-argument is Lehman: nobody wants a repeat of the chaos that ensued when the company went under and debt holders were wiped out. But the mistake here wasn't the failure to protect the debt, but rather allowing the company to go bankrupt, which not only impacted Lehman’s equity and debt holders, but also stiffed Lehman’s countless clients and counterparties. It’s the latter that caused the true chaos. Lehman should have been seized and put into conservatorship, so that all of Lehman's clients and counterparties could have relied on Lehman (as was done with AIG) – but debt holders would have taken losses as they were realized (which is not being done with AIG).

A final argument for protecting the debt is the fear of contagion effects: for example, other financial institutions who own the debt might become insolvent (this was probably why Fannie and Freddie subdebt was saved). Also, debt markets might freeze up such that even currently healthy banks might not be able to access debt and collapse.

Regarding the former, the debt is owned by a wide range of institutions all over the world: sovereign wealth funds, pension funds, endowments, insurance companies and, to be sure, other banks. Some of them would no doubt be hurt if they take losses on the debt they hold in troubled financial institutions – but that’s no reason to protect all of them 100% with taxpayer money.

As for the latter concern that debt markets might freeze up, causing even healthy banks to collapse, it’s important to understand that right now there is no junior debt available to any financial institution with even a hint of weakness – there’s very high cost equity and government-guaranteed debt. Neither of these will be affected if legacy debt holders are forced to bear some of the cost of the failure of certain institutions.

Conclusion

The new Obama administration needs to understand that the greatest heist in history is underway – at least $1 trillion is being transferred from taxpayers to debt holders of failed financial institutions – and take steps to stop it before taxpayers suffer further unnecessary losses.

Disclosure: Short BAC

Comments

[Consider_this:]

Nationalizing the bank may be the only way out of this.

The issue isn't the banks themselves only, because if it is, we would let them go bankrupt and then clean up the mess efficiently (and much more cheaply) *while* them as functional, employing companies.

The issue are the various CDOs and derivative bet on these banks's survivial, which if allowed to explode in isolation, would end up costing us several tens of times of the national GDP and would pretty much cause a systemic event.

By an interesting twist, the CDOs become a non-issue, if the govt takes all of the banks, merge them into one GIANT "one bank to rule them all"; and then disintegrate the banks back into small enough to fall sizes. The deliberative contracts will "cancel each other out" and amount to nothing (moving money really quickly from your left pocket to your right, then back to your left, repeat a trillion times)

Funny that this is another way of saying "nationalize all the banks".

Jan 20 10:15 AM

[Jubilee Year:]

Delaying the inevitable, shifting the burden to innocent civilians, destroying our dollar, what is the point of all this? As you said, the losses are real, they are huge, and they will have to be realized. Let the bad wood fall, liquidate the debt, re-regulate the banks, move on. All these piecemeal proposals will only drag out the depression.

Instead of dragging this out, I say we speed it up: cancel the debt in one fell swoop and reset the financial system.

Jan 20 10:34 AM

[forest:]

The government isn't necessarily robbing the taxpayer to pay bank bondholders...the government is robbing holders of US Dollars. In other words, it's using the printing press to pay for the bailouts as our tax dollars have already been allocated to other (most likely wasteful) uses.

Admittedly many of these dollar holders include US citizens, but other large groups include the Asian institutions, the Saudis, etc

Jan 20 10:38 AM

[Consider_this:]

Problem with having a Jubilee (i.e. cancel all the debts in one fell swoop).

In a Federal Reserve system, money is debt (or debt is money)! Once a unit of money is created, some units of debt is also created along with it.

While an individual with the money may not be the one that carried the debt or even aware of that debt, it is in the system. In fact, most of the time, the govt or even foreign CB's are the ones carrying it or it's claim.

In this system, Jubilee effectively destroys both debt as well as "the claim on the debt" (what you and I call money). And this carries over to all asset and equities claims as well.

So to paraphrase the call to Jubilee:

Are you willing to have all your debts forgiven, if you would also trade in all your worldly possessions, your valuable assets and all your stocks, homes, cars, bank account, CD's, bonds, etc?

I think most people won't want that kind of Jubilee, but that's what you get,

Jan 20 10:43 AM

[Consider_this:]

forest:

"The government isn't necessarily robbing the taxpayer to pay bank bondholders...the government is robbing holders of US Dollars. "

Right only if you consider debt to be a single time event. I used to think that way too.

If you zoom-out and consider that we refinance our debt whenever they're due (we've no capability to pay all of it at once, or even a significant chunk as they become due), then debt, or a better word, "credit" is a "stream of debt", not ONE.

In such a case, if you bite the hand that feeds you, what happens?

No more future credit.

Now what happens when the next batch of govt debt is due (and they're due almost daily)?

If printing money to satisfy debt is the path to riches, then post WWII, Germany would be the richest country around, not USA. Zimbabwe would be much richer than any of us. (100 billion dollar eggs anyone?)

Jan 20 10:47 AM

[foster fezz...:]

Nice plan. It is intolerable that bad judgment and foolishness should be rewarded. Another SA columnist suggested a new bankruptcy chapter to handle "too big to fail" cases. Seems like a good idea. Bring BofA into bankruptcy that sells off the viable assets to healthy banks and distributes the losses from toxic assets to all debtholders.

I suppose this would have a chain reaction, but effectively that's already happened: the credit markets don't work. But if the healthy assets of all such banks were distributed to healthy institution (infused with cash if need be) then lending between the latter could commence immediately.

Is anyone considering that trying to save these rotten banks could bankrupt USA, Inc, which would actually be much WORSE than the great depression?

Jan 20 11:12 AM

[vranger:]

Mr. Tilson is both right and wrong at the same time in this analysis. He is correct that there are some real losses for which someone is going to have to take the hit.

However, the taxpayer, for the most part, does not get robbed if the debt holder is protected. Why? Because in many cases, the debt holder and the tax payer are the same entity.

When you invest in a mutual fund, and the mutual fund invests in mortgage instruments, you are the debt holder. If the legal debt holder is wiped out, your mutual fund investment in that instrument is wiped out, and your part of that investment is wiped out. Conversely, if the legal debt holder is protected, your investment is protected.

Here's the rub. Protecting the debt holder creates more national debt if the device which protects the debt holder is a bailout from government funds. That creates a larger National Debt. However, you may not personally have to pay as many dollars in taxes as a consequence of that increase in the national debt as you would lose if your investments go belly up.

That's why there is a National Debt in the first place .... the government cannot collect as much in taxes as they like to spend. Since it is unlikely that the National Debt is EVER going to be paid off at any time, that in essence gets the taxpayer 'off the hook'.

Is this 'funny accounting'? Yes. But its the same 'funny accounting' we've been living with out of our Federal government since at least the 60s.

Jan 20 11:17 AM

[Jason Rines...:]

I fully agree. No one can quantify this opinion but I believe we destroyed global investor confidence worse by government picking winners and losers rather than nationalizing. All U.S. citizens enjoyed the debt bubble in various degrees, all should feel the pain.

In regards to CDS $60 T in notional value what is real and due ultimately winds up being 2% of commissions that will be argued or fought over, roughly 1 T that someone has to bear. And NO this burden should not be felt by the taxpayers who have to fix there own household balance sheets. And as the author notes, much of the debt is sovereign. American government must decide who is more important, it's own citizenship or overseas sovereign nation investors. Both are painful choices with consequences. Both cannot be fully placated.


On Jan 20 10:15 AM Consider_this wrote:

> Nationalizing the bank may be the only way out of this.
>
> The issue isn't the banks themselves only, because if it is, we would
> let them go bankrupt and then clean up the mess efficiently (and
> much more cheaply) *while* them as functional, employing companies.
>
>
> The issue are the various CDOs and derivative bet on these banks's
> survivial, which if allowed to explode in isolation, would end up
> costing us several tens of times of the national GDP and would pretty
> much cause a systemic event.
>
> By an interesting twist, the CDOs become a non-issue, if the govt
> takes all of the banks, merge them into one GIANT "one bank to rule
> them all"; and then disintegrate the banks back into small enough
> to fall sizes. The deliberative contracts will "cancel each other
> out" and amount to nothing (moving money really quickly from your
> left pocket to your right, then back to your left, repeat a trillion
> times)
>
> Funny that this is another way of saying "nationalize all the banks".

Jan 20 11:30 AM

[discov:]

All that I am sure of is that the common stock of the banks has no rights, the government is effectively stripping the rights of the common stock holders.

concisetrading.blogspo.../

Ryan

Jan 20 11:34 AM

[Jubilee Year:]

To Consider_this, I think you are confusing real assets with paper assets. In a Jubilee, you get to keep all of your real asset (cars, homes, etc). You would lose you paper assets if they involve debt to someone else. You would not lose your savings accounts, within the 250K FDIC coverage. The banking industries would be hit hard, obviously, but could quickly rebuild based on the new spending, saving, and investing, as the real economy was jumpstarted. Imagine how the economy would take off if no one had any house payments, no car payments, no credit card payments, and our gov't no longer had to pay interest on its debt. As you can easily see, there would be little credit, but lots of savings. Governments would be forced to run balanced budgets, as well as a balanced trade account. The upside, for just about everyone, would be huge.

Jan 20 11:47 AM

[Jake Berzon:]

Just because this should be done doesn't mean that it will be done. How many times have you seen a measure implemented just because it was the right thing to do? Instead it had to either be extremely popular or even more often serve the needs of a powerful lobby. I think we are all hoping that Obama will do the right thing, but I am not counting on it...

Jan 20 11:55 AM

[jazzmanJim:]

This article should be required reading for anyone on this issue!!

Jan 20 12:01 PM

[Socialism c...:]

" don’t like it either, but the alternative – inject hundreds of billions of dollars of taxpayer money and not take control – is even less palatable."

Why inject any money at all? Pay out the FDIC-insured amount to depositors, and let the rest of it rot. We need to allow failure and not bail it out.

Jan 20 12:16 PM

[mbr:]

Why not declare all credit derivatives contracts null and void?

Jan 20 12:18 PM

[Jason Rines...:]

Your screen name denotes the Year of Jubilee in Israeli culture. This seven year forgiveness system of debts worked very well, but the culture built it's economy around that event. This would not work in the U.S. at this point for too many reasons to list. I also liked the Israeli judicial system of governance and a tithe system of 10%. How did Israel get so wealthy by King Solomon's day without fractional reserve lending?!? LOL.


On Jan 20 10:34 AM Jubilee Year wrote:

> Delaying the inevitable, shifting the burden to innocent civilians,
> destroying our dollar, what is the point of all this? As you said,
> the losses are real, they are huge, and they will have to be realized.
> Let the bad wood fall, liquidate the debt, re-regulate the banks,
> move on. All these piecemeal proposals will only drag out the depression.
>
>
> Instead of dragging this out, I say we speed it up: cancel the debt
> in one fell swoop and reset the financial system.

Jan 20 12:36 PM

[akapital:]

What do people think about letting people borrow against their future Social Security?

What it effectively does is use future soc sec entitlement as default insurance and would motivate banks to lend, result in a serious injection of money into the economy. Also motivates responsible borrowers as when people are paying off their house they are also effectively putting money back into their retirement?

Jan 20 01:34 PM

[Thomas J. G...:]

A well written article with a nice tone and good explanations of very complex topics. The part about why we "really" lost a trillion dollars and why highly leveraged institutions are at risk when writeoffs occur were very good. If you want to read something that advocates debt cancellation that is a little more shrill here it is. In his defense Denninger was very early to predicting the problems:

market-ticker.denninge.../

Jan 20 02:12 PM

[PROXIMO:]

The answers to that question are too numerous to be contained on the World Wide Web.


On Jan 20 12:18 PM mbr wrote:

> Why not declare all credit derivatives contracts null and void?

Jan 20 02:38 PM

[DW:]

Great article.

Corporate boards are now useless it appears. If the BOA and CITI leaders still have their jobs then why have boards?

Jan 20 02:42 PM

[Dirk McCoy:]

I have some concerns here.

First, this debacle was created by 18 Fed rate hikes that caused homeowners and businesses to envision a future where they needed to come up with 2-3X debt service (don't forget profit ratios requiring additional profit on top of the debt payment), and respond how you would expect them to- pull back and put assets up for sale. Since the root cause can be layed at the doorstep of the Federal government (as money supply is the Constitutional responsibility of the Congress, who has outsourced it to the Fed), they bear some responsibility to mitigate its effects.

Second, these problems can be mitigated via inflation. Because of the excess labor and production capacity, and substitutionary technology on the shelf, adding significant money should not create hyperinflation, though gold and oil should rise- as should house values.

Third, as home values recover, the losses will be mitigated. The $800K house will be valued at $600K, not $3-400K. There will be $100K in losses, much of which should be the liability of the original borrower. Banks should be willing to provide time and leeway for the homeowner to sell the home over the next few years and rent it in the meantime.

At the end, there will be losses to dollar holders (who have racked unearned gains), banks, and people who borrowed more than they should have. The biggest losers may be people who were looking forward to buying houses for 40 cents on the dollar, but if this isn't handled this way I believe the economy will tank as the price of risk will overshadow all other costs, including labor- and they won't have jobs to support their purchase anyway.

Jan 20 03:05 PM

[Anandakos:]

Jubilee Year,

I am sorry, but you are advocating theft on a stunning scale. What level of "moral hazard" would arise from government mandated cancellation of whole classes of debt? The closest parallel would be Russia after the Soviet victory when the workers' paradise revoked all indebtedness. Immediately the was nation plunged into penury.

I would venture that you have much more debt that you do "paper" (your scornful term) assets. So you are probably arguing for your own benefit. You are also conflating the grifters in the fixed income units of Wall Street firms with the buyers of the "debt" instruments they created. How different from the scamsters are you?

The managers of a Landsbank in Germany who bought mortgage backed securities rated by Standard and Poors as AAA should not be penalized for making what they have reason to believe in foresight was a sound investment. Nor should the CFO of a manufacturing company who bought commercial paper as working capital to be liquidated over the coming year as needed for operating costs.

You make it sound as if the credit markets are an expendable luxury. I managed accounts payable for a small warehouse business; believe me I know that credit is essential for any business, small or large.

On Jan 20 11:47 AM Jubilee Year wrote:

> To Consider_this, I think you are confusing real assets with paper
> assets. In a Jubilee, you get to keep all of your real asset (cars,
> homes, etc). You would lose you paper assets if they involve debt
> to someone else. You would not lose your savings accounts, within
> the 250K FDIC coverage. The banking industries would be hit hard,
> obviously, but could quickly rebuild based on the new spending,
> saving, and investing, as the real economy was jumpstarted. Imagine
> how the economy would take off if no one had any house payments,
> no car payments, no credit card payments, and our gov't no longer
> had to pay interest on its debt. As you can easily see, there would
> be little credit, but lots of savings. Governments would be forced
> to run balanced budgets, as well as a balanced trade account. The
> upside, for just about everyone, would be huge.

Jan 20 03:11 PM

[Consider_this:]

Jubilee Year:
" To Consider_this, I think you are confusing real assets with paper assets. In a Jubilee, you get to keep all of your real asset (cars, homes, etc). "

Only if you completely own the asset free and clear. Otherwise, the debt cancellation must also accompany the confiscation of contracted collateral.

Otherwise, I'll buy borrow to buy all the land in USA; and then dispose of my debt. Surely you see why it won't work with assets that are not free and clear?

"You would not lose your savings accounts, within the 250K FDIC coverage."

FDIC is not meant to guard against a complete bailout of every single saving account holder to 250K. This is what a Jubilee would guarentee -- that the FDIC will have to pony up for each savings account, since the bank assert are basically junk in a Jubilee (banks own DEBT!! DEBT = zero, then bank = zero! All FDIC!)

"The banking industries would be hit hard, obviously, but could quickly rebuild based on the new spending, saving, and investing, as the real economy was jumpstarted. "

How would the real economy jumpstart? There'll be no money available anywhere (you just jubilee'd it away!) Yeah, there's plenty of "free and clear" assets sitting around, but nobody have money to lend to anyone else as credit.

"Imagine how the economy would take off if no one had any house payments, no car payments, no credit card payments, and our gov't no longer had to pay interest on its debt. "

First, you'll have widespread poverty as most cars, homes, etc are not completely paid for and need to be confiscated. (I won't even entertain the concept of debt forgiveness with no recourse, see paragraph above.)

Even our govt is not paid for.

Second, if you cancel or default on every debt, then you become untrustworthy. By definition, future interest rate will be either confiscatory (would you want to lend to someone who drops his debt?); or hard to come by (you've already cheated all the assets off your richest uncle, so there's nobody else as rich to cheat off next in future)

"As you can easily see, there would be little credit, but lots of savings. Governments would be forced to run balanced budgets, as well as a balanced trade account. The upside, for just about everyone, would be huge."

No it won't. Like it or not, we *ARE* currently facing a destruction of debts; which is exactly what's causing our money and credit issues.

Your Jubilee is a "Fairy tale" scenario where people in the story say "oh, too bad. It's ok. I forgive you" and happily goes on to continue lending / giving money at the same rate to the little bad boy who borrows and splurge on random things (who will need Jubilee again sometime in future, etc). It also assume that the act of Jubilee itself doesn't destroy the source of the money itself.

In the real world, people would remember it when you had to borrow again, and the loss is also real and potentially damaging to the SOURCE of the credit.

Jan 20 03:19 PM

[Anandakos:]

This is madness; sheer madness. The obvious problem is that there is nothing to "borrow" from except special treasury bonds. Congress would have to issue general obligation treasuries to buy out the special bonds (this is what will have to happen in the future, too, so it's merely an acceleration). People would spend the money however they chose, which I guess from a Republican perspective would be a good thing, but it would mostly go to Asia for toys. How many people are really going to pay off their houses with the proceeds, as the AKapital supposes? Few.

This is just one more way to keep the consumer driven whirl of grasshopper parties spinning along. We need serious, sober investment in capital goods. The government can invest in communally owned capital goods -- mostly transportation and energy infrastructure -- but the rest of the investment must come from personal savings.

A second problem is that who is going to make people forfeit their benefits in the future? Certainly not the politicians for whom the forfeiters will be voting.......

TANSTAAFL

On Jan 20 01:34 PM akapital9 wrote:

> What do people think about letting people borrow against their future
> Social Security?
>
> What it effectively does is use future soc sec entitlement as default
> insurance and would motivate banks to lend, result in a serious injection
> of money into the economy. Also motivates responsible borrowers as
> when people are paying off their house they are also effectively
> putting money back into their retirement?

Jan 20 03:25 PM

[Consider_this:]

On Jan 20 01:34 PM akapital9 wrote:

> What do people think about letting people borrow against their future
> Social Security?

Awesome. Lets say I'm a 21 year old fresh out of college person who just got a brand new job.

Let me borrow all of my social security. Heck why stop there? I'll borrow all of my my projected 401K withdrawals (when I turn 67), I'll borrow all of my children's social security payment too! Heck, I'll even throw in a free generation (my grandchild) as interest payment.

Sounds funny? Look into the mirror. This is exactly what we're doing as a nation. And the game is up.

Jan 20 03:31 PM

[rufusmcbufus:]

Wait a second...exactly WHAT was wrong with letting Lehman go under? The world is still here. If anything, it has been the propping of those other zombies that is making this whole balloon take a lot longer to deflate than it should have. Absolute rubbish is your call for for the taxpayers having to take on a single penny of these bad loan losses. Bring on lower prices!

Jan 20 03:45 PM

[Moon Kil Woong:]

When Countrywides old CEO started a buying distressed mortgage business funded by government backing you should hear alarm bells going off. The profit is siphoning down to the same guys who created this problem. In fact the government is buying toxic assets at a premium then selling them to others at the same price premium but with a full government guarantee. So basically they are selling them at a discount to what they are now (safer than most corporate debt). They are getting ripped at both ends of the deal.

Yum yum, the crooks rule once again. No rules, no regulation, no oversight, no reporting, no accountability, and no reform. You got to love it. Bernie Madoff is a saint compared to these guys. $50 billion is chump change in the whole scheme of things.

Jan 20 03:55 PM

[a believer:]

constructe-
The crooks have just found a new, easier and *better* way to steal called TARP. Forget writing liar loans - that was WORK!

Jan 20 05:13 PM

[a believer:]

So, lets take this to its logical conclusion. The bankers goal is to create more and more IOUs, inflationary. When I pay off the loan, neutral - neither inflaties or deflates. If I default because my house value dropped and I lost my job that act is deflationary because the debt money is no longer anywhere in the system.

However, if the debt money that disappeared due to my default is reimbursed to the bank by Treasury, my IOU was just transferred to Treasury in a different form - it is no longer I who owe the money but Treasury to the bondholder.

So, TARP translates a percentqage of the banks mortgage IOUs into Treasury IOUs, the PONZI scheme lives on! Treasury cant pay the IOUs without fresh bond sales. Down the road, there must be a huge increase in T-bond sales to pay off the existing IOU obligations!

So what will happen when the sales volume will not cover the redemptions? A major decrease in bond prices resulting in inflation! The Treasury bubble is real, just a matter of time.

Jan 20 06:29 PM

[Simon Smelt:]

Government puts new money into a business in order to rescue it, but then subordinates its claims to the old money being rescued. As Whitney Tilson says, this seems ridiculous and amounts to the prudent majority funding the imnprudent minority.
BUT, three possibly sensible reasons for doing it with the big banks:
(1) The government is desperate to retain a private ownership structure, as management by politics is bad news. Keeping a private ownership structure may help attract capital when (if) the market recovers.
(2) Nationalising one bank and letting private equity and debt owners take the hit could trigger a rush for the exit by such owners with other banks (which is sort of happening anyway).
(3) Overseas interests that would lose out also have very large hoidings elsewhere in the economy. They (China, Saudi) are in position to threaten the U.S. government though, if they took action against the U.S., it would also hit them. There appears to be debate in China currently about how aggressive to be with the U.S.

My guess is that it is a mixture of all three factors, rather than cronyism, that's behind current policy.

Jan 20 07:43 PM

[Prof. Samue...:]

It is a tragedy when an individual borrower defaults on the mortgage and loses his/her home. The tragedy is magnified when the borrower is a small business owner, employing from 1 to 10 employees. The loss of jobs related to mortgage defaults and the resulting business failures will further weaken our economy and prolong the recession.
President-Elect Obama is planning to use the TARP funds for Foreclosure Relief. I would like to “sound an alert” that there should be a focus on a group who is especially vulnerable to Foreclosure and whose failure will result not only in loss of home, but also result in millions of lost jobs. I am referring to the millions of Self-Employed Small Business owners who are at-risk of default, foreclosure, and business failure.
A recent national survey determined the extent of involvement of this segment of the small business community in the risky “Toxic” mortgages that are expected to “reset” in 2009, thereby resulting in the 2nd “Tsunami” Wave of Foreclosures that will dwarf the Subprime Mortgage Crisis.
On December 14, 2008, CBS’s “60 Minutes” had a segment on the 2nd Wave of Foreclosures. CBS indicated that experts were expecting another wave of mortgage defaults on ALT-A and Option ARMs mortgages which will dwarf the Subprime Mortgage Crisis. CBS MISSED A VERY IMPORTANT FACT!
Many fail to realize that there are millions of self-employed smaller businesses that are holding these “toxic” mortgages that are going to reset in 2009 through 2012. These borrowers are Prime and Near-Prime borrowers who hold ALT-A, Option ARMs, Interest-Only mortgages. There are $1 Trillion ALT-As, and $500-600 Billion Option ARMs.
So, here we have a major problem. Not only will these small business owners lose their homes, but there will be the resulting JOB LOSSES on their business failure. Although President-Elect Obama is stressing the need to create 3 million new jobs, we must understand that JOB RETENTION IS AS IMPORTANT AS JOB CREATION.
I authored a survey which was conducted by the National Association for the Self-Employed (NASE) to its national membership. The NASE survey is at
advocacy.nase.org/rese...
See the NASE News for the Survey on Toxic Mortgages. Please read my Commentary.
According to this survey, it is estimated that 3,709,800 small business owners hold Alt-A and other “toxic” mortgages. Of this number, 3 million are “very worried” about their ability to make the monthly payment due at “reset” , and 1,279,800 are already delinquent as they have missed one to three or more monthly mortgage payments at mid-November, before the expected Resets that are scheduled to begin in 4th Quarter 2008 through 2012.
The solution lies in the hands of Congress as they meet in January to structure an Economic Stimulus package. Congress should take note of this survey and be “proactive” in addressing the situation, rather than “reactive” as the case has been in the Subprime Mortgage Crisis.
We can’t afford another shock to our economic system at this time. This 2nd Wave of Foreclosures which will be caused by the ALT-A and Option ARMs will not only result in Foreclosures, but also Job Loss.
I would appreciate if you would bring this info to light in Washington.
Thank you,
Samuel D. Bornstein
Professor of Accounting & Taxation
Kean University, School of Business, Union, NJ
Tel: (732) 493 - 4799
Email: [e-mail]

Jan 20 08:01 PM

[Prof. Samue...:]

Everyone admits that the core of the problem are the "Troubled Assets" or the so-called "Toxic" Mortgages.
The key to a solution to this Economic Crisis is the Borrower’s ability to make the monthly mortgage payment.
This reminds me of a quote from Winston Churchill in 1943..."Never before have so many owed so much to so few".
The simple fact is that the underlying assets of the Mortgage Backed Securities and other related investments are the "Toxic" Mortgages.
Everyone is betting that the Borrower will default and that foreclosure will follow. The key to increasing the valuations of these securities is the Borrower's ability to avoid default.
The Borrower's track record is poor. Note that after loan modification, the Re-Default rate is 60% within 6 months!
The Borrower's failure is to be expected. After all, the borrower has no "understanding" to make informed financial decisions. He is like a "boat without a paddle". How can he deal with his complex financial environment? He is like a "Prehistoric Man" in a "21st Century body".
No Loan Modifications or Bailouts will work unless we address the cause of our great financial crisis…The Borrower has no concept of managing his/her money. Bailout will not work. It is similar to taking a "drug" for an illness. Sometimes the "side-effects" are worse than the disease. Sometimes proper "diet and exercise" will cure the disease without complications. That is precisely what we need now. A "natural" cure, not a "drug".
We are "up against the gun". There is not much time to embark on a so-called program of Financial Literacy, which has been proven to be a complete failure. The Gov't has spent millions on these Financial Literacy initiatives that simply disseminates "information". What is needed is an initiative to help the borrower "understand" how to manage money and avoid the pitfalls that have previously caused financial distress.
The solution is a program of "Immediate and Specific Financial Guidance" that will help the borrower "naturally" be able to make the monthly payment, without "bailout" or extensive loan mods which have proven to be a failure.

Jan 20 08:02 PM

[John Whelchel:]

Assume that all bank debt but the senior debt is wiped out as you suggest. What will the effect on the financial system be of the payments required on outstanding credit default swaps with regard to that defaulted debt? The exposure on the credit default swaps with respect to this debt may be many times the principal amount of the debt, as there was no limit on the positions that could be established with respect to the debt, and there is no central record/clearinghouse of these positions. Won't the required payments, which may be huge, spread insolvency through the system?

Jan 20 10:11 PM

[Jet Pilot:]

iThinkBig:

Isaiah 60:1 !

I looked at you website, I agree with you 100%. Right now the systems of this earth are being shaken. Jesus is Lord!


On Jan 20 12:36 PM iThinkBig wrote:

> Your screen name denotes the Year of Jubilee in Israeli culture.
> This seven year forgiveness system of debts worked very well, but
> the culture built it's economy around that event. This would not
> work in the U.S. at this point for too many reasons to list. I also
> liked the Israeli judicial system of governance and a tithe system
> of 10%. How did Israel get so wealthy by King Solomon's day without
> fractional reserve lending?!? LOL.

Jan 21 05:20 AM

[Jet Pilot:]

"If the American People ever allow banks to control the issuance of their currency, the banks and corporations that will grow up around them, will deprive the people of all property, until their chidren wake up homeless on the continent their fathers conquered" - Thomas Jefferson

This is the greatest heist, of all time - and you know who's doing it!

See also Revelation 13:16-18

Jan 21 06:14 AM

[Allen Charles:]

The Worldwide DEBT is the problem.

The best solution for the present economic crisis would be a REBOOT or restart of the entire debt system for the ENTIRE WORLD.

1. A data base listing ALL DEBT, government, business and personal needs to be created. The list would need to list the debt and debt holder with a bank that could make an accounting of the debt. Included would be all national debt of all nations, all mortgages car notes and credit cards for individuals. All outstanding bond and other debt for corporations, The idea is to list ALL DEBT of any kind owed.

2 . Every government on the planet would need to call a special secession of its legislature.
Using the same authority that governments have to use or create FIAT CURRENCY the legislatures and Central Banks need to authorize the creation of ACCOUNT CREDIT in an amount equal to all the listed debts in the world.

3. The Various governments and Central Banking Systems then need to make a accounting change equal to the debt in the form of an ACCOUNT CREDIT or CREDIT zeroing out ALL THE DEBT in the entire world.

The following day the economy of the entire world would restart and the Stock Markets of the world would react to the new renewed capital in the banking systems, the Capitol now available to restart all business and the disposable income to the individual people would restart and grow the retail sectors and the manufacturing sectors of the entire world.
Allen Charles Report
allencharlesreport.blo.../

Jan 21 07:34 AM

[john s. gordon:]

some good insights in this article, especially regarding california
> jack

Jan 21 08:25 AM

[monopoly money:]

Real losses? WRONG! Instead of inept crybaby bankers who created the problem in the first place and are now exacerbating it getting bailout money they should be getting a boot in the a##.

Picture this...you(who has a vault full of money) and your associates(who also have vault-loads of money) control 40% of all the available housing in the county.

Do you A: Cry in your beer and ask for pity?

Or B: Form a plan with your rich buddies to become Ultra-wealthy Real-estate moguls?

Grossly over-paid bank (mis) management made this mess.They shouldn't get paid for making it worse.The problem is seems is that they became multi-millionaire employees without ever risking anything of their
own and never leaner how to run a business.

No Bailout...and No BAIL!

Jan 21 09:50 AM

[MikeW:]

How about this, then: Why not declare null and void all credit default swap contracts that are not held by a holder of a position in the underlying debt, or their counterparty?

In other words, CDSs may have a legitimate purpose as insurance,
but not as an unregulated speculation. We should try to separate
those, and unwind (or nullify) the latter.


On Jan 20 02:38 PM PROXIMO wrote:

> The answers to that question are too numerous to be contained on
> the World Wide Web.

Jan 21 10:27 AM

[Jubilee Year:]

Thank you for your comments, I have tried to address some of them here.


"What level of "moral hazard" would arise from government mandated cancellation of whole classes of debt? "

Jubilee actually has a very low "moral hazard", as it prevents the same problem from happening again because credit would be tight after a Jubilee. Jubilee also dramatically decreases the moral hazard inherent in banking, since the threat of Jubilee keeps the money-lenders in check, preventing them from recklessly gambling with other people's money for their own profit, creating bubbles and crashes the way they have recently (and throughout history when under-regulated).

"The closest parallel would be Russia after the Soviet victory when the workers' paradise revoked all indebtedness. Immediately the was nation plunged into penury."

America's wealth is not based on debt, it is based on capital, skills, knowledge, and initiative. If we cancelled all debt tomorrow, we would still be as wealthy as the day before.

"FDIC is not meant to guard against a complete bailout of every single saving account holder to 250K. This is what a Jubilee would guarentee -- that the FDIC will have to pony up for each savings account, since the bank assert are basically junk in a Jubilee."

Instead of throwing trillions at banks, we would be throwing trillions at individual citizens. That is right, and correct.

"You make it sound as if the credit markets are an expendable luxury. I managed accounts payable for a small warehouse business; believe me I know that credit is essential for any business, small or large."

Operating costs mainly have to be paid for out of cash reserves and cash flow. If a company is a going concern with a valid business model, they will be able to get credit even after a Jubilee, but a Jubilee will force us to switch back to the savings model rather than the debt model of economic growth.

"There'll be no money available anywhere (you just jubilee'd it away!) Yeah, there's plenty of "free and clear" assets sitting around, but nobody have money to lend to anyone else as credit."

Money, even though it is fiat paper, would not disappear. We would still be able to conduct trade with currency. Banks would also be able to lend out what they had in savings, just as they do now.

"If you cancel or default on every debt, then you become untrustworthy. By definition, future interest rate will be either confiscatory (would you want to lend to someone who drops his debt?); or hard to come by."

No one's individual credit-worthiness would be impacted, as Jubilee is a general amnesty. The American federal government would be uncreditworthy, but that would be a good thing, forcing our federal government to keep balanced and backward-looking budgets.

"You are advocating theft on a stunning scale."

Jubilee is the opposite of theft. Jubilee is returning assets to their rightful owners. Bankers don't create wealth, in fact, they are just parasites on the productive economy. Our economy is overrun with parasites right now, and we need to shake them off.

Jan 21 10:53 AM

[Gdub53:]

and Federal Reserve must be abolished and with it the fractional reserve banking scam


On Jan 20 11:47 AM Jubilee Year wrote:

> To Consider_this, I think you are confusing real assets with paper
> assets. In a Jubilee, you get to keep all of your real asset (cars,
> homes, etc). You would lose you paper assets if they involve debt
> to someone else. You would not lose your savings accounts, within
> the 250K FDIC coverage. The banking industries would be hit hard,
> obviously, but could quickly rebuild based on the new spending,
> saving, and investing, as the real economy was jumpstarted. Imagine
> how the economy would take off if no one had any house payments,
> no car payments, no credit card payments, and our gov't no longer
> had to pay interest on its debt. As you can easily see, there would
> be little credit, but lots of savings. Governments would be forced
> to run balanced budgets, as well as a balanced trade account. The
> upside, for just about everyone, would be huge.

Jan 21 11:35 AM

[GloomBoom.com:]

I totally agree. We should not buy these "assets". We have no idea what they are worth. Good luck convincing Obama of that.

Jan 21 12:43 PM

[aware:]

Get the guns and get ready.

Jan 21 02:05 PM

[Chuch:]

Im tired of being pushed into companies I dont want to invest in like GM, Ford, etc. The govt needs to focus on the banks and let companies go under, they dont do the economy any good, look at the loans still due, see here crashmarketstocks.com

Jan 21 02:08 PM

[Phillip Jain:]

1. LEH wasn't saved partly because its surviving competitors with political clout i.e. GS/MS wouldn't have had anything to lose by its failure. Do you think GS/MS would depend on leh contracts? Secondarily, LEH as world's largest bond broker was much more opaque about where its debt was at risk till its dying day i.e. its past sins were so bad that $500b+ were without hope.

2. US cannot write off all soveriegn debt holders of all the crap that was sold to them. To some extent that was done with allowing LEH to fail as it mainly hurt UK & Europe. However, if Mideast & China get hurt they will simply stop buying US treasuries. Without that, how will the US dollar or federal govt fare?

3. Where do you think 'FDIC-secured' bank desposits are right now? Traditional S&L have loaned them out to mortgages,etc. It is all too convoluted, but the deposits aren't just sitting there in the bank vaults are they? So if the 'debt' disappears, maybe so do huge chunks of end bank deposits. Since FDIC has very few assets, the taxpayer directly has to pay out to depositors! This would be triggered by the insolvency of the banks.

4. The 20:1 of BAC or 30:1 LEH leverages required debt from SOMEWHERE! Other debt holders would be corporate treasury portfolios, pension and mutual funds. Again who do you think holds that - mostly 401k salary-earners! Madoff screwed a very wide range from sharkish Real estate speculators to mom-and-pop retirees in Florida. So your pension/401k is on line to quite some degree.

Bottom line: if this $1T debt goes poof very ROUGH guesses are
- 50% of are foreign sovereign debt holders
- 25% are FDIC deposits
- 25% are mutual funds, 401ks, etc....

In other words even if the US pisses off China/Sheikhs, it still has to come up with $250b in cash (not fed funny money) to pay out FDIC deposits.

Also, most people's nest eggs would disappear. If asset allocation is 50% bonds, 50% equities. The bond (debt may be 50% treasuries & rest debt which is wiped out) is then chopped out half of that. The equity side has lost 40%-50% due to S&P500. So the TOTAL net nest egg drop of 40%+. Combine that with losing 1 job per household if things dont 'recover', then the US is looking to a lot of poor retirements!

Panic now, pay off those credit cards, sell that SUV & save, save, save ... ha ha .. not quite YET!

---- Phillip Jain
Above is an extract from my Investing blog at finance.degree7.com

Jan 21 04:42 PM

[prognosticator:]

The reality is the US will print lots of money in the next little while...which will increase inflation...which will increase wages and the "value" of homes (at least in terms of US dollars)...which will actually prevent many of these "permanent losses" from becoming permanent. It may still take a few years, but with a 30% or higher inflation rate, many of these assets will be selling at their previous prices again in a few years. This crisis WILL be solved by creating another crisis - inflation. Bet on it!

Jan 21 05:13 PM

[Harry Tuttle:]

Good article. One problem, there are plenty of people lobbying to save the equity and nobody lobbying to wipe it out.

Thus, the most expedient (and probable) solution is that they will protect equity holders at the expense of future taxpayers.

Since the market is ultimately a perverse mechanism, I believe that, somehow, the scheme will blow up in the administration's face.

People in general think that the government resources are infinite. Bernanke operates under that assumption and Geithner is no exception.

Jan 21 05:17 PM

[nova:]

Jubilee Year wrote:
"Delaying the inevitable, shifting the burden to innocent civilians, destroying our dollar, what is the point of all this?
Instead of dragging this out, I say we speed it up: cancel the debt in one fell swoop and reset the financial system."

This is a terrible idea. It sends a catastrophic message: there is no need for any fiscal discipline. Keep committing crimes again and again and even at a larger scale, and everything will be forgiven.

Enron was just a "dry run" for the present financial and economic catastrophe when NOBODY paid price for their crimes. The major investment and commercial banks and financial institutions committed endless crimes by looting their institutions, their customers, and their shareholders. Nobody went to jail and nobody was forced to return the loot.

This is exactly why ALL bailouts are a bad things.

The objectives of US government and the FED must be
- Preventing systemic collapse by nationalization and restoration of financial institutions with consequent privatization
- Removing and prosecuting top management of financial institutions responsible for financial crimes and their banks failures. Furthermore, these criminal must return their loot and also pay restitution to their victims and to US taxpayers.
- All, even most senior debt holders, must take some financial hits.

Letting bank robbers go free will not restore health to US financial system. It will make the present malignant system even more dangerous.

Jan 21 08:52 PM

[nova:]

prognosticator wrote:

" It may still take a few years, but with a 30% or higher inflation rate, many of these assets will be selling at their previous prices again in a few years."

Well, a 30% inflation will transform the USA in a third-world country with many hungry and starving people and civil unrest.

Jan 21 08:58 PM

[beenburnedt...:]

I wrote my congressman years ago that I would forfeit the entire contents of my Social Security contributions, and my employer's, and my self-employment component, to the federal treasury in exchange for eliminating my future personal SS taxes, and with no prospect of recovering any of its benefits. I still believe that today, and I'm sure the combined value in constant dollars exceeds $250,000. My congressman never responded.

Why don't we all do that so we can deleverage some of this toxicity? It would be consistent with the amount of sacrifice that Mr. Obama is asking each American to donate, and we can return to a simpler time, where we have to save and look out for ourselves and our families responsibly.

Jan 21 11:17 PM

[Jet Pilot:]

"The money powers prey upon the nation in times of peace, and conspire against it in times of adversity. The banking powers are more despotic than a monarchy, more insolent than autocracy, more selfish than bureaucracy. They denounce as public enemies, all who question their methods or throw light upon their crimes. " Abraham Lincoln

Further, Thomans Jefferson said,

"The end of democracy will occur when government falls into the hands of the lending institutions and moneyed incorporations."

"The Bank of the United States (GEE......What Bank is Jefferson speaking about???? ) is one of the most deadly hostilities existing against the principles and form of our Constitution. The system of banking is a blot [defect] left in [unsolved by, and unfortunately tolerated by] all our Constitutions [state and federal], which if not covered [eventually solved and revoked] will end in their destruction. I sincerely believe that banking institutions are more dangerous than standing armies; and that the principle of spending money to be paid by posterity is but swindling futurity on the greatest possible scale."

"It is well enough that poeple of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution by morning" - Henry Ford

Wake up America!

Jan 22 05:54 AM