Barron's Plan to Save the Economy - For Just $200B?

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by: SA Eli Hoffmann

Barron's cover this week is devoted to a surprisingly sparse plan - The Barron's Plan - which it purports will "fix America's financial system and pull the U.S. out of recession." Quite a lofty goal.

If you - and the markets - thought Tim Geithner's financial rescue plan last Tuesday was a little thin on the details, The Barron's Plan is downright emaciated.

Here goes:

1) Take $200B of TARP money and give it to banks and financial institutions that hold subprime-related debt, on condition that they use the money to shave just under 25% off the principal of the some $850B in outstanding U.S. subprime mortgages.
2) Oh wait, that's all.

Barron's notes that by reducing the amounts subprime buyers owe to banks, homeowners' monthly payments would drop:

This would give homeowners in the subprime category a better chance of repaying their mortgages, and in many cases it could put their principal amount below the current market value of their homes, reducing the temptation to walk away from their obligations.

That makes sense. Last week a similar idea was floating around Capitol Hill - subsidizing mortgage payments. Barron's plan, though, is far more 'comprehensive.' Apparently you wouldn't need to apply for help or prove that you can't keep up with your payments. Just submit your subprime mortgage contract (you know, the one that has 'subprime' stamped on the file folder), and you get a break.

And how will this relatively inexpensive plan "fix America's financial system and pull the U.S. out of recession"?

The plan helps the banks and other mortgage holders by giving them funds that could be used either to invest in the credit markets, make new loans or absorb the losses required to sell off the toxic subprime mortgage assets. Banks could also use the funds to offer relief to troubled borrowers who have prime mortgages. All of these activities would bolster the economy.

The TARP recipient banks have just been whitewashed, having seen 25% of their (already decimated) subprime portfolio vaporized. Now they're probably happy to do so, because it's ultimately in their best interest to keep homeowners in their homes - at least those whom there's some hope they'll be able to keep up with their (reduced) mortgage payments. And hey, the government's footing the bill, right? To which Barron's suggests some banks might choose to use their money to "absorb the losses required to sell off the toxic subprime mortgage assets." Gee, you think so? Probably more likely than that they'll use it to "offer relief to troubled borrowers who have prime mortgages"? And just how far can we stretch this $200B?

It's no secret the Treasury has not had an easy time getting banks to lend out the first $200B or so of no-strings-attached TARP money Secretary Paulson gifted them with not so long ago. With Barron's $200B funding round conditional on banks forgoing a matching amount of subprime debt, and given the option of using the money to cover their losses, why would we think they would instead "make new loans" and "invest in the credit markets"?

Besides which, we all know why banks aren't lending. It's not tightfistedness - it's prudence. There simply aren't all that many creditworthy loan applicants these days.

It's also unclear how Barron's rescue plan would address all the other innumerable holes in our Swiss-cheese economy. Consumer debt. Commercial real estate. Non-subprime mortgages. Crippling stock market losses. Pension plans saddled with a $445B deficit. Etc.

This is not to say that The Barron's Plan has absolutely no merit. Perhaps using $200B to unilaterally shave 25% off the debt umbrella of so-called subprime mortgages would be a good use of our money (though it's hard to believe doing so without any attempt to ascertain whether the homeowner is in trouble, or conversely very likely to default even after the 25% haircut, is advisable). But this is Barron's grand plan to "fix America's financial system and pull us out of recession"? Do I pay for this magazine?

Help me out here - am I missing something?