Barron's Plan to Save the Economy - For Just $200B? 48 comments
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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?
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This article has 48 comments:
I have a slightly better plan:
Convert all sub-prime loans to prime loans (everyone pays the same low interest rate) by having Fannie and Freddie cover them.
What do you guys think?
On Feb 16 03:01 PM tinman wrote:
> Wouldn't it be easier to drop the $200 bn from helicopters? I'm sure
> it would be just as effective.
probably have more hypothesis to end
the subprime mess. 200 billions are peanuts,
look at how much is at risk
Top of the list remains JP Morgan Chase Bank. It held $91.7 trillion, yes, trillion in derivatives in the third quarter of 2007. One year later, it held only….$87.7 trillion! A shrinkage of $4 trillion. Now, JP Morgan’s assets are only $1.7 trillion in 2008, better than the $1.2 trillion they had in 2007. At least one financial institution is getting some benefit from the crisis and US government bailouts, but with a huge risk.
Bank of America was third in derivative contracts in 2007, now is the second. In 2007 its Derivatives were at $32 trillion and in 2008 are $38.6 trillion! its assets were $1.2 trillion in 2007 and $1.3 trillion in 2008, so they increased their assets in only 100 billion dollars ( close to the size of the refined copper market), but its Derivatives rose by $5.4 trillion. Pretty risky.
Citibank is the third now US bank with more derivative contracts and holds $35 trillion in Derivatives, one trillion more that the $34 trillion in Derivatives of 2007. With total assets more or less unchanged of $1.3 trillion it looks in a pretty risky position to me.
thanks Elaine for the data
Doesn't matter. The Fed guarantees the banks, and the GSE's which are in receivership. It's the same pair of pants.
A larger issue is that banks are having a hard time lending as people that want a loan do not qualify and people who can qualify for loans do not want to borrow.
This is a hard reset.
This sets a floor. Mark to market no longer a problem.
As BudH states, gov't can rent out homes to poor. Then, sell homes in 10 years or so, hopefully at a profit but maybe breakeven.
This way irresponsible homeowners who took out loans they couldn't handle won't get rewarded.
I just don't think it's fair. It will encourage more reckless behavior in the future.
There will be no easy solution to this. The underlying economic problem (low savings rate, overconsumption, massive debt) has not even been addressed at all. To my opinion, all tools should be put forth in order to put America back on track for sustainable long term economic growth, no matter its implications on the short term. Or else we are just delaying the shipwreck...
Jay
My gut is that the best thing to do is to take the pain and let the market sort out with a minimum of government involvement. Since that is a pipe dream the only fair way to make corrections would be to do so in ways that are completely evenhanded such as tax rebates proportional to the individuals lifetime tax input or a universal statutory proportional and time limited reduction in all consumer interests rates. Letting the government hand pick winners and losers is an awful idea.
Presenting a simple solution to this massive problem gives their readers hope that this will all be over soon. It won't be.
For example, if I were to sell 100, 100 strike april expiry, put option contracts on IBM at a cost of $9/option... I now have a $1,000,000 obligation in few months time if IBM stays below $100 by expiry. All for a $90,000 premium.
So now what, my asset is $90,000 and my liability is $1,000,000? No.
The $1,000,000 is the nominal value but the asset (options) based on time of trade is worth $90,000.
If i close this trade out by buying back the put options before expiry/exercise, I can immediately close out the $1,000,000 nominal amount and book a gain or loss based on the dollar amount that changes hand on the close.
The example above is only of one type - equity options. The nominal/notional value is small in comparison to swaps where the notional is often greater than $100,000,000 per deal.
You can't simply look at the notional value to determine risk. Risk is far more complex than that - in fact, it is a very gray area that brought us into this mess in the first place. We use quantitative theories to arrive at some formula to calculate a number that can be interpreted in some way to determine how risky something is. If everything breaks down as it did in the sub-prime mess, we begin to question the number, the calculation, the formula, and the theories. This uncertain area is what we should be scared about -- NOT the notional values.
On Feb 16 03:25 PM phdinsuntanning wrote:
> buying Venezuelan sovereign bonds
> probably have more hypothesis to end
> the subprime mess. 200 billions are peanuts,
> look at how much is at risk
>
>
> Top of the list remains JP Morgan Chase Bank. It held $91.7 trillion,
> yes, trillion in derivatives in the third quarter of 2007. One year
> later, it held only….$87.7 trillion! A shrinkage of $4 trillion.
> Now, JP Morgan’s assets are only $1.7 trillion in 2008, better than
> the $1.2 trillion they had in 2007. At least one financial institution
> is getting some benefit from the crisis and US government bailouts,
> but with a huge risk.
>
> Bank of America was third in derivative contracts in 2007, now is
> the second. In 2007 its Derivatives were at $32 trillion and in
> 2008 are $38.6 trillion! its assets were $1.2 trillion in 2007 and
> $1.3 trillion in 2008, so they increased their assets in only 100
> billion dollars ( close to the size of the refined copper market),
> but its Derivatives rose by $5.4 trillion. Pretty risky.
>
> Citibank is the third now US bank with more derivative contracts
> and holds $35 trillion in Derivatives, one trillion more that the
> $34 trillion in Derivatives of 2007. With total assets more or less
> unchanged of $1.3 trillion it looks in a pretty risky position to
> me.
>
> thanks Elaine for the data
Here are the REAL problems:
1. Real Incomes in the U.S have declined since 2000.
2. Consumer Debt skyrocketed beyond anything possibly sustainable to maintain standards of living and these levels mostly still exist
Subprime and "stated" income loans were created BECAUSE of these two problems, they did NOT cause the problem.
It was a mathematical certainty that the economy was going to implode (at some point) because of the incredible growing divergence of income/debt. This type of divergence has never happened before. Essentially, virtually all of the alleged growth since 2000 was based upon paper (leverage). The growth wasn't real and the game would eventually end and end very badly. The leverage simply masked the underlying decay - temporarily. But it is NOT the problem.
Therefore, you can resolve the financial issues (unwinding the leverage and bad loans) but it does nothing to address the real issue - we, as a nation, consume FAR more than we produce and this is why real incomes are falling. If a country consumes more than it produces, there are 2 options for that to continue - savings or debt, both of which are temporary. Since we have little savings, growth was "created" by debt. The other option is obviously to dramatically lower our consumption (standard of living).
In summary, even if 100% of all bad loans are gone, we are still in the exact same box - without the probability of leverage. Meaning unless we have some significant changes that reach far beyond nonsensical stimulus packages that will only slow and mask the decay (once again via debt), nothing has changed. In fact, it will be worse as there will be a tax bill due to pay for it - eventually, further eroding real wages.
In short, this article has a total and complete lack of understanding of the true problems we face. I would expect far more insight from Barron's than a simple mathematical equation to resolve one VERY small piece of one problem. This is exactly why I said many times when this issue first came to light that people were wrong, this was NOT a subprime loan problem, and would not simply be a normal cyclical downturn. It is a severe cyclical downturn caused by the leverage bubble popping that was created in an attempt to maintain standards of living - on top of a fundamental downturn that started a decade ago but was hidden from obvious view. We have to address the fundamental issues or any cyclical upturn will be short lived.
Sorry I was so long winded..... but I thought people FINALLY were beginning to understand that this downturn was not caused by subprime loans which are paltry in dollar terms compared to the bailouts required (shouldn't that be a clue that this isn't a subprime issue???). Obviously there are a few people that still just do not get it.
"Bank CEO' s drop bombshell: Bailout actually not necessary."
bizzlo.com/story.php?S...
If this is not the case, they could solve all problems by
1. Make credit swap market illegal again.
2. Let all current financial institution with credit Swap and toxic assets to collapse
3. Reduce the existing home mortgage rates to 2% for all automatically without requiring refinancing.
4. All new homebuyers will pay 2% interest with minimum of 20% down payment regardless of credit. They must show proof of income only.
Item 3 and 4 alone will reignite the economy instantly within one to two months. consumers will be back buying auto, furniture, clothing, dinning and traveling again...... 63% of USA economy GDP depends on the consumer spending…….while the remaining majority of the 37% is related to housing…..
We all know that, the people in power are smart; they could have done what it takes to solve the financial problems, but Only, if they want to change the situation. The goal is to reduce the rate of economic growth of other countries, lower the USA dept value, and create inflation to indirectly make all homeowners rich again, this is the whole reason for the GOLD bubble that has just started and it could reach $3000 by the end of 2010.
"gov't can rent out homes to poor."
This was stated in several ways by several posters.
Am I the only one to see the oxymoron in this statement?
RENT........TO POOR????????
Ayuh
It is not necessry to eliminate forclosures. Cutting them in half would be sufficient. Borrowers who committed fraud in securing their mortgages could be left out of it and they could suffer the consequences of their actions. Investment and seasonal properties woudl not be included.
The remaining underwater mortgages could have principal reduced to a 90% LTV. But this would be acheived by directing the bank that actually originated the mortgage to take it back and write it down. Then the government would replace the lost capital, by buying convertible preferred stock and receiving warrants sufficient to recover the investment when the bank's share price would recover. Shareholders would be diluted in exact proportion to the excessive or reckless lending that management perpetrated.
However, shareholders would still be better off because the banks would (for the most part) not be bankrupt nor would they need to raise capital in the face of a blizzard of short-selling.
seekingalpha.com/artic...
According to the first chart in his analysis, sub-prime is a problem of the past - option ARM resets pose a much greater problem going forward.
Besides that concern, reading this Barron's piece makes me wish I was profligate in my spending, because I could have bought a house for $250,000 in 2002 no money down, refinanced it at 100% D-to-E in 2006 to pull out another $250,000 (the house being worth $500,000), and then wait for this precise moment when the government would hand me another $125,000 to subsidize my profligacy (the house being now worth $375,000 in this example). I would have had $375,000 of FREE MONEY to spend during this time, as long as I kept current on my ARM mortgage, which will probably never reset due to the next Barron's plan of preventing all future ARM mortgages from resetting, all at the tax-payer's expense.
There is some great, undeniable truth in simply letting markets function without interference.
On Feb 16 03:01 PM tinman wrote:
> Wouldn't it be easier to drop the $200 bn from helicopters? I'm sure
> it would be just as effective.
Not a single one is subprime!
All are due to overleveraged investors.
When we talk of unfettered markets, why not bring up the 18 Fed rate hikes that artificially pushed short term interest rates above long term rates, creating fear amongst many homeowners and companies that their debt service requirements would break them. Had the Fed levelled off at 3-4% in 2005, I doubt we'd be in this situation, and the housing market would have corrected on its own.
Now, the Fed should fix the mess it created. As for someone saying we have too much capacity- the world has 3 billion people living on $2.50 a day or less- let's make it more affordable to use the capacity we have to pay down our debt by making the things the world needs.
On Feb 16 09:05 PM Borscht wrote:
> Give every American taxpayer a CDS proprotional to the tax they paid
> last year. Hand them out on street corners in every neighborhood.
> Don't let the banks have them. Give them to the people who paid for
> them. I'll take some, whatever I'm entitled to.
On Feb 16 03:28 PM gtmcduffy wrote:
> bloggingstocker.blogsp...
>
>
> bloggingstocker.blogsp...
>
>
> seekingalpha.com/artic...
>
>
> Restoring the uptick rule and modifying Mark-To-Market will do more
> for the markets then any dollar spent. And it's free....GT McDuffy
?
On Feb 16 03:28 PM gtmcduffy wrote:
> bloggingstocker.blogsp...
>
>
> bloggingstocker.blogsp...
>
>
> seekingalpha.com/artic...
>
>
> Restoring the uptick rule and modifying Mark-To-Market will do more
> for the markets then any dollar spent. And it's free....GT McDuffy
On Feb 16 10:21 PM meritman wrote:
> You are so right. Why can't the powers that be see this and do it....soon.
>
> ?
How about give money to all those who didn't buy an unaffordable house which they can use as a credit to get a 25% stake in some idiot who did?
Momentum investors follow momentum up AND down. I know investors are not supposed to be emotional but really. Wouldn't you call short selling alot more based on greed and profit motives than investing in a company because you believe in it? Shorting practices do not seem to stimulate the economy very well do they? Funny the economy is stimulated when the stock market is going up but not down so what do all of the short sellers do with their money?
On Feb 16 10:47 PM The AntiCramer wrote:
> What good will restoring the uptick rule do? They banned short selling
> a few months ago. What did that accomplish? Shorts aren't the problem.
> People realizing their investments are worth far less than they think
> and selling is a much bigger issue. Quit blaming shorts.
Huge problem we have right now is the decimation of American wealth thru the stock market in the tune of $12 trillion dollars as of Nov 2008. So much beigger than the $1T subprime market that is supposed to lose $400B. $12T loss among people who are prime producers of goods and services as well as the primary component of the 70% consumer economy. $400B loss from people who have no money in the first place and never was a productive part of that 70% consumer economy. What happens to the economy when you destroy half the wealth of it's productive citizens?
Huge problem we have right now is the crippling 500,000+ lost jobs every month with no solution in sight. If this keeps going on or gets worse; we could be facing civil unrests, street riots, supermarket mass lootings and eventually martial law in 3 to 5 years if left unchecked.
Huge problem we will be facing later this year will be spiraling bankcrupcy filings as company after company starts to crumble under the weight of massive consumer spending contraction. You don't destroy half the wealth of the consumers and not suffer accordingly.
Huge problem we will be facing next year will be the drastic loss of government tax revenue as companies' profit goes to practically zero or negative this year. What happens when your budget was based on $2.2T tax collection of 2007 and it goes down to $1.5T or less while you have to spend a lot more in order to prevent further deterioration of your income? Will the government be able to survive in the long run if we go thru 10 or 20 years depression? Either way, political instability will become severe as the govt fights for it's own life. WW3 may even be the next card on the table 5 to 7 years from now in order for it to get out of this hellhole.
The government needs to find a way to encourage investors to return that $12 trillions back into the economy. Those few investors who were able to withdraw their money at the expense of the great majority will have to re-deploy a major portion if not all of that cash back to the economy in order to prevent such nightmarish scenarios from taking roots thru time and neglect.
Why tackle subprime problems with such vigor when huge problems left unchecked will cripple the whole economy systemically? We all know that unless property prices goes down to sustainable levels; those who would like to buy house and lot simply cannot afford it, specially in an economy on the downward trend.
Rather than subsidize mortgages taken on by subprime borrowers, incentivize investors to purchase these homes through an expanded rent subsidy program which will keep the current owners in the homes, but will guarantee a portion of the rental income stream to keep the investors and banks solvent.
Here's the better plan to save the economy:
www.nnnrent.com/2008/1.../
On Feb 17 11:55 AM jhaus wrote:
> Ex the moral-hazard issue, this plan would work. However, there is
> another, equally effective way which solves a large portion of this
> moral hazard...
>
> Rather than subsidize mortgages taken on by subprime borrowers, incentivize
> investors to purchase these homes through an expanded rent subsidy
> program which will keep the current owners in the homes, but will
> guarantee a portion of the rental income stream to keep the investors
> and banks solvent.
>
> Here's the better plan to save the economy:
> www.nnnrent.com/2008/1.../
As good as this sounds to homeowners underwater, as someone who owns property that is not underwater, I find any such proposal morally repugnant. But, it is a less-evil solution.
On Feb 16 11:35 PM constructe wrote:
> If you are giving away free cash shouldn't you reward those who were
> prudent, not those who weren't?
>
> How about give money to all those who didn't buy an unaffordable
> house which they can use as a credit to get a 25% stake in some idiot
> who did?
what happens if they take just a 1% loss of the notional values? THE END