Fixing the Economic Crisis in Six Easy Steps

There is a lot of chatter about different plans, market anticipations, and pitfalls when it comes to “fixing” the economy and, specifically, nationalization. Despite the fact that I don’t have the same reach as several uneducated members of the media, I figured I’d share what I think the way forward is, regardless.

Step 1: Nationalize Citi and Bank of America. Let’s be honest, with recent talks of expanded stakes, ringfenced assets, and no end of the losses in sight, it’s probably time the U.S. Government came to grips with the fact that they already own the losses and the positive impact of letting shareholders keep the upside is nonsensical. Further, these institutions will need more money for a long time to come. And, if you’re paying attention, you know that the markets seem to twist and turn with the news coming out of financial institutions. Nationalization rumors depress the markets, talks of further government action scare away new capital, and the fundamental health of these firms makes current investors run.

Step 2: Begin lending. With so much chatter and anger about institutions not lending, it almost makes me wonder why there is such a deep lack of understanding. These sick institutions are trying to shrink their balance sheets and have a ton of souring assets on them. They have to raise capital to support their current asset base, so why do we really expect these banks and other firms to lend? Some would claim that lending for the sake of lending got us into this mess, but they are either telling only part of the story or don’t get it–excessive leverage and poor risk management got us to this point. In fact, I suspect that defaults on even the riskiest loans would be much lower if bank capital was free enough to continue making mortgage loans based on normal requirements for returns and risk/reward.

So, how do we begin lending? Simple, start a government bank. Well, not exactly, but the government now owns Fannie (FNM), Freddie (FRE), AIG (AIG), Citi (C), and BofA (BAC) (see step 1).

Clearly the government already (by step 2) has the infrastructure and technical know-how to manage the logisitical issues of setting up and running a lending platform. Now the government can lend directly and not wait for sick banks to do it. Further, they can underwrite to fairly normal lending standards and get a premium return on their capital. Also, rather than poaching the nationalized entities’ “talent,” the government can employ many out of work finance workers throughout the country (after all, lending in Missouri should probably be done by people in Missouri).

Step 3: Begin replenishing bank assets with new, cleaner assets. With all of these souring assets on the books of banks, their capital base being eroded, and leverage decreasing, TARP capital is probably being deployed very inefficiently and, obviously, conservatively. Well, since step 2 involves lending and creating assets, the government should then implement an auction process–all assets the government creates would then be auctioned off, much like treasury bonds are, to banks. Since the government would be lending based on normal underwriting standards (as compared to the previous paradigm of loan underwriting), these assets would have a strong credit profile and will likely perform much better than legacy assets. JP Morgan (JPM), for example, should jump at the chance to generate higher levels of retained earnings by buying assets when the rates it needs to pay are at historically low levels, once its capital frees up. This solves the chicken-and-egg problem of curing sick banks, hurting from consumer defaults and depressed economic activity, to free up the credit markets and getting economic activity to increase despite a lack of credit.

One could easily permute this plan in many ways. One possible way is to offer to swap new assets for legacy assets at current market levels to facilitate a much more immediate strengthening of the banks’ balance sheets. Another variation could include some partial government guarantee on assets it originates. I’m sure there are thousands more ways one could add bells and whistles.

Step 4: Broaden the Fannie and Freddie loan modifications and housing stabilization plan to the government’s new properties. I suppose this should be some sort of addendum to step 1, but it’s important enough to require some emphasis on its own. With Citi and Bank of America being so large, I’m sure the housing stabilization plan will have a much broader reach once those are wards of the state. We’ve all heard the arguments for stopping foreclosures and refinancing borrowers… When the house next door is foreclosed upon, your house loses tens of thousands of dollars in value, increases housing supply, etc.

Step 5: Break up the institutions that are owned by the government. Markets have been clamoring for Citi to be broken up for years. Bank of America shareholders probably want Merrill to be broken off A.S.A.P. (ditto for Countrywide). Chew up these mammoth institutions and spit out pieces that, in the future, could fail because they aren’t too big. This should be done to AIG, Citi, Bank of America, and both Fannie and Freddie.

Step 6: Immediately implement a new regulatory regime. This is pretty much a “common sense measure.” President Obama has begun to call for this, and it’s pretty clear that with no more major investment banks around, the S.E.C.’s role needs to be re-defined. I’ve already laid out my thoughts on what this new structure should look like.

Between all of these steps, we should have the tainted institutions out of the system, credit will start to free up, the banks' asset base will become more reliable, and systemic risks will go down as we significantly decrease the number of firms that are “too big to fail.” Seems logical to me…

Comments

[Symfornix:]

I tend to dismiss articles which throw numerical bullet points that supposedly 'fix' a problem 'easily' - save it for weight loss scams.

This can not (and will not) be 'fixed easily'. Given your obvious intelligence in these matters, you must know this.

IANAB (I am not a banker), and I know you are offering solutions based entirely within the staus quo; fine. But my 4th grader understands the basic reality here - people messed up with bets consisting of other peoples money (savings, retirement, pensions, etc). Why should those affected be forced to take a job at Walmart through their retirement when (in their view) they were simply doing what they were told? Because they listened?

Fix it by letting these insolvent institutions fail. Stimulate the fallout from this critical action. None of us has a right to place bets for future generations. We must NOT burden our childrens' children by making it their problem - which are exactly the types of solutions being proposed across the board. Todays problems should be (and can be) solved today.

American 'main street' (and I loathe to use the phrase) knows this. There is only ONE other street they know - 'Wall Street' - which they also know is NOT them.

Vote this down, up, or sideways for all I care. People know the truth - they feel it in their gut. Times are going to get rough, and there is nothing the average American feels they can do about it. I see this sentiment everyday, being the owner of an IT services company which services 'Main Street' small businesses (<20 employed).

People are pissed off, want answers, and are impatient. I feel for them, and our children(s children).

Feb 26 05:56 AM

[ironpants:]

Pt 1 - how original.

Want to fix the mess?...

From Motley Fool:

Specific Changes Needed to Fix the Financial Markets and the Economy

The following policy and regulatory changes that Christopher Cox, the SEC, and other regulatory agencies made and implemented from 2004 through 2007 need to be reversed after January 20th, 2009 or immediately. These policy and regulatory changes have destroyed the integrity and reliability of and confidence in our financial markets. The money sitting on the sidelines (approximately $13 trillion) in Money Market and Cash Accounts will not be re-invested back into the markets until these changes have been reversed and the proposed changes below implemented. I am recommending that all of the following policy and regulatory changes be made and implemented immediately by the new Administration:

1. The "Uptick Rule" on all securities (i.e., equities, ETFs, options, futures, and commodities) needs to be reinstated and implemented on all domestic and global exchanges and financial markets. Without the “Uptick Rule” in place, it creates an unfair and imbalanced playing field that favors the short sellers. This gives short sellers the ability to drive stock prices down to nothing. The exchanges are just as guilty and responsible for this problem as all others. The markets/exchanges were not meant to be casinos. New laws, oversight, regulation, and technology needs to be implemented and changed in order to solve these serious problems and abuses and restore integrity and order back to the markets. Get the "Uptick Rule" back in place and the markets will stop crashing. This one item is destroying good, healthy corporations.

2. The new SEC Chairwoman, Mary Schapiro needs to dump or get rid of the Mark-to-market accounting rule now. At the worst possible moment we as a nation chose to alter the way financial assets were evaluated -- through something called FAS 157. We required financial institutions to mark holdings to forced trades in illiquid assets -- mark-to-market accounting. The most powerful critic of this approach was William Isaac, the former head of the FDIC. His viewpoint is that the entire financial crisis -- the destruction of major financial firms, the huge bailouts, the destruction of retirement accounts, and the socialization of private companies -- all could have been avoided with a more measured approach to the needed reduction in leverage. This rule could have been changed by Christopher Cox, Hank Paulson, Ben Bernanke, or even by the president.

3. The SEC under Christopher Cox’s tenure and the exchanges relaxed the dynamic circuit breaker thresholds on all major securities, options, and futures exchanges to levels that are too high and therefore ineffective under current market conditions and volatility levels. The current three dynamic circuit breaker thresholds of Level One (10%), Level Two (20%), and Level Three (30%) should be reversed and reset back to the previous circuit breaker thresholds of Level One (2.5%), Level Two (5%), and Level Three (10%) for all exchanges and markets.

4. All ETFs should have the same SEC/FINRA/CFTC/NYSE/NA... reporting, filing, and regulatory requirements as Mutual Funds. ETFs will need to comply with all of the Rules and Regulations of the Investment Company Act(s) of 1933, 1940, and all their later amendments.

5. All ETFs should be converted back to Closed-End Funds. This means that you can no longer buy/sell/write options, derivatives, and/or short sales on ETFs.

6. All Ultra Short ETFs should be abolished or banned. These products do not perform as specified and their claims are fraudulent. They promote negative price fluctuations and volatility on the underlying securities and indices and perpetuate a disorderly and unreliable marketplace.

Feb 26 06:32 AM

[Roscat:]

You must be joking.

Nationalizing will do nothing to the taxpayers but increase their burden. That includes you too.

So, I sold my shares in BAC and C so you can force them down my throat by purchasing them through the government and then lose even more money because they are insolvent? Let me just say that I don't subscribe to that point of view.

There are old and very good bankruptcy laws that are very alive and well. They were invented in Capitalism. Use them wisely. Take example from Saab.

Regards.

Feb 26 06:57 AM

[Ferdinand E...:]

Sounds to me like Dear John is trying to corner the bad advice market. Even if his recommendations made economic sense, which is dubious, the terminology is wrong. "Nationalization" is not a word that is suitable for prime-time viewing.

Feb 26 08:30 AM

[ROLEXDAYTONA:]

Nothing can be fixed, market will reflect the real economy now, as leverage is closed, now it's real market who goes to zero.
I don't say about up and down moves, in 1930's there were plenty of it, but Wall Street looked then as after atomic bomb attack, people were lucky to get enough calories on their dinner table, nobody even thought about money, it was all about food.

Feb 26 08:37 AM

[Alphameister:]

Open an express lane for would-be immigrants to the U.S. who would commit to buying a house within three months of their arrival. Eliminate mark-to-market accounting for at least two years. Cost to taxpayers: zero.

Feb 26 09:19 AM

[Sailorman:]

Bush, Paulson, Bernake all stepped in to save their buddies from bankruptcy court. That is the only real way to end this mess and solve the issue of valuing the assets for what they are worth. Then the world can start over.

The new rules of the game need to be established first, because the old rules have not worked.

We need to get the whole world into long term investing and stop this day trading casino. Only long term investments give the secure platform for the world's econmies to thrive on!

Feb 26 09:26 AM

[axelrod608:]

Sorry, no sale. People continue to ignore the realities that accompany deleveraging. Assets leveraged at 30 to 1 create $30 in losses for every $1 drop in the asset price. Anyone who thinks there's a "quick fix" or a "simple fix" to the mess we're in is either ignorant or in denial.

The national asset base has shrunk by tens of trillions of dollars. The unwinding is nowhere near complete.

I would make your #6 my #1. Fix the regulatory system first to protect whatever is left of our economy from getting flushed down the toilet ever again by the greedy scum that will do ANYTHING to make a buck.

My #2 would be to prosecute the crooks that originated, bought and sold high risk loans and packaged and resold them as AAA securities. Prosecute the rating agency fools who rated these toxic assets AAA.

If the crooks are not eliminated from the financial sector, they will look for new ways to avoid, skirt and subvert whatever new regulatory safeguards are put in place.

The economy will not improve while the foxes are still in charge of the henhouse.

Feb 26 10:59 AM

[Green Eyes:]

Wow.... please tell me I should read this article with the utmost degree of sarcasm.

Big government is NOT the answer. Every time I turn around the government has their hands in my pockets... I CERTAINLY don't need them cashing my paychecks as well. (as if they don't technically do that, they already take half as it is)

Nationalizing banks is NOT the answer here. The whole essence of freedom and america is to be able to live out a dream and have choices, and have the ability to succeed... OR FAIL. Lately it seems that the world has been so busy teaching their children they there are no losers -- no child left behind, everybody gets a trophy or 'participation' ribbon, and so on -- NO
There IS a first place and a second place. A winner and a loser. The sooner we get back to these basics the better off this country will be. Sometimes you succeed, sometimes you fail. You have to take it in stride, learn from it and emerge better because of it. You don't put your hand out, beg, and suck from the government teet.

Perhaps that's how we got where we are. Ttoo many people forgot that failure is essential to human character. It's drilled into our children in school and in the media that everybody wins..... sorry, they don't.

Feb 26 11:01 AM

[Thomas J. G...:]

A regulator was told directly and correctly that Madoff was a crook and couldn't push it through to a correct concusion. Federal regualators get paid whether they sit in their office or they do something effective. Why is your new regulatory regime more effectiive than the one we've had for the last 20 years?

Feb 26 06:09 PM

[Bar Lock:]

I like your comprehensive approach, especially #5 & #6.

The federal government already has huge stakes in these financial entities and only the federal government has the power to force the breakup of the "to big to fail" into pieces small enough to be allowed to fail wothout dragging down the rest of the economy. Only the federal government has the power to establish and enforce banking regulations that will close down the street corner gambling with strangers these financial institutions were engaged in with derivatives.

The deregulated financial markets have proven unwilling and/or unable to police themtseves voluntarily. Only the power of the federal govenment can create and impose sensible rules/restrictions and restore order to our financial markets, something the "no nationalization" crowd fails to recognize.

Feb 26 06:21 PM

[McPhilip:]

@ironpants:

"6. All Ultra Short ETFs should be abolished or banned. These products do not perform as specified and their claims are fraudulent. They promote negative price fluctuations and volatility on the underlying securities and indices and perpetuate a disorderly and unreliable marketplace."

Reminds me of the routine SKF bashing rants from Cramer. The idea that the products don't perform as specified is simply untrue and reflects a lack of understanding of what it means to mirror the performance of an index on a daily basis. Morningstar, and even ProShares, have released articles explaining how investors should be careful when using inverse ETF products.

I think it's especially hypocritical to call for Ultra Short ETFs to be banned without also demanding the same for Ultra Long ETFs.

Feb 26 06:29 PM

[Larrysyr:]

If the recent stories about Madoff's lack of trading activity are true, all it would have taken was a simple audit step to find that there were no securities to back up the customer statements. Clearly, his "independent" auditor was neither conducting an audit nor acting with any independence. Clearly, the SEC failed to do even a cursory check on his activities.

Without some sort of enforcement against criminal activities such as fraud, we have no markets, only banditry.

I guess this means a lot of people should go to jail in addition to Madoff himself. (Up the river, not up to the penthouse!) We did it in the Enron case. We need to do it again. And we need to take "white collar" financial crimes at least as seriously as we do drug crimes and violent crimes.

Feb 26 06:39 PM

[Guns & Secu...:]

I agree with all of the bloggers before me who said that it is ridiculous that any solution can be a "quick fix". Of course, a problem that has been building over sixty years is going to be difficult solve. But, I can assure you, Americans lending more money to unqualified borrowers is not the answer. Remember, this is the CREDIT crisis, so throwing out more CREDIT for the sake of throwing out more CREDIT doesn’t make a lot of sense to me.

The problem's complexity arises because we as a nation need to deleverage. Our debt on the consumer, corporation, and national level is maxed out. In a best case scenario we would have deleveraged in a methodical fashion, however; pandemonium struck.

Now, with lending decreasing and spending dropping, America's 80% service based economy is unwinding at an accelerating rate (i.e. see job losses). The problem is, the more jobs that are lost, the less services' are needed and the cycle continues leading to more and more job losses. In addition, lenders will continue to tighten up even more, with this activity you can begin to see how GDP could drop more than 8% next year.

To avoid systemic risk Barack Obama was forced to sign a stimulus to help avoid massive unemployment and economic deterioration. One might notice how counterintuitive it might be to borrow more money, to get out of a problem that was caused by borrowing too much money. However, to help avoid collapse Obama's hand was forced. The hope is that we figure something out before the stimulus runs out. Anyone got a stop watch?

In the next couple of years America will need to figure out a new paradigm for financial markets. The next one won't be the orgy the last one was.

The world is changing and we are on the brink. The sooner we as a nation face the problem we are confronted with the stronger we will turn the corner. However, if we continue on the path of excessive spending and lending then we will risk devastation.

Feb 26 06:41 PM

[EEB:]

I just want to comment on step one. On the way home today, I heard on the radio that the government's stake in Citi is now about 40% or will be soon. Does anyone seriously believe that a 40% stake does not make the US government the controlling interest in Citi? Citi has already been taken over by the government. I completely agree that the honest approach would be to simply admit this, take control, and break up Citi into smaller units.

For all of those who propose to simply let banks fail, I would urge a closer study of the depression in the 1930's. After the market crashed, banks started to fail. The bank failures were economically devastating. I don't understand why we would want that to happen again. Some will argue that captialism is superior to socialism, but these -isms don't exist in the real world. There is no 100% free market society in the world, and for good reason. This discussion of socialism and capitalism is frequently used to reach the conclusion that we should never intervene in the "free market." I think that such ideological rigidity is naive. I don't know of any flourishing economy where the markets are not heavily influenced by the existence of many governmental institutions. This has been true of human civilization for thousands of years. In other words, completely free markets are an ahistorical myth. If we need more government intervention in the banking system to stave off a full-blown depression, then I'm all for it. This doesn't mean that I necessarily agree with what the government is currently doing, but I do believe that folding our arms and letting nature take its course will be very, very bad.

Feb 26 07:53 PM

[jeerio:]

most of these "steps and fixes" articles just want to re-create what is now gone. can't happen, won't happen. we need a replacement system (still capitalism, but more constrained due to appropriate oversight which is what allowed this mess to occur).

once we let go of the old system, establish some new core values and see our progress in a different light (not just 'how'd the Dow do today?'), we'll then begin a new adventure that will need all of our creativity and effort to make it work.

it will simply be...different.

Feb 26 09:11 PM

[Moon Kil Woong:]

Sorry, feeding government money to public institutions implies they are already socialized. And as we know by now, socialization doesn't work. They just want more $.

Once socialized they either can't compete making them obsolete, or need special favors (like government guarantees so they can compete unfairly) perverting the free market and exacerbating the problem like Fannie Mae and Freddie Mac. What we need is the exact opposite of socialization.

How we get there without taking the $trillions in losses BoA, Citibank, AIG, and the rest have hidden should be the only question in people's mind.

Feb 26 10:02 PM

[Bar Lock:]

On Feb 26 06:09 PM Thomas J. Gordon wrote:

> A regulator was told directly and correctly that Madoff was a crook
> and couldn't push it through to a correct concusion. Federal regualators
> get paid whether they sit in their office or they do something effective.
> Why is your new regulatory regime more effectiive than the one we've
> had for the last 20 years?

The Security & Exchange Commission is part of the executive branch. Failures in that area rest with the administration they occurred under, wouldn't you agree?

A new regulatory agency that isn't politicized combined with tough new regulations to keep the degenerate bankers from gambling away the stockholders equity would do wonders for our financial system.

Feb 26 10:45 PM

[User 61196:]

The Glass-Stegall Act was incrementally dismantled because financial lobbyists convinced (see contributed to) members of Congress that these safeguards to our financial system were no longer needed. Thereafter, the S & L collapse, stock market bubbles and crashes, predatory lending practices, .......etc. This crash may really be the big one. Look at Glass-Stegall again - reinstate the regs that made our financial system safe and controlled the theivery made possible by deregulation.

Mar 02 11:21 AM