Curing the Credit Crisis: A Better Alternative Plan

by: Avery Goodman

Once again, the index ETFs (Dow (NYSEARCA:DIA) and S&P (NYSEARCA:SPY)) fell yesterday, showing the extreme skepticism that investors have about the wisdom of the bailout plan being presented to Congress by the Bush Administration. Federal Reserve Chairman Ben Bernanke went “off script”, during his testimony before Congress. He admitted that he and Secretary of the Treasury, Hank Paulson, want to buy toxic mortgage paper at full price (see here). However, he failed to mention that much of the toxic paper consists of subprime mortgages with default rates at high as 41.6%. Is it sensible to pay full price for such worthless assets? It is not likely that the U.S. taxpayer has any chance, whatsoever, of recouping such a price, if it is paid for such investments.

Bernanke’s slip, however, helped us a lot. At least, we now know that what the Bush Administration really wants is more crony capitalism. To get it in place, they are engaging in fear mongering in Congress, pressuring the people’s representatives to pass a hastily drawn, poorly thought-out bill with few if any safeguards, and even fewer chances of success. They want to avoid judicial review because, if it exists, they will be unable to reward friends and punish enemies in the course of allocating the big giveaway. This is the Bush Administration’s answer to the credit crisis.

In truth, there is no complete answer. The things that were done to destroy the stored value of trillions of dollars of hard earned money can never be undone. Inflation will be the inevitable result, in the long run. Whatever we do now, we will take it on the chin. We need to grit our teeth, and bear the unbearable.  

But, before we do, we must see the ideas, presented by Paulson and Bernanke, as bankrupt, as being as bankrupt as the financial institutions they want to help.  We cannot easily forget that Hank Paulson presided over Goldman Sachs, during the heyday of production of the very same toxic securities that are creating this financial collapse. He exited Goldman Sachs (NYSE:GS) with some $500 million in his pocket.  After he left, Goldman went on to embark on a Machiavellian course of conduct, buying hedges against what they knew would be the inevitable demise of those toxic instruments, and that is why the company is now doing better than its peers. 

Does anyone doubt that part of Paulson’s cash came from profits generated by creating toxic debt instruments? He showed no foresight while in charge of Goldman Sachs, and his “plan” to save us from the credit crisis shows no foresight now. Both Bernanke and Paulson have exhausted their credibility and, hopefully, their political capital. Let’s recall that Hank Paulson is the very same man who assured Congress that if he had the “bazooka” in his pocket capable of bailing out Freddie Mac (FRE) and Fannie Mae (FNM), it would never be used. Two months later, he was using the bazooka. He has already put $5.2 trillion worth of extra debts on the backs of innocent American taxpayers. Now, he wants to increase that burden.

We are a great nation, with vast human talent, creativity and resources. Now is the time for this greatness to manifest itself. We must harness and mobilize all those who love their country, and don’t want to see it ground into the dirt by a few short-sighted greedy men.  This is no time to abandon the principles that made our nation great. It is no time to abandon the advice of our forefathers who conquered this wild land, and made it a beacon of light for the rest of the world. It is no time to adopt socialism as a way of life.

We cannot allow our government to be turned into a socialist state that micro-manages the economy and tries to centrally plan everything. That system was proven to be a failure by the fall of the former Soviet Union.  Yet, our perilous times require fearless action in the face of multiple fears. This is no time to be afraid, but we cannot help but be. We should not, however, fear for our long term future. We are a great nation, and we will continue to be. That much will never change, unless we allow our insecurity to conquer our senses, and pass into law the type of foolishness that is now being presented to Congress.

Our future will come to us, no matter what we do. But, we can travel forward, and defeat the enemy if we embrace a solid conviction that this battle can be won. With resolute firmness and strength of character, our nation can pull ourselves out of this abyss, as we have done many times before. But, in our travels forward, we must be careful to stand up for what we believe in, against those who would turn the nation into a machine that generates money to bail them out of the just rewards they must receive for their greed. We must stop privatizing profits, while socializing losses.

Here is an alternative plan that will work far better than the one being presented by the Bush Administration. The FDIC will protect against bank runs. Innocent little people, who have done no wrong, have a right to be bailed out by contractual promises made by the agency, when it was created 84 years ago. But, the FDIC needs to do more. It needs to guarantee ALL deposits, no matter how large, not just $100,000 per depositor. That will instill the confidence that we need to go forward. 

More than anything else, the government must start being honest with the people. The FDIC, for example, holds a vast quantity of information about the financial stability of the nation’s banks. That information must be made public in the following manner:

  1. Release the names on the “failing bank” list before the banks fail;
  2. Expand the list to include all banks that are shaky, not just the ones that are going to fail within the next month;
  3. Release this expanded list to the public. 

People will then know who is solvent, and who is not. They will shift funds to the solvent banks. They will stop doing business with the insolvent banks. The insolvent banks will fail. Strong banks will buy their assets and deposits. To facilitate this process, the FDIC can be recapitalized by the same $700 billion that the Bush Administration now wants to use in subsidizing its friends. It is likely that this amount will be more than adequate to cover all losses, but if it isn’t, we can expand the amount.

My plan will insure that the foolish executives who caused the crisis, and the underlings who helped them, will all be punished. They will quickly find themselves unemployed. Bankrupt banks will not have money to pay golden parachutes, so even the bad actors who have been removed from office will also be punished. There will be no bank runs, because FDIC will bail out depositors, even deposits over $100,000. Valuable assets will be purchased by shrewd bankers, at institutions like U.S. Bank (NYSE:USB), Wells Fargo (NYSE:WFC), and a host of community and regional banks that never engaged in foolish lending. Good banks run by good managers will reap a rich reward, vastly expanding the franchises. A solid and solvent America will regain its footing in the economic universe.

Wall Street, of course, will suffer badly, but so it should. It caused the problem, and it should not escape the cause and effect of its actions. Wall Street players should not expect to be rewarded for misconduct and/or outright incompetence and stupidity. Stocks, generally, will drop sharply. However, they will eventually rise again. The slow death, by a million little pinpricks, which we are now experiencing, will end. The economy will eventually heal, and normal banking will resume. At that time, we can consider whether it might be wise to return to the gold and silver coinage standard (no paper money), that was written into our U.S. Constitution by our Founding Fathers, and studiously ignored for 227 years.

Disclosure: none