Curing the Credit Crisis: A Better Alternative Plan 27 comments
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Once again, the index ETFs (Dow (DIA) and S&P (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 (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:
- Release the names on the “failing bank” list before the banks fail;
- Expand the list to include all banks that are shaky, not just the ones that are going to fail within the next month;
- 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 $100,000. Valuable assets will be purchased by shrewd bankers, at institutions like U.S. Bank (USB), Wells Fargo (WFC), and a host of community and regional banks that never engaged in foolish lending. Good banks run by good managers will reap a rich reward, vastly expanding the franchises. A solid and solvent America will regain its footing in the economic universe.
Wall Street, of course, will suffer badly, but so it should. It caused the problem, and it should not escape the cause and effect of its actions. Wall Street players should not expect to be rewarded for misconduct and/or outright incompetence and stupidity. Stocks, generally, will drop sharply. However, they will eventually rise again. The slow death, by a million little pinpricks, which we are now experiencing, will end. The economy will eventually heal, and normal banking will resume. At that time, we can consider whether it might be wise to return to the gold and silver coinage standard (no paper money), that was written into our U.S. Constitution by our Founding Fathers, and studiously ignored for 227 years.
Disclosure: none
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This article has 27 comments:
I could not agree more! Transparency, transparency, transparency.
You comment illustrates the thoughtfulness of the American people, and their willingness and courage to think for themselves! It also shows the need to take the time to debate even the best intentioned rescue plan, in order to make sure it is workable and wise, rather than ramrodding it through Congress.
Rather likely it is true because when the 700 billion US$ are used to buy the stuff at market value, record losses have to be taken...
To be honest, your plan makes a lot more sense compared to what debt huggers Paulson and Bernanke are doing. Therefore it will not happen (the Americans themselves allowed Wall Street to suck up all this power all these years and their political system is from 5000 BC so it will not happen).
This author mistakes "par value" with Bernake's reference to "hold-to-maturity pricing”, which will be much less than par value, but perhaps above the fire-sale price. Deposit protection is clearly not the core issue in this crisis, although the FDIC may have the answer to solving some issues. We don't have a depositor mess, we have a capital markets mess. The author provides more divisive ranting than real solutions in this article.
Look at the quote that Goodman himself points us to above: "In subsequent questioning, Mr. Bernanke distinguished between, on the one hand, “fire sale prices,” the ones that prevail “when you sell into an illiquid market” and, on the other, the prices that holders think the assets are really worth, sometimes described as “fundamental” values or “hold-to-maturity” value."
Fundamental value is not full price, as the article says--it is what holders think the assets are really worth! Goodman, get a clue, and research before you write. Paulson talked about yield to maturity and fundamental values, which you should understand before you fly off the handle and reveal your total ignorance. Next time, please try fair and accurate reporting??
The Fed and Treasury are not trying to turn the US into a socialist state, so get off your soap box. You don't seem to realize what could happen if this plan doesn't go through--you obviously don't understand that the events of last week were pushing our financial system to a high probability of something looking like a severe recession or another depression. If we don't do something quickly, that is the distinct possibility we face. I'm not willing to take those odds and that kind of worst case scenario, are you?? Get real.
These people are liars and theives !! But they look nice in there $3,000
siutes !
Let the smart banks buy the bad mortgages at 20 cents on the dollar and negotiate with the homeowners to reduce their mortgage to 30 cents on the dollar. If we buy bad mortgages at face value we will continue to have foreclosures and fat bankers.
I disagree. It is clear from what Bernanke said, that the Treasury intends to pay very near full price, if not full price. You ought to do some research yourself.
The Federal Reserve has already been paying very close to full price, with respect to very similar mortgage backed securities that Mr. Bernanke has polluted its balance sheet with. They take a very small "haircut" to the par value, but it is insignificant compared to the nature of what they have accepted in exchange for good collateral in the form of Treasury bills.
We must not rush out and do the first thing that comes into the minds of Paulson & Bernanke. They have both already been proven to be wrong, time and time again. There is no reason to believe they are correct, now. They had 1 year and 2 months to come up with a well planned vision of what to do, and to bring it to Congress. Why, then, the rush?
The problem is that they had no vision, then, and they have no vision, now. Their "plan" is is just plain wrong headed. Far more permanent damage will be done by rushing into throwing away $700 billion, than can possibly be done by debating the issues adequately.
There is very little liquidity in today's banking system to handle those kinds of runs. Banks are being required, in the immediate term, to de-leverage, which means they need to reduce lending. The only way to prudently de-leverage is to raise capital through earnings, offerings and as the loans payoff. The Paulson plan, while not perfect, would give banks the time for that to work. By all means, let's not overpay for the assets or allow the greedy executives windfall gains. But restoring liquidity is paramount.
Moral hazard is not only theoretically bad, but it also can cause recessions and depressions, both inflationary and deflationary.
Anger and resentment by the majority of the population must be capped by appropriate remedial action to insure that those who caused these problems do not walk away "scot free". If that is allowed to happen, loss of faith in our way of life will course through the population. Faith is what determines, ultimately, whether or not there is recessions, depressions or boom times, not the mathematical amount of money that we throw at a problem. Indeed, money is merely an abstraction, representing storage units for past work that give you the right to purchase someone else's work in the future.
Loss of faith will torpedo the American economy more thoroughly than any amount of bailout money can fix, no matter how we give it out as gifts to financial institutions or others. You cannot simply throw money at this problem and hope it goes away, as the Bush Administration apparently wants to do.
This problem needs to be solved in a way that appears fair to the American people. That includes fixing blame upon the guilty, recognizing incompetence, and insuring that there are some consequences for bad or inept behavior.
I do not claim to have the perfect plan. It is only a framework for an alternative. Some comments to this article are very good, and could improve the basic concept. However, simply printing and then throwing money onto a problem, like this, without imposing any consequences, subsidizes of incompetence and malfeasance. That will injure the soul of our nation a generation, or, maybe, longer.
"To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures". Nothing about Gold.
The problem is the Paulson plan gives more cash to banks that aren't lending what they have because they are afraid they won't get paid back. We should be creating effective demand for loans instead of transferring paper around.
If all the instruments created from these home loans are honestly priced, the financial institutions holding them should have no reason to fail. Of course, if they are not honestly priced, and if they are highly over-leveraged, then guaranteeing the home loans would not provide 'cover' for that. And, those financial institutions making such foolish investments would and deserve to fail. New financial institutions would surely be formed, ones that operate on sound economic principles. So, the whole episode would work the way economics is supposed to work, weeding out the bad banks and investments banks, and creating new, sound banks in their place.
Ceo Pay caps, Golden Parachutes , Taxpayers getting a equity stake in companies they help , only giving Paulosn 150 Billion and seeing how that goes ,, NOW today behind closed doors they give the Republicans EVERYTHING they Want, Basically NO Real conditions at All Just a little wondow dressing with no way to enforce any of it ! So NOW the Taxpayer Will Be stuck with a HUGE 700 Billion debt it will INCRESASE Taxes on EVERYONE course if Your a working man they can get at your taxs through payroll alot easier then the Rich guys . Franks is a WIMP he caved in ON EVERTHING . And were Will the $700 Billion come from? China at 10.5% a year interest that $70 Billion a year . And the Bank stocks are SOARING they Love it Paulson and Bush are going to give them almost Full value for there bad debt and TRY and sell it maybe they'll get 20 cents for what the paid 80 cents for .. Wall Street is partying right now. So John McCain rode into Washington and SAVED America , John McCain couldnt Find the Bathroom on his own !! And What of Obama ? He's there too I guess he's VOTING PRESENT !
Im NOT Voting this year, Let The DEMs stew when Mc Cain wins they better NOT Ask Why , because they CAVED into the Republicans AGAIN they have NO BackBone. Copy this and send it to ALL Your Friends so they know How The Democratic Party SOLD OUT MAIN STREET America and the little guy .
J.Masters
I think you are using highly inflammatory political assertions that have no basis. You say that Paulson and Bernanke have been proven wrong time and time again, but you fail to back that up with any facts (and your other facts are often colored by your personal beliefs anyway). You say that Paulson has already paid full price, and yet Paulson has done nothing but guarantee securities at Bear (which to my knowledge has cost the Fed nothing so far, and may not cost a dime, depending on how this economy pulls out of the current situation), and guarantee Freddie/Fannie obligations (which again have not cost the Fed a dime yet, and may not, but no one knows). There is a big difference in a guarantee and a purchase, as you know. I'm not a Fed employee defending the boss here. I have stated publicly and privately that Paulson's plan is imperfect. I agree that public discussion is positive. But standing on your soap box making empty, inaccurate, and inflammatory assertions about big giveaways, crony capitalism, the socialization of America, etc, is completely unfounded. Another great example: you highlight Goldman's "Machiavellian course of conduct, buying hedges against what they knew would be the inevitable demise of those toxic instruments." Why is this Machiavellian?? Goldman was among the few firms that knew the risks to these instruments if the real estate market went south. Understanding finance and buying hedges against any type of investment is simply sound business practice and evaluating risk/reward, nothing else.
Blame should be fixed on guilty parties (after we fix the current problem of market lock), and those guilty parties include everyone up the ladder of homeborrowing--from the borrower that borrowed more than he/she could afford to the bank that made the loan despite knowing the lender couldn't afford it, to the bank regulators, to Congress and the banking oversight committees that sought to maximize home ownership regardless of the consequences, to the Wall St. banks that securitized loads of junk, to the Fed and the SEC, and to the investor that bought the junk. It should be clear many people were asleep at the wheel along the entire chain. More important than fixing blame, we need to correct the system to avoid future repetition. Eviscerating Paulson and Bernanke for trying to fix the problem as best they can (when the situation calls for swift action, not weeks or months or public debate) when NO ONE has a crystal ball and no one is omniscient about the ramifications of any plan seems a very big stretch to me--especially when your background is in law and not finance or economics. It is clear to me and should be clear to others that you have some sort of personal agenda and/or vendetta (on the Obama payroll perhaps?), and that you are not being objective here by any stretch of the imagination. As such, readers should consider your skewed assertions accordingly and move on. As will I.