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How to Spend $700B and Actually Solve the Problem

by: Diane Ritter September 25, 2008 | about stocks: AIG / BAC / GS / LEH / MER / MS / XLF    

Diane Ritter

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If you're willing to spend $700 billion dollars to solve this problem, take that $700 billion that Paulson wants to pour down a rat hole buying bad debt, and spend it setting up 50 or 100 new, good banks, with adequate capital, and let them begin lending to all of the credit worthy borrowers in the US that can't get credit from all of these crippled, dying banks. With an equity stake of course, so the US taxpayer can get well after this crisis is over. Or let there be a reverse auction to find the 200 or 1000 strongest banks in the country, with the cleanest, strongest balance sheets, in each region, and inject equity capital into them. Congress ought to like that, since the most effective way to short circuit the recession would be to identify the BEST banks in each district, and inject $700 billion dollars worth of equity capital into them.

And then stand aside and let the terminally crippled banks fail. If there are one or two companies that really truly must be saved, like AIG (AIG), to avoid a systemic meltdown in the derivatives market, then let Paulson, or his successor, come to Congress and make his case and ask for funding to support that company. And, hey, maybe he could get his act together a little bit and figure out more than a day ahead of time that something needs to be done. The best thing we can possibly do for the stock market and the credit market is to identify now and very publicly which companies the United States will stand behind and bailout if necessary, and which ones we won't.

But the most important thing to realize is that we can't save them all. And we shouldn't even try. It would be stupid, short sighted, and counterproductive to do anything of the sort. It would make our country economically weaker, it would make our country fiscally weaker. And it would make the recession much longer and deeper than it otherwise would be. If you are in any doubt about this, go take a look at Japan, and what happened to them when they tried to save their weak banks instead of letting them fail. And, hey, it would also be morally and ethically sound.

But not one thin dime to bail out the irresponsible, profligate lenders (or borrowers) who got us into this mess.

Disclosure: none

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This article has 33 comments:

  •  
    Sep 25 08:42 AM
    This reads like a dose of common sense! Which means it just wont happen because its in the hands politicans(a.k.a. Congress).
    Reply
  •  
    Sep 25 08:44 AM
    I like these ideas. I've read a lot of blogs over the past few days on the Paulson plan and I'm seeing so many ideas that are better than what we'll probably end up doing.
    Reply
  •  
    Sep 25 08:48 AM
    Diane plans seems more appropriate than Paulson's. However, with so much vested interest bailing out buddies out there, they won't consider other better alternatives.
    Reply
  •  
    Sep 25 08:49 AM
    Although your proposal would make sense it would never work. They (Fed and Treasury) aren't join at the hip to any cronies at those other banks you are talking about. Be realistic this is all about patronage so unless you got some sort of a proposal that does that? Oh wait there is one proposed isn't there...

    I've seen a number of comments about fascism thrown around lately and I think it worth quoting Benito Mussolini "Fascism should more appropriately be called corporatism because it is the merger of state and corporate power. "
    Reply
  •  
    Sep 25 08:50 AM
    brilliant idea but this mess is so wide spread that providing credit only will not solve the problem. I think the choices are limited to just save the situation from disaster. And dont forget to punish those who got us into this massive mess including the ceos, the regulators and the works . They should have to pay in $ they made or unethically earned.
    Reply
  •  
    Sep 25 08:59 AM
    riiiight. And the foreign bondholders, and foreign Treasury holders are going to take their lumps AND buy yet more treasuries.

    How about the Fed and Treasury explain truthfully that they are going to buy up MBS, CDO's et al. Try and find the good the bad and the ugly. Resell the good, keep the bad, and let the ugly blow up on their own turf. They will buy and sell up to 700billion dollars worth rotating them until they get through the mess.

    In return foreign holders won't dump Treasuries or other Bonds, sending the US into a massive depression instead of a very deep recession.
    Reply
  •  
    Sep 25 08:59 AM
    I still haven't heard one proposal to "stop the hemorraging" by suspending for ~12 months SARBANES/OXLEY & FASB 157. These are the accounting pressure points which have caused Assets to be driven down nearly to zero. Not because they are worthless--even Paulson admits that! But because of CYA of Exec's forced by auditors/accountants to "Mark-to-Market&q... [FASB157] assets with undeterminable value. Add SARBOX which makes O/D "personally" liable for financial misstatements, and the death spiral is greased. Naked Shorting accelerated the process downward.
    My analogy is a patient in the ER with a gaping wound, hooked up to a 10 gallon sack of blood for transfusion, but the doctors not repairing the wound....................
    America is great at throwing money at a problem, but real solutions seems to escape our brightest in DC!!!!!!!!!! What happens when the hospital runs out of blood????????
    Reply
  •  
    Sep 25 09:06 AM
    Isn't it ironic. Enron manipulated mark-to-market to create an overvaluation of its enterprise. Now mark-to-market is the cause of a devaluation of financial institutions. Things could be worse though - there might not be a level 3 categorization.
    Reply
  •  
    Sep 25 09:26 AM
    Gingrich has been thumping on getting rid of Sarbanes-Oxley:

    blogs.abcnews.com/poli...

    I'm a bit mixed on that, but it's a better idea than what Paulson is floating. If, as the advocates of the Paulson plan claim, the problem is that mark-to-market rules have required writedowns to an unnecessary extent, then the solution would seem to be to repeal or modify those rules. I don't buy into mark-to-market being the main culprit here, however. And even if it is, the institutions that own the assets are probably going to have better knowledge about which assets are "overvalued" and which ones are "undervalued"... on the books --- hence, they're going to get rid of the former and keep the latter.

    I would like to see SarbOx get re-evaluated, though, mostly because it imposes too high costs on small businesses.
    Reply
  •  
    Sep 25 10:04 AM
    I'd like to float "A Modest Proposal." For $700,000,000,000 (it DOES look pretty big with all those zeroes actually written) the government could go a long way toward paying off those shaky mortgages underlying this mess. That would take the pressure off the banks. Think about it.

    The social consequences would be horrendous, and it's pretty obvious that there would be an artificial boom that would make 1999 look tiny. So maybe a few less hundreds of billions might be a better number: saving money on a bailout isn't bad.
    Reply
  •  
    Sep 25 10:04 AM
    I understand that the problem is basically homeowners who must default on their mortgage payments. WHY? Obviously, the homeowner is either laid off from his job, or the interest rates on ARMs has gone thru the ceiling. Use some of this $700B to work with the homeowner to reconstruct their mortgages so they can continue to stay in their homes by changing the type of mortgage to a fixed rate at a rate originally contracted, and secondly, extend and or increase the unemployment subsidies so the homeowner can continue to make his payments while he is looking for a suitable job.
    Reply
  •  
    Sep 25 10:18 AM
    This makes sense, and it approaches the solution used in the Great Depression, when commercial banks were formed. They could only lend county-wide. Banks became a service the citizenry that were restricted from gambling with the citizen's money that was on deposit..
    Reply
  •  
    Sep 25 10:22 AM
    Most of this worthless debt is 'NINJA' loans to borrowers with No Income, No Job, no Assets. The loans came about because Congress mandated that banks MUST make them: to atone for decades of supposed 'redlining', not making loans to people in certain urban areas. In the past banks would not loan to people who did not meet the credit requirements thought 'safe'. Those people were generally poor, and many lived in high-crime, low-value-housing areas: read 'The Ghetto'. So social engineering changes to banking regulations erased the necessity to have some form of collateral to assure a bank of payback on a loan. 'The Government' assured the banks that their risk was covered, and the loans got written. Real estate boomed, and values went up and up. Soon defaults on mortgages began to rise, and at a certain point, the value of all those bundled high-risk portfolios came into question. A house that in the boom time looked worth $500,000 was suddenly looking more like $300,000 based on sales of comparables in the neighborhood. Many a mortgage exceeded the current value of the property, so why pay it off? You would spend more on the payments than the property could give you back; and the riskiest bets went down first. Fannie Mae and Freddie Mac led the charge, and now lead the retreat, along with Wall Street debt-portfolio slicers/dicers who hid the risk by making salami of bundled toxic morgages and assigning fictitious value ratings to it. So by all means, lets completely dismantle our entire national credit structure, and precipitate a global recession, to punish those greedy schmucks! It's great election year politics! But get Congress' social engineers first, starting with Pelosi, Obama, and Dodd, who torpedoed the Fannie Mae, Freddie Mac fix legislation in 2005, while receiving mucho contributions from those greedy Main Street and Wall Street bankers.
    Reply
  •  
    Sep 25 10:25 AM
    Look folks- The gov't makes money here; Mark-to-Market is part of the problem- value longterm assests on a shortterm fluctuating basis is wrong. This will eventually be corrected.

    But right now the gov't is going to pick or "real" assest that; becuase they can hold and have a longer term horizon- WILL re-flate and appreciate.

    This whole issue at the moment is about crisis of confidence not the $$$$$ - and the irresponsible polititicians who do not understand this are dealing with more than fire - they are dealing with "china syndrom" financial meltdown -

    That is why the deal will get done with appropriate "CEO pay" window dressing and LONG XLF is the right position to be in.


    On Sep 25 10:18 AM TheBookkeepe r wrote:

    > This makes sense, and it approaches the solution used in the Great
    > Depression, when commercial banks were formed. They could only lend
    > county-wide. Banks became a service the citizenry that were restricted
    > from gambling with the citizen's money that was on deposit..
    Reply
  •  
    Sep 25 10:28 AM
    My question to these ideas is, "Who will be able to get their money out of the old banks to deposit in the new ones?" All the banks have to sell paper to honor withdrawals. But there are no buyers.
    Reply
  •  
    Sep 25 11:15 AM
    If we really want a quick help to main street lending start by having emperor Paulson start paying dividends on the Fed and Fanny preferred shares he blitzed. This would immediately provide at least 50 billion in capital to local community banks who held these preferred shares - 50 b in capital translates to about 200 b in new lending.
    Reply
  •  
    Sep 25 06:03 PM
    First lets really talk about what this is not. It is not a BAILOUT. A bailout would be a blank check to the institutions effectively saving them at no cost to the institution (“pay us back when you can”) and the US taxpayer facing a 100% burden. That is not the case here.
    What the American media is labeling this reflects their level of understanding. Since when has a journalism degree or a conversation with the Fed Chairman been a proxy for an economics or finance degree. Let’s not forget many of these journalists chose journalism because math and statistics were not their strongest subjects. Rather playing with the written word is, and they have done a fantastic job of misrepresenting what is going on to the American public making them believe we are paying one big bill all at one time; essentially having a huge greenback bonfire of $700,000,000,000.00 which we will never see again. It has been poorly misrepresented and pathetically, even the Wall Street Journal is guilty. If anyone in journalism should know and understand better it is the Wall Street Journal, and they have not properly characterized this.
    It will cost the US Treasury about $30,000,000,000 a year in additional interest payments, if all $700,000,000,000 was outstanding at one time. $30 billion is 1/10 of the Defense department’s budget in a given year and there is now ability to profit from those expenditures.
    There is tremendous opportunity for upside here. Let’s simplify this to an Ebay model. Those with experience on Ebay understand if you have to sell something quickly because you need the cash, then use the Bid Now feature. You will not get what the article is worth, but you will get what you need much faster. Of course, this depends on your credibility as a seller, judged by your rating. If your rating is poor then the bidders may be skeptical of your desire to sell quickly and of the authenticity of the article. Meaning they may bid less than even the Bid Now feature.
    This is exactly where the holders of the Mortgage securities find themselves (Ebay Seller). Other bank and institutions (Ebay bidders) doubt the quality of the asset being sold and do not trust the institutions selling them. So they are not bidding close to what the securities are worth or will not bid at all. Why take the chance?
    This leaves only one solution, which is what the Treasury is pursuing. In order to get proper pricing for the assets you need to remove both the timeline (Bid Now issue) and credibility (counterparty risk) issues.
    Since the Treasury has the longest timeline and the cheapest borrowing costs of any institution, they can hold the assets until a proper bid is entered (a sale) or to maturity. Thereby minimizing the Bid Now problem other backs have. Further, there is a reason the interest rates on gov’t securities are considered to be the risk-free rate. Having the Treasury hold and sell them puts the future buyers at a better chance to really understand what they are buying. They have time to wait out the irrationality and panic.

    In either case the Treasury will receive the interest payments as the Bondholder which should be significantly higher than their cost of borrowing, making a profit on the spread, and in the case of a sale since they have the ability to wait until rational minds reenter the market it should be substantially higher than the discounted value they will be buying them for.
    In closing, let’s not forget Henry Paulson is a fmr CEO of Goldman Sachs. He is not a career bureaucrat. If his time at Goldman is a guide, we should expect some of the most capable people available to be executing on the legislation congress just passed. In fact I hope they are willing to pay for the best, because that is what the taxpayer deserves in protecting our position in all of these transactions.
    His legacy is riding on this. Hopefully he will be able to separate it from the administration that put him in place.
    Reply
  •  
    Sep 25 09:50 PM
    Mark-to-market makes sense. If there's no buyer, an asset has no value, just like the crap in your attic. If the potential buyer cannot set a value, the seller surely cannot be trusted to do so.

    Just don't hold concentrations of similar assets! Risk Management 101.
    Reply
  •  
    Sep 26 12:05 AM
    To Linguistics:
    Give me a break! Your Ebay model is like apple and orange, not a logical comparision .
    It really depends on your definition of "bailout." It doesn't matter since sometimes the means and ends are confusing.
    Okay, I accept your belief of what it is not. But what it really is?
    Okay, they have time to wait out the irrationality and panic. Do you think their ability is greater than a communist regime in terms of capitalism or free market? Yes, any communist party can wait for good timing to take place. They don't care about the market mechanism. What's their economic results? Gee, Paulson is dreaming to be a king beyond law and supervision, per his Section 8 of his proposal. Do you really believe that his socialism to have such a power to choose a better opportunity and perform better than the nature course of capitalism.
    There is one lesson just mentioned by the former Chief of RTC a few days ago: The longer the unperforming asset is held, the less value it has.
    Let the "invisible hand" work out naturally and keep the government intervention to the least level.
    Please click on my article "Wow! Joe Can't Spend Money?" at activerain.com/blogs/r.... I would like to have your further comment on my viewpoint about this issue.
    Reply
  •  
    Sep 26 09:07 AM
    paulson/bernanke characterize solutions using a specious strawman argument to manipulate debate and to narrow 'choices' to theirs or theirs. there are other choices. 'we the people' are characterized by the whole gov't. and media as helpless victims. 'we're helpless please fix it daddy [washington and wall st.] we're scared. only you experts can save america.'

    one thing we do know for certain. neither the gov't nor the conventional wisdom of wall st. can save us. they cannot even save themselves. maybe we'd better go another way. subsidizing them is like rearranging the deck chairs on the titanic.

    it is rare that the gov't. is so willing and even eager to spend huge amounts of money. perhaps that money, our money, would be better spent as capital investment in america. fyi: america includes wall st. wall st. fails to include america.

    stop throwing our money down the rabbit hole. let free market capitalism work. put that capital to work building industry and jobs, reviving the bank industry and increasing the resultant tax base.


    . , etc. not cash being dumped into the rabbit hole of wall st. finance and its fellow-travelers.


    all this serves to steamroll the paul and bernie plan which may not work and which may cost well over 700,000,000.00.

    if the gov't is of a mind to spend let's put money to work for the people not for wall st.'s failures. make room for better finance houses etc.

    rather than some form of gov't guarantees on toxic paper have gov't guaranteed loans; capital. revive in who have driven themselves to bankruptcy ; put people to work, build and repair infrastructure, reactivate industry, the service industries will grow, the tax base will grow, let the capitalist free market do its darwinian winnowingthe greed and incompetence of wall st. would be replaced in darwinian fashionand give a a leg up on acttually send rfps out for necessary work on infrastructure. what results is an economic stimulus in private sector: industry, finance and services. i'm too tired to
    Reply
  •  
    Sep 26 09:09 AM
    paulson/bernanke characterize solutions using a specious strawman argument to manipulate debate and to narrow 'choices' to theirs or theirs. there are other choices. 'we the people' are characterized by the whole gov't. and media as helpless victims. 'we're helpless please fix it daddy [washington and wall st.] we're scared. only you experts can save america.'

    one thing we do know for certain. neither the gov't nor the conventional wisdom of wall st. can save us. they cannot even save themselves. maybe we'd better go another way. subsidizing them is like rearranging the deck chairs on the titanic.

    it is rare that the gov't. is so willing and even eager to spend huge amounts of money. perhaps that money, our money, would be better spent as capital investment in america. fyi: america includes wall st. wall st. fails to include america.

    stop throwing our money down the rabbit hole. let free market capitalism work. put that capital to work building industry and jobs, reviving the bank industry and increasing the resultant tax base.
    Reply
  •  
    Sep 26 09:11 AM
    There are two main problems: 1) "opaque" instruments, like CDO's riddle with shaky mortgages 2) mortgage defaults. I support some intervention to deal with CDO's and a return to regulation of banks to prevent future abuse. As for 2, wages have been stagnant and housing prices did a huge "bubble". I think restructuring loans -- freezing ARM resets for example-- could help a lot. As for the "redlined" poor causing the mess as scrooge opines-- that attitude is contemptible. It is only a small part of the problem. The banks SHOULD have denied bad loans. And people of all income brackets are involved in this mess. Some people got into ARMS and "stretched" too much. Others willfully abused lax credit standards and bought multiple properties, hoping to "flip". The fact that real estate lloked for a long time like a "magic" investment that always goes up, clouded people's judgement. I have long looked at ratios of average salaries to housing prices. And the ratio of renting costs vs ownership costs. I could see years ago that trouble was brewing.
    Reply
  •  
    Sep 26 10:46 AM
    Two fundamental problems need to be fixed:

    1. There needs to be a regulated market for financial paper with daily auction trading similar to stocks. Then mark to market can work and illiquid assets can not hide until they explode.

    2. The current paper pyramid of mortgage and other debt needs to be unraveled and restructured to obtain the maximum possible return / lowest possible default.

    Unfortunately, this will not happen without government involvement. To allow only free market forces to resolve this will impoverish the many and enrich the few.
    Reply
  •  
    Sep 26 10:48 AM
    PS:

    In Part 2 (above), the weakest financial institutions should be allowed to fail, which is part of the Diane Ritter proposal..
    Reply
  •  
    Sep 26 01:27 PM
    To Dianne: AMEN!
    Reply
  •  
    Sep 26 02:37 PM
    It would appear that the Congress is as confused as the general public about what this bill/bailout/guarrante... is all about. Politics prevails and intelligent thought as usual is secondary to what needs to be done. I for one do not understand what the real problems are thanks to media obfuscation. I do understand that there is a significant problem with the flow of capital and the losses experienced by stockholders and bond holders in the failled companies. I also know that the congress is probably the worst place on earth to really accomplish anything. The President had the right idea to call a meeting the problem is he invited the wrong people. What should have been done was to convene a meeting of the brightest and most experienced people of the financial world hash out a plan and present it to the American People with a full and complete explanation of what the problem was that caused this fiasco, what the solutions are that are recommended and submit them to the Congress for ratification and passage sans political rhetoric
    Reply
  •  
    Sep 26 03:18 PM
    Great idea!
    Reply
  •  
    Sep 26 03:18 PM
    Great idea!
    Reply
  •  
    Sep 26 04:07 PM
    There are three thousand community banks that are capital starved or near capital starved.

    When Wall Street absorbs the $700 billion, Main Street banks will pay dearly to maintain their capital ratios.

    It makes more sense to distribute the $700 billion to American community banks so they can lend for local transactions or use it to recapitalize Wall Street.
    Reply
  •  
    Sep 26 05:29 PM
    Couldn't agree more with the solution proposed by this article. Also, couldn't agree more with its political expediency as the main fault of the proposal. Also couldn't agree more with Tom B's analysis of the nearsighted Scrooge in the root cause.

    So, where does that leave us? With a bunch of impractical and/or unpalitable "solutions" to the imminent crisis.

    So,where are all the "capitalists"... when we need them, salivating at the risk/reward opporunities? Why do we need government intervention is this supposedly "free market" of ideas and the homespun crap that we so often hear from "free market capitalists"?

    All so strangely silent and willing to accept Paulson and Bernanke on their knees begging to save their Wall Street buddies.

    Can anyone remember the last time that Paulson was on his knees?
    Reply
  •  
    Sep 26 05:32 PM
    I believe there is in deed no legitimacy and urgency for such a Paulson's plan. It is very questionable why we need the Paulson plan and what is the motive for him to bring it to us.

    Need proof for it? For a recent example, please look at what just happen to Washington Mutual who has $310 billion asset and $190 billion deposit. OTS took it over last night in an unusually urgent speed.(some called it "breathtaking.&qu... Even Alan Fishman, who took over the title of chairman of WaMu 16 days ago, was knocked off while he is on an airplane from DC back to Seattle. Why is it so urgent? Don't ask me,I didn't care Mr. Fishman's JP Morgan working history . Just look around who is benefited from it? The same steal for them: 3 cents for a dollar deal, again? Damn good God deal! Oh, my God! Great, as Bill Clinton said, "I envy" them.) But read in between of what OTS Chief said. He said, "there is no cost to FDIC or taxpayers and create a seamless transaction to all the concerned."

    What he meant? All the financial students predicted that FDIC would have a loss of about $90 billion and quickly run out of its fund because WaMu would cost at least ten times what Indymac did. In fact, It seems nothing happen even the biggest thrift of our country failed. NO, no big deal. No turmoil like bank run after the seizure. Sun still comes up, the Wall Street is running (no crash or collapse). And hard to believe, stock price is rising up this morning. It is totally contrary to all the scary episode described by those reports. Looking at the cool WaMu realities, in particular, with bad news in general economy, Paulson's action is freaking enough to me.

    Who decided WaMu is failed as they did in Indymac case? Oh, It is purely an Administrative discretion to act very agressively to meet an urgent need to protect the public. In other words, it is the Treasury or Mr. Paulson. Yes, nobody can go ask a court of law to review the seizure decision as Henry Paulson wanted for the $700 billion in his 3 page proposal.

    activerain.com/blogsvi...
    Reply
  •  
    Sep 26 06:00 PM
    blaming the CRA for this ... The lamest of Fox talking point rationalizations, I'm sure intended to deflect attention from the abject failures in monetary ploicy, fiscal policy and prudential regulation by the Ayn Rand skim the cream clique of the Republican party

    shame , shame, shame
    Reply
  •  
    Sep 26 09:23 PM
    Do u really think the amount will be only $700 b.
    Reply
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