Monday, September 22, 2008

Some ideas to fix the credit crisis

How the Democrats created this mess is another account of the Democrat opposition to Fannie Mae Oversight in 2005 that could have prevented the housing bubble and the subsequent crisis we are in. Now the same malefactors who created this mess are going to have a welfare program for the irresponsible plutocrats who bet on leverage in a bubble market. It's easy to go all populist in rage at this outrage, and it's understandable too. However, such declarations won't really solve the problem we are in.

What is the solution? The Paulson way? Paulson's proposal is, like a turkey before Thanksgiving, getting larded up for the Congressional vote. We are told that this plan is necessary because doing nothing will lead to a credit meltdown. This is about stopping Great Depression 2.0. The credit panic last week had the markings of a possible very disruptive, crash-like event: Another 1987; What Asia had in 1998; etc. Great Depression analgoies were pulled out. The credit system had seized up and institutions were even pulling money out of money market funds.

The bailout will in the end not cost as much as that $700 billion price tag. Assets are being marked down to very low prices and the Govt might actually make money on this situation (Congress will make sure that miracle doesn't work to the benefit of the taxpayer alas). But the price of this 'cleanup' will still be stiff to taxpayer overall: Hundreds of billions already to backstop Fannie Mae; more hundreds of billions for a housing bailout; tens of billions for an IRS check 'stimulus'. All of these are non-solutions to a credit crunch caused by bad Government actions and non-oversight.

Heritage has Some thoughts on what not to do.

My view is that Paulson's plan is indeed better than nothing, but it carries the risks of 'moral hazard', corruption, and a continued bleeding of the taxpayer to feed an instant gratification credit system that should be deleveraged more.

We need a solution that doesn't bilk the taxpayer but gets the credit system working - a workout, not a bailout:

1. Assist banks with better pricing on illiquid assets with one rule change:
Suspend the mark-to-market rule for illiquid assets like CDOs.

2. Make the $700 billion bailout mostly SELF-FINANCING WORKOUT that provides liquidity but not a subsidy for the holders of these marked down assets. Solvent companies have crappy suspect assets. The value of these assets is not clearly known, nor is the liabilities involved. But the firms can offload these into the Govt Asset Management organization (RTC-II), that takes these assets and holds on to them while the crisis passes. Here is how:

Govt purchases of distressed assets from currently solvent firms will be based on a 'consignment basis'. The Govt will pay for 40% of assumed market value, and the remainer of the payment held in reserve (or Govt gets senior notes for remainder). When the product is later sold, the original holder is given the sold value if it was anywhere from 40-100% of assessed fair market value. Above that, ie if govt sells at a profit above original assessed value, the Govt and private firms share the gains 50/50. If the Govt sells it for less than 40% of originally assessed value, Govt eats the cost partly, and partly takes up debt from the selling company. Since there is time cost of money, there can be simple rules regarding how much the Govt owes in interest on gains, and/or that can be viewed as a transaction cost.

These rules would add clarity and taxpayer protection. Right now there is no clarity as to the taxpayer liability. Rules regarding how resale gains and losses are are to be assessed is required. The 40% rule enables one trillion in assets to be purchased with only $400 billion in credit, and it can then be 'worked out' over a number of years. The cost is less and the taxpayer protection is much greater. BANKS ARE ABLE TO OFFLOAD ASSETS AT 40% LEVEL AND THEN GET A POSSIBLE "UPSIDE" RETURN LATER IF VALUE BOUNCES BACK. If that 40% level is too small to encourage participation, then it could be raised so long as there is an assurance that taxpayers won't be picking up assets at inflated prices.

3. level 3 assets for all financial reporting institutions must be transparent and reported.

4. NO regulations on financial compensation, and NO equity stakes. The Govt should not takeover these companies. If there is any debt of collateral, it is senior debt. Regulation reform needs to come: Unify the regulation of the financial sector. But that should be in a separate bill, not this bill.

5. Dont muck this bill up with housing and foreclosure stuff. The Dems already did a $200 billion housing bailout, we dont need another right now, save it for the next Congress.

6. McCain wanted in 2005 to regulate Fannie Mae. Democrats killed that plan, as linked to above. It's past time to pass that bill.

The we need a twin bill, An Economic stimulus bill:
1. MAKE THE BUSH TAX CUTS PERMANENT. The cost of this is less than the bailout and the benefit will be HUGE.
2. Then cut the corporate tax rate.
3. Repeal Sarbanes-Oxley (which has killed IPOs).
4. Open up all offshore drilling. No limits.

Will this be the right thing? Will it be enough? We don't know, but we do know that America's economy is strong because it is dynamic and these ideas attempt to set thing aright without undermining our dynamic economy's workings. Anything that destroys the dynamic nature of the economy and its free enterprise moorings, harms our long-term prosperity. We see us slipping further away from that with every Fed and Treasury intervention in the market.

We need to carefully weigh the right way forward here. In the end, the only real crisis we face is the crisis in leadership. It's time for some conservatives to lead and propose alternatives to this bailout bill that are actually better. Cause if its "Paulson Plan or Bust" I don't want to be rooting for the latter.

UPDATE: Don Luskin makes good points on this: "Is it necessary? Will it work? And even then, is it morally justifiable?" His answers: We don't know.
Ron Paul say the Government bailout will cause an economic rough ride. Either way we will have a rought ride, but Ron Paul is saying it's time to get off the Government intervention merry-go-round.

Republican Study Committee has their proposals:
- Two-Year Suspension of the Capital Gains:
- Schedule the GSEs for Privatization:
- Stabilize the Dollar:
- Suspend “Mark to Market” Accounting:


Anonymous said...

How about this ?

The US Financial system needs a bailout. Only the govt. aka the US taxpayers
can do this. It needs to be done as fairly as possible.

The solution is to give $7000 (about 700 billion) to each taxpayer but with
the following restrictions.

If you are in default on any debt (auto, home, credit card, student), then
7000 will first go to repaying the loans. This helps keep people in their
homes, cars, schools, etc. and helps liquify the lenders with payments on

If you are not in default, the money will be held in a self directed
Government account for you by social security number. The money must be
invested in NEWLY issued stock (common or preferred) and/or Mortgage backed
securities from a list of firms to be determined by the treasury department.
These shares could not be sold for 5 years. Also, up to 2000 dollars could be
used for a payment against a current home loan which would be deducted from
the $7000 balance. Again this would help keep people in their homes and still
bail out the lenders.

Since everyone is getting the money, there is no moral hazzard in bailing out
the idiots only. The lending institutions are liquified and most but not all
people are helped with their home mortgages. It also gets directly to the
of problem, home mortgages and banking illiquidity.

Bottom line. We need a bailout by the taxpayers. But this would do it in a
that would relatively fair, have some free market aspects to it and benefit
all taxpayers if it works. Any inflationary aspects of "printing" up 700
billion should be delayed by 5 years when we might be in a better situation.


therer is a way for money to flow into taxpayers pockets, not wall street, it involves a tremendous amount of capital, repeal of exisint laws, firgive early withdraws for intruments suc as 401 k defined benifits ia, these taxes can take 10-30 percent in taxes, grandfather this to jan 1, people who have already withdrawn money would get credit toward taxes paid. this money goes directly to main street, without gong to wall street, taxes lost are in bailout anyway.

FloridaBill said...

Good ideas. We should prop up the banks with some injection of capital in exchange for an ownership interst, much like Warren Buffet has now done with Morgan Stanley and GE. Why we don't listen to more ideas on this is beyond me. We should try several other options before creating indebtedness for future generations of Americans. I want our government to focus on prevention of another crisis in the future, not being the ultimate fixer for bad bets (versus bad debts).

FloridaBill said...

Forgive me, it was Goldman Sacks, not Morgan Stanley that just got a multi-billion dollar injection of cash from Mr. Buffett.

Anonymous said...

An easier way to deal with the acute credit shortage is to delay tax collections for a few months. Us GD is $13 trillion, tax collections probably about $3 trillion pa, or $1 trillion in 4 months. With that additional credit, asset prices will be restored, and there won't be a crisis anyway. So you must then reduce the delay in tax collections to keep the balance.

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