We are about to witness "Big and Sweeping" actions on part of the US Government to rescue America and the World from annihilation in banking activity, so crucial to the modern economy. Though Need of the Hour it is, Big & Sweeping action can easily go wrong if its direction is misconceived. That is, "Big" can have huge consequences, of either type – Good or Catastrophic, depending upon the details of the "Big". As a silly example, "Big & Sweeping" can end up translating to say, pumping $200 B each into 20 banks each to write off their losses – only to find over time that the direction was but a black hole that continued to suck in more and more, and eventually resulted in the dollar becoming a meaningless artifact.
The "Big" should be an article of willingness even as the effort should really be to keep it small, focused, right-directional and effective.
The Swift, Dramatic Action package needs to also have an element of "finite" designed into it; and an approach that limits the losses to the public, in fact, a realistic chance of profiting from the rescue operations. "Sweeping" should include the possibility of looking at approaches paradigmatically different from what’s already been tried with little success: interest rate cuts, quantitative easing, help money going right to the CEO commode. "Sweeping" could include consciously letting the number of banking organizations to shrink significantly, yet making sure that there is a Banking System standing at the end of the reform and reconstruction.
The idea has been in the air to put public money into creating a "Bad Bank". This bad bank will buy out the non performing mortgages and MBS’s from the regular banks, so unlock cash for them and their books from the effect of "mark to market". This idea is plagued with the ‘black hole’ syndrome and lacks due diligence on what it means between the lines:
The "Bad Bank" will have to purchase the non performing assets and securities on their face values (or nominal discount thereto) which are way off from the real juice in them. One can suspect that even if the Govt. were to buy these at full face value, the banks are too jacked up to survive even then. As foreclosures continue to cascade, it’s a never ending saga to keep buying them and increasing the size of the rescue bill. It’s a rat hole of a direction that leads towards making currency and the concept of earning your profits utterly meaningless.
Public "Bad Bank" is a Flop. Let's Flip it over instead.A Govt. spun business-like Good Bank would be a much better idea. It would be a bank that is not rooted in the aim of artificially keeping a banking institution alive, yet ensure that there's a viable Banking System at the end of the cleanup road. This bank would be willing to buy non performing asset from a regular bank at say, 10% of its face value, no more. That gives it a lot of maneuver-space to carry out loan modifications on the assets it acquires, make the salvageable loans performing again, write off the others - taking possession of the house and putting up for resale, or temporarily even renting it out to the same occupants at reasonable rental. This Bank can actually make a profit in its operations. If a regular bank goes into liquidation, the Good Bank will be credited the FDIC assured amounts and Govt. covered Retirement Savings Trust accounts held in the failed bank. The erstwhile depositors of the failed bank will be able to commence their banking on the Good Bank. Of course, they will lose any amounts that were not covered by FDIC or any other scheme. This Bank can commence normal lending operations with its money - prudent home loans, working capital finance, what have you.
In this Good Bank model, no attempt is made to save a failing institution. It works on the "Too Big to Save" premise rather than the "Too Big to Fail" that has been followed so far and could well bleed the whole economy dead.
At best, the last two or three regular banks set for bankruptcy and liquidation can be "saved" via Nationalization at a price of 1 cent – like Barings sale to ING in the 1990s, and many others that happen in such a circumstance. This will ensure that the whole scheme does not end up with just one monopolistic Govt. bank.
Of course, in the longer run, 5-10 years timeframe, all the Governmental banks born are best privatized via sale of equity to the investing public or corporate entities.
Nothing new here. If any banks receive money at all as bailout from public funds, they should have to first show a plan of action on how the bailout money will be used for survival, and what public purpose will be served by the bailout, what organizational and wage, compensation & bonus rightsizing will be effected to ensure efficiency in the use of funds provided. No more donated funds going into renovating toilet commodes. Also to be rejected, the notion that bubble payouts to "talent" have to be maintained to retain them, else they will leave. To Where?? And, What "talent" – the one that produced losses that have to be salvaged by the whole society? There is plenty of this talent strewn all around that’ll thankfully work for deserved compensation levels, not what was mistakenly paid all these years.
A related development that would be in order would be to reassess the Govt. protection to savings in near cash instruments and deposits. And the limits can be linked to the holder’s age. Say, for example, FDIC protection for savings deposits and CDs could be reduced to $100 K for those less than 40 years in age, $150 K for those in their 40s, $200K for 50s, and so on. Reckon a similar protection structure for the money market mutual fund balances protected by the Govt.
This will give security to the people in retiring ages, yet invoke those that are younger to participate in economic revitalization taking the entrepreneurial risks that make an economy strong. Create an outlet for the money currently precipitated into FDIC insured and money market mutual funds into buying equity in the Govt.’s Good Bank, or the banks that end up in Nationalization. It will contribute to reduce the amount of new money that the Govt. will have to throw out there for the Banking System Reconstruction-Rescue. Also see next point.
A key cause of the housing bubble was that there was a lot of "investible" money out there that had nowhere to go, and a boom-"opportunity" in housing was created, accentuated by the use of ARMs in housing deals. Then Home Equity Lines of Credit boomed in a big way. But there was still more cash around, so it went into commodities speculation. The inflation in everyday life caused by the commodities Bull Run, dollar devaluation due to oversupply, saturation in home prices even with ARM deals, end of the honeymoon period for the earliest ARM borrowers, and so on, finally crashed the whole game. The borrower’s income never rose sufficient to cover for the new payment and the new prices of everyday goods, HELOC was also maxed out. Just a few foreclosures were sufficient to trigger the fall of the house of cards. The housing and the commodities bubbles played the Big-MAD (Mutually Assured Deflation) to each other.
The important thing is to recognize a key actor here: too much money around without genuine investment channels – that got channeled in ruinous directions and huge malinvestment. Individuals jumped onto trends in home prices ("they always go up at 6% per annum"), and then commodities, that the financial industry initiated with their own overstock of money that had no place to go. After the tech bubble pop in 2001, there were insufficient new-paradigm products conceptualized in America. For the existing "low value" products (where not much innovation can be expected), it was thought more appropriate to offshore the production to bring cheaper prices to American public and shore up the Corporate profits with lower costs. There was not enough stuff in the Real Economy for the banks to finance, commensurate with all the cheap money they had. So the bubbles began.
It is best that both the Economic Recovery & Reinvestment, as well as Financial System Reconstruction, tap into the individuals’ money as much as possible before creating new money.
The Socio-Economic Infrastructure & Capacity Building projects should try to recoup as much as possible via Progressive Income Tax Increases and use of "Cheap-Gas Tax"; while the Financial System Reconstruction should be rooted in "Big in Willingness Yet Only the Necessary Size, Direction & Approach in action" - and attempt to draw individuals' savings into the venture.
Also See: Economic Recovery Mission & Tax Cuts Just Don’t Mix!©2009 Ohm, all rights reserved. You must have written permission from the author in order to republish this work.
Published: Sunday, January 25, 2009
Last modified: Saturday, February 21, 2009
The views expressed in this article are those of Ohm only and do not represent the views of Nolan Chart, LLC or its affiliates. Ohm is solely responsible for the contents of this article and is not an employee or otherwise affiliated with Nolan Chart, LLC in his/her role as a columnist.
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