No to Bailing Out Global Capital and Yes to a Progressive Alternative

Under threat of Bush's veto, the proposed Wall Street "rescue" includes a provision providing for purchases of foreign assets held by foreign firms. Here's the text:

SEC. 112. COORDINATION WITH FOREIGN AUTHORITIES AND CENTRAL BANKS.

The Secretary shall coordinate, as appropriate, with foreign financial authorities and central banks to work toward the establishment of similar programs by such authorities and central banks. To the extent that such foreign financial authorities or banks hold troubled assets as a result of extending financing to financial institutions that have failed or defaulted on such financing, such troubled assets qualify for purchase under section 101.

There are other things that we can do. The problem on Wall Street is that the banks are weighted down with too many bad debts and not enough good assets. For nearly all other companies in the U.S., that's called bankruptcy.

If the federal government were to force these companies into bankruptcy proceedings, the current owners could be wiped out in favor of the creditors, who exchange their debt for equity. The new company can then open for business the following day debt-free with new shareholders and management, or purchased by more solvent firm as was demonstrated by the immediate purchases of WaMu and Wachovia just within the past week.

As a former WaMu account holder, I can testify to the fact that the transition was completely seamless. But supposedly, the companies that stand to receive the bailout are "too big to fail", i.e they cannot be allowed to go bankrupt because the global economy would be irreparably damaged beyond repair. Karl Denninger has some of the better ideas I've heard about why this is not true:



There's also the House Democratic Progressive Caucus' "Bailout Alternative":

DRAFT

No BAILOUTS Act

Bringing Accounting, Increased Liquidity, Oversight and Upholding Taxpayer Security

1. Require the Securities and Exchange Commission (SEC) to require an economic value standard to measure the capital of financial institutions.

This bill will require SEC to implement a rule to suspend the application of fair value accounting standards to financial institutions, which marks assets to the market value, no matter the conditions of the market. When no meaningful market exists, as is the current market for mortgage backed securities, this standard requires institutions to value assets at fire-sale prices. This creates a capital shortfall on paper. Using the economic value standard as bank examines [sic] have traditionally done will immediately correct the capital shortfalls experienced by many institutions.

2. Require the Securities and Exchange Commission to restricting naked short sells permanently

This bill will require SEC to implement a rule that blocks naked selling, selling a stock short without first borrowing the shares or ensuring the shares can be borrowed. Such practices many times harm the companies represented in the sales and hurt their efforts to raise capital. There is no economic value produced by naked short sales, but significant negative effects.

3. Require the Securities and Exchange Commission to restore the up-tick rule permanently.

This bill will require SEC to implement a rule that blocks short sales without an up-tick in the market. On September 19, 2008, the SEC approved a temporary pause of short selling in financial companies "to protect the integrity and quality of the securities market and strengthen investor confidence." This rule prevents market crashes brought on by irrational short term market behavior.

4. "Net Worth Certificate Program"

This bill will require FDIC to implement a net worth certificate program. The FDIC would determine banks with short-term capital needs and the ability to financially recover in the foreseeable future. For those entities that qualify, the FDIC should purchase net worth certificates in these institutions. In exchange, these institutions issue promissory notes to repay the FDIC, counting the amount "borrowed" as capital on their balance sheets. This exchange provides short term capital, with not [sic] cash outlay. Interest rates on the certificates and the FDIC notes should be identical so no subsidy is necessary.

Participating banks must be subject to strict oversight by the FDIC including oversight of top executive compensation and if necessary the removal of poor management. Financial records and business plans should be subject to scrutiny while participating in the program.
In 1982, Congress approved a program, known as the Net Worth Certificate Program, that allowed banks and thrifts to apply for immediate capital assistance. From 1982 to 1993, banks with total assets of $40 billion participated in the program. The majority of these banks, 75%, required no further assistance beyond the certificate program.

5. Increase the FDIC Insurance limit from $100,000 to $250,000.

The bill will require the FDIC raise its limit to provide depositors confidence that their money is safe and help eliminate runs on banks which are destabilizing to the industry.

I'm not completely in favor of their plan. For example, the accounting rule suspension actually promotes the kind of funny accounting that led to this crisis, where firms refuse to acknowledge their current financial position leading to distrust between them. Banning short-selling is kind of a "kill the messenger" move. But any discussion of alternatives cannot help but be a good thing right now.

But regardless of which way we want to go, we have to get away from the "core" of the Paulson Plan, which is to send $700 billion cash to Wall Street in return for untold truckloads of paper, the value of which has been determined by the free market to be zero. The bill as it now stands includes that essential core.

And if we can save $700 billion in public funds by forcing these firms into bankrutcy, we could still dedicated some federal funds to helping Main Street deal with the fallout with:

1. Direct loans to bona fide distressed homeowners.

2. Grants to municipalities for the purchase of foreclosed and abandoned properties.

3. Job-producing investments in public infrastructure.

And, of course, this is not to dismiss every other positive, progressive possibility that we should preserve our ability to someday implement, but these just relate to the particular crisis at issue.

So please, people, communicate with your representatives. Let them know what your priorities are.

The Financial Crisis: An Alternative "Bottom-Up" Proposal

Instead of giving $700 billion in taxpayer funds to Wall Street bazillionaires, how about a federal program to make loans available to homeowners who need help getting and staying current on their mortgage payments? The loans could be secured with a lien against the property due on sale, with no prepayment penalties, interest to accrue on outstanding balances. Participation in the program would be limited to a maximum of, say, two years (enough time to either sell, refinance or otherwise improve your financial situation), and of course only bona fide owner-occupants would be eligible.

This would address both the root cause of and the real human suffering that has resulted from, this crisis: people losing their homes through foreclosure. A federal intervention to help homeowners avoid defaulting on their mortgages would mean that the securities backed by these loans could again be bought and sold again freely in the capital markets. This would also decrease the pressure on all the trillions of dollars in credit default insurance that has been issued on these loans. The program would be temporary in nature, only remaining in place until the credit markets returned to a state of relative normality.

Of course, there would continue to be significant defaults, mostly due to the ineligibility of house flippers and speculators. That's OK. Some homeowners are in too far over their heads to be helped even by this program. That's OK. Those who took the biggest risks in all of this, should take the biggest losses. The continuing defaults in would remain a problem on Wall Street, but not a cataclysmic one.

The cost? By my rough estimates, it would be a fraction of the trillions being sought by Paulson and most of it would be very likely to be recouped sooner or later by the federal government, with interest. There are probably about $200-300 billion dollars worth of outstanding mortgages in some stage of arrears right now. If you take 1% of that as the average monthly payment (i.e. a $100,000 loan would at most have a $1,000 monthly payment), then you are talking about total payments of $2-3 billion a month, more than half of which would likely still be covered by the homeowners in question. At most we're talking about $20 billion a year, and the program shouldn't have to last more than 2-3 years.

Most importantly, however, the money would go to where it would actually make the most difference in terms of improving the lives of actual people. It could be argued that some homeowners might be getting a windfall compared to others who acted more prudently. But as a homeowner myself, I can't imagine feeling envy at another citizen who has a lien by the federal government against their house.

Thoughts?

The Democratic "Alternative Bailout": Lipstick on a Pig

Let's be straight about what this bailout involves. Banks made a bunch of bad loans where there was no down payment and no documentation of the borrower's income because such loans were mega-profitable as long as housing values were going up. A lot of other financial products were sold based on these loans, which were also mega-profitable as long as housing values were going up.

Now that housing values have gone, and continue to go, down, all of these loans and financial products are worth a small fraction of their original value. Nobody wants to admit these losses because to do so would expose the fact that a lot of people don't have as much money as they and others thought they did. Because of this, nobody really knows exactly how much unrecognized losses are out there, but it's clearly measured in trillions.

For a while, the banks just kind of ignored the presence of these unrecognized losses on the books and kept doing business as if they weren't there. But as the losses piled up, the weaker players became unable to cover their day-to-day expenses, and the bankruptcies, bailouts and buyouts began. Now, people don't want to do business with anybody with these losses on their books because they don't know who's going to go down next and leave their creditors holding the bag.

So, now Mr. Paulson, the former chair of Goldman Sachs, is riding to their rescue with trillions of federal dollars (potentially) in tow. The money is to be used to pay these banks presumably something close to the full original value for these loans, thereby converting the losses from private Wall Street losses to public federal government losses.

The problem is that the federal government can no more afford to take these losses than Wall Street. The federal debt is already approaching 10 trillion dollars, with another 500 billion being added annually. The bill for the Iraq War continues to mount, with the veteran's costs just starting. "Crisis" or not, Social Security and Medicare payouts are rising faster than tax receipts. Our infrastructure has been neglected for decades.

Taking on trillions in additional debt (and no $700 billion is not the limit, that's just the limit at any one time, the authorization allows the Treasury to take on new debt as old debt is sold off) will be devastating to the federal budget. If we're lucky, it will simply mean that there will be no new money for federal programs for a generation, no universal health care, no "Apollo" alternative energy project, middle-class tax relief, etc. If Obama is elected, he'll inherit nothing more than a pile of debt to find a way to service, and the "progressive agenda" will be a moot point.

If we're unlucky, the foreign investors who we rely upon to buy $2 billion a day in Treasury notes will decide that the U.S. federal government is itself no longer a safe bet to make good on its obligations. That would mean a federal bankruptcy, something that has never before happened in our nation's history, not even during the Great Depression. It's impossible to know what a federal bankruptcy would look like, but I have to believe that it would be 100 times worse than anything that would result from a few more Wall Street bankruptcies.

It seems crystal clear to me that this is the final play in the cynical Republican strategy to "starve the beast" of government by removing so much money from the Treasury that there is simply no money left for anything progressive. Having granted themselves two trillion dollar tax breaks, then wasted probably another three or four trillion on various post-9/11 activities, not the least of which is the Iraq War, which have not made us safer, now with mere weeks left in his term, they want to siphon off the last couple of trillion left in the coffers (or at least under our debt capacity) for one final gorging of cash at the trough for their friends and cronies.

Why in the world any Democrat would even think of going along with this I have no idea. What good could it possible do if we were to inherit a bankrupt federal government in January? Why would we participate in this scheme to bankrupt our government in order to prevent Wall Street from collapsing of the weight of its own greed and stupidity? And even to the extent that this measure does stave off a bit of suffering for a few more weeks, doesn't that just help McCain?

But I hear Chris Dodd on NPT this morning praising Secretary Paulson as a fine public servant, boasting about how closely Democrats are working with Republicans on his plan, and pledging to pass it before the Congressional recess, scheduled for next week. I cannot imagine a more stupid and self-defeating line to be taking right now. The Democrats cannot go along with this. Please call your Senator, your Congresspeople, the Obama campaign, Sen. Biden, and let's put a stop to this before it puts a stop to us!!!

Oh...and if you want an alternative...Let the chips fall where they may on Wall Street and use a fraction of those billions to create a federal program to give grants and loans to municipalities and nonprofit organizations to buy vacant and abandoned foreclosed properties, fix them up, and either sell or rent them at affordable rates depending on the conditions of the local market.