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.