How to Repair What Ails Us
Over the past several weeks and months, we have continually identified errors, flaws and mistakes being made by policy makers.
Some of these errors were due to mistaken assumptions -- that a firm like Lehman could go bankrupt without significant repercussions elsewhere in the financial system. Some were an issue of focus, such as the unhealthy obsession on asset price deflation and "confidence." Others involved the lack of leadership at the top -- the 3 page TARP proposal was laughable indictment of an AWOL president, and a flailing administration. Others were just plain ole dumb, like canceling short sales; this removed the most aggressive buyers during any crash. Its no coincidence that the worst week in the market's history occurred when there was no shorting allowed.
We've already spent enough time pointing fingers; Its time for some concrete suggestions as to how to fix the mess:
1. Recapitalize Banks: We've discussed this previously; Its the root of the credit freeze. We should follow a Swedish/Buffett/British type preferred purchase plan. Match private equity investments, allowing the private sector with their own capital at risk to select the banks to be saved and the terms of the investments.
2. Suspend Dividends for 1 year: US banks are sending $40 billion per year to shareholders, when they should be holding onto every last dime. No bank want sto do this, as their share price will get even further slaughtered. The Fed should call for a 6 month (or 1 year) suspension of divs, and require this to be enacted if banks want access to their lending facilities.
3. Guarantee ALL deposits for 6 months: To stop money from flowing out of banks, the Fed and FDIC should announce zero limits on bank guarantees.
4. Mortgage Workouts: Those homeowners that are in a position to be possibly saved, should have their own mortgages reworked. Use the HOLC standards: One home per family, primary residence, less than $1 million dollars, etc. Exclude flippers, speculators and those folks in homes they cannot possibly afford.
5. Guarantee all interbank lending: If you want to see banks begin lending again, have the Fed -- the lender of last resort -- guarantee the transactions.
6. Kill the Bad Banks: Aggressively seek and destroy those banks that won't make it. Put down the bad banks so those that can be saved can be rescued.
7. Restructure Regulations Intelligently: This crisis creates an opportunity to streamline and intelligently restructure banking and financial regulations. This will likely fall to the next administration to do. Let's hope they do a better job of it than either of the past two administrations.
8. Coordinate with other Countries: In the early phases of this crisis, we did not do a good job in convincing other nations the system was at risk. Some of this stems from the worldwide weakened opinion of the US (post Iraq), and some was simply poor salesmanship.
9. Start listening to experts: Ignoring warnings of failures, and criticism of policy flaws has gotten the country into this mess. The general disdain for expertise and experience in Washington D.C. is nothing short of astounding. Take advantage of the intellectual capital in the USA.
10 Lead: The absence of strong leadership allowed a bad situation to become much much worse. We need forward looking thinkers in positions of authority. Let's hope the next administration -- Obama or McCain -- is smarter then a the gang that couldn't shoot straight who is presently mismanaging things.
I am very confident that an intelligent application of the strategies and tactics discussed here and elsewhere can lead us out of the present mess. Let's hope we have the courage to do what's necessary, to make the hard choices and sacrifices that will put us back on the road to prosperity.
>
Previously:
Fix the Credit Problem, Not its Symptoms (October 2008)
http://bigpicture.typepad.com/comments/2008/10/fix-the-credit.html
Fixing Housing & Finance: 30/20/10 Proposal (September 2008)
http://bigpicture.typepad.com/comments/2008/09/fixing-housing.html
Alternative Ideas for Rescue Plans (September 2008)
http://bigpicture.typepad.com/comments/2008/09/alternative-ide.html
Monday, October 13, 2008 | 07:21 AM | Permalink
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iT's big bounce monday campers! Problems are past and the sun is shining. At least until the first bit of bad news casts a shadow,, and then the Panic will resume.
I cast my vote for GM, that great american repository of bad buisness decisions, to be the source of said shadow. Bounce or no, the numbers are up for cars, and those lucky builders that also have half interest in fine juicy mortgage companies.
Roll that wheel of karma......
Posted by: TulsaTime | Oct 13, 2008 7:42:32 AM
Why is it that the liberal media must always play by the rules of fair play and assign equivalency where there is none, while the right wing media just propagandizes without conscience and restraint? A McCain administration that will be smarter and an improvement over Bush? Come on, Bar.
As Keith Olbermann and Sarah Silverman lamented last week, where the hell is my Jewish left wing media? I spent decades as a Republican railing against this bias only to find out, when I need it, it's a myth?
Sorry, I just looked up to see Genius Joe Kernen holding up the NYP with the headline "Obama Panic?"
Posted by: CNBC Sucks | Oct 13, 2008 7:46:06 AM
Barry, Love your site and learn a great deal from you and others who comment. On the 3 page 'plan', I disagree. If HP had brought the functional equivalent of the ten commandments (or however you wish to describe the perfect plan), Congress would have shredded it, no question. The best plan was no plan at that point, imo.
Thanks.
Posted by: doug | Oct 13, 2008 7:47:21 AM
Folks, in order to make money, you have got to be able to play both sides of a market. Right now, we are extremely oversold. Barry has even started buying (which hasn't happened in a long while), and overseas markets have popped between 5 - 10%. Geez, it doesn't mean all our problems are behind us, but the market is now pricing in the fact that we may not all end up back in caves, chasing down our meals each day. Pessimisim has saved most of you on the way down, however let's see how many of you prepetual bears can actually make a little money long - my bet is most of you can't.
Posted by: jdamon | Oct 13, 2008 8:05:36 AM
Thanks BR - I wish that your comments would amke it to the MSM .
Posted by: Bill | Oct 13, 2008 8:10:03 AM
Very good proposals, although I like Hussman's idea for reforming mortgages. A shame that nothing but bandaids will be distributed for at least three months.
Banks will get capital with no regulations.
Failing banks will be supported because of politics.
Mortgage workouts will be done haphazardly.
The only way anything will get done soon is if Paulson turns out to be a Joe Kennedy and realizes that the financial system has to be reformed if it wants to be saved.
Posted by: Mike in NOLa | Oct 13, 2008 8:21:14 AM
I have never understood why American companies have this obsession with constant dividends. It seems like everywhere else in the world, they will make dividend decisions based on profit/business needs. In America, companies will borrow money if they have to just to keep the dividend.
Posted by: matt | Oct 13, 2008 8:21:37 AM
BR,
In relation to #4, the whole mortgage mess really hit home for me this weekend.
My wife and I will probably be relocating to Florida in the next few months, but it's a short-term thing; probably only a few years. At any rate, I was looking on the Intarwebs for rentals, and a peculiar thing happened: you can buy a house in one of the major US metro areas and pay half the cost of renting by owning the home outright. PITI with no money down and you're still at 2/3 the cost of renting on a conventional 30.
A few realtors I spoke with said that home prices have fallen as much as 50% in bedroom communities slightly north of the city.
50%? In a year? And none of those realtors were sure if a bottom was anywhere close. My wife and I had been discussing accelerating our college savings planning for the kids, but with prices as low as they are down there, we can probably knock that whole thing out over the next two years because of how bad the real estate market is (via the savings from renting/owning being funneled to the 529, and that includes grad-school funding as well).
Anyway, you know I've been a very long time reader, but prices up here in the DC metro have stabilized or dropped only *some,* so hearing about that kind of carnage was a huge eye-opener.
Posted by: Byno | Oct 13, 2008 8:31:05 AM
Great list, however I would add a mandated cap on existing floating rate loans (perhaps limited to subprime and Alt-A if they could be defined appropriately). This would likely go a long way in reducing defaults on the margin for those who can afford to make their current payments.
Posted by: EB | Oct 13, 2008 8:33:35 AM
As for point 8 above, how could we have convinced other countries to act on this crisis in its early stages, when here at home we were being told that everything was fine, no recession at all, right up to the moment when Paulson went to Congress and demanded his ransom or the economy would explode? We can't lead other countries when we can't even lead ourselves. Please.
Posted by: Rusticus | Oct 13, 2008 8:34:03 AM
Until we quit ignoring the real problem "jobs" and good ones at that, our economy can't possibly recover. People have no money to spend, creative financing can't and won't fix that.
Keep hoping, but it isn't going to happen.
Posted by: Concerned American | Oct 13, 2008 8:34:15 AM
"Now that you posted essentially what is Nouriel Roubini's plan, are you going to give him credit?
Posted by: Jim | Oct 13, 2008 7:52:22 AM"
I was thinking the same thing. But, then again, much of this is just common sense - save the good ones, cull the bad, don't reward the ones responsible, save the little guy, work together, restore trust. Amazing that those common sense goals happen to be the opposite of how our government/finance has been managed these past many years.
Posted by: Mind | Oct 13, 2008 8:42:18 AM
BR - Regarding the suspension of dividends, what about dividends on the existing preferreds? Do you think those dividends should be suspended? Meredith Whitney, who is one of the few bank analysts who has some credibility in this mess, has come out and said that she actually likes bank preferred shares. You've made preferreds a mainstay of your recapitalization plan. And you've talked about what a good deal Buffett got in GS and GE. If the US bails out banks, would you have those banks not pay a dividend to the preferred shares the US would buy?
I ask because I was thinking of buying some bank preferreds myself. JPM, WFC, PNC and maybe BAC.
Not asking for specific advice. Just asking if you think that bank preferreds should stop paying dividends in addition to the common.
Posted by: Don | Oct 13, 2008 8:42:55 AM
Just a suggestion but, since money represents a promise of future work there is a limit to the amount of money possible in any given population. Whether that money comes from private debt or public promise makes no difference. What is unlikey, improbable or impossible is so regardless of who made the promise.
Posted by: wally | Oct 13, 2008 8:54:56 AM
The core issue that needs to be addressed is asset values. Are there any ideas that will retain / enhance the value of assets ? ( Forget for a moment they are homes).
There is an oversupply, demand - supply rules will mandate that demand has to be stimulated by policy decisions. This may be more than fiscal or monetary policy may cover immigration and other comprehensive solutions.
The other way to increase an asset value is to actually improve upon an asset and making such improvement that injects more value into the asset may be achieved by policy means.
The rest of the pieces should fall into place once housing stabilizes.
Posted by: Jay Smith | Oct 13, 2008 9:04:22 AM
Any thoughts on the idea of nullifying CDS contracts by fiat?
Or would that be the way to enact #6?
Posted by: Dr. Kenneth Noisewater | Oct 13, 2008 9:11:51 AM
A quote from my Bloomberg really struck me:
This is from Jeffrey Immelt, only the head of GE.
"I'm pretty optimistic now. Government always wins and government is going to win this one."
Can someone explain to me a) how stupid is Jeff Immelt, and b) How can this POSSIBLY be a good thing to anyone with even a rudimentary knowledge of history and economics?
Posted by: Jay Weinstein | Oct 13, 2008 9:25:32 AM
Great post Barry.
Byno, don't forget property taxes and HO insurance in your question. Florida has some of the strangest tax laws in the country.
Posted by: weinerdog43 | Oct 13, 2008 9:28:05 AM
BR, Nothing about dealing with this massive CDS obligation? That's why LIBOR is out of whack, the system has a ungodly amount of CDS obligation's sitting out there waiting to explode. We need to wipe these CDS's off the books, make them worthless or 5 cents on the dollar. That's the fix.
Posted by: steve | Oct 13, 2008 9:29:06 AM
I agree with your plan. However, one thing is left unsaid that undermines it - the US has been spending beyond its means for a long time - at the government, consumer, and business level. No matter what we will do, we will be consideraly poorer. All these plans imply that we will go back to how it was. No, and when we don't people will get angry.
Posted by: fresno dan | Oct 13, 2008 9:50:15 AM
From WSJ: http://blogs.wsj.com/economics/2008/10/10/world-bank-meets-so-where-are-the-protestors/
THE CORRECT WAY TO HANDLE CDS SYSTEMIC RISK, from a former bankruptcy attorney as well as former General Counsel to a Mortgage-Backed Securities Issuer:
Markets will not resume rational behavior until the nuclear threat of credit default swaps has been rendered harmless. There are $55 Trillion of these private, non-regulated insurance agreements outstanding involving every major money center bank, investment house and major insurer worldwide.
There are two ways to take away counterparty risk. One is to guaranty their performance. The other is to render them unenforceable or of only limited enforceability.
Systemic confidence in world banks is so low that a government guaranty of counterparty obligations is totally worthless. Once everything has been guaranteed, nothing is guaranteed.
As a matter of public policy, the risk of enforcement of credit default swaps would be much more destructive to world economies than would be the risk of their unenforcement. These instruments were an unregulated, and unsanctioned, form of insurance. These instruments must be taken out of the equation in order to return the world banking system to the status quo ante.
The G7 meeting should result in a unified announcement that none of the currently outstanding credit default swaps will be enforceable in any of the G7 nations’ courts for at least five years as a matter of public policy. A G20 announcement could follow. A Derivatives Court of Claims could then be set up at the Hague to review such instruments, submitted by the parties and counterparties.
The Court of Claims could then act as a Court in equity to determine the putative obligations and cross-obligations of the parties, with a decision as to what percentage of the obligations should be enforceable, if any.
This would be, in effect, a bankruptcy court for an entire shadow insurance system, if you please.
Remove the CDS Sword of Damocles by declaration of unenforceability. Then, banks could begin lending to one another again without worthless guarantees from each other or from governments who are already on the hook for systemic risk.
Comment by Robert C. - October 11, 2008 at 5:41 pm
Posted by: from wsj | Oct 13, 2008 9:52:24 AM
Barry, I like your ideas so much, you inspired me to learn RSS using outlook. Now please edit your article to include a moratorium on Credit Default Swap Contracts for 3 years. Once those contracts expire we can take another look at them after cleaning up the financial carnage.
Posted by: Darrell Catmull | Oct 13, 2008 9:54:51 AM
Gee barry!
Exactly the plan Paulson wouldn't endorse. Does this guy realize that he works for the People?
I guess not.
Posted by: Francois | Oct 13, 2008 9:55:35 AM
Exactly!
The problem is #9. Those in charge never listen. If they did, we wouldn't be in this fine mess.
Posted by: Marc | Oct 13, 2008 10:01:07 AM
BR @ 7:21:
“…Match private equity investments, allowing the private sector with their own capital at risk to select the banks to be saved and the terms of the investments…”
Good idea in principle, but the devil’s in the details. I would be concerned that the bank managers would want to just create the illusion of private investment, in order to get the government money. For example, the bank executives might arrange to get the private equity money just long enough to get the government money, after which the private equity money would depart. Or the bank might grant a “loan” to the very financial firm that had made the investment. Worse, the bank executives might transfer money “under the table” after the private money was secured.
The point here is that there is no easy answer to the question of who decides which banks to save and which to kill; above all there is no easy way to keep the politicians out of that decision. Keeping the politicians out of that decision-making process is the most important objective of all.
Posted by: D.L. | Oct 13, 2008 10:08:29 AM
