An Alternative Bailout Proposal

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An Alternative Bailout Proposal

Fundamentally, the entire credit crisis has been caused by two basic problems.

1. Too much borrowing.

2. Not enough saving.

That sounds really trite and overly simplified, doesn’t it? The fact of the matter is that it’s true. The housing crisis wasn’t caused by a surplus of houses, but by an overeagerness to lend without considering a borrower’s ability to repay. Easy credit meant demand for houses went up, and supply went up to keep pace. Now that credit is more restricted and borrowing is harder, supply is up but demand is down.

Second fact of the matter is that saving is down, considerably. The average American over the past five years has spent more than they earned to the tune of 130%, relying on easy access to, yes, credit, to fulfill their consumerist desires. With no money put aside for a rainy day, vast numbers of Americans are finding themselves underwater in a financial hurricane. In the past, when the economy has taken a downturn, Americans had some financial cushion to rely on, but with the devaluation of stocks, even things like 401(k) retirement plans have lost considerable value.

Lehman Brothers Building PhotoshoppedThe bank bailout proposals currently floating around Congress do nothing to address either issue. Secretary Paulson’s plan calls for 700 billion – that’s700,000,000,000 – to buy poor quality assets (failed mortgages and investments) from banks and try to sell them off at a later date. If you as a banker, rationally, want to do what is best for your bank, you’ll gladly sell the Treasury all your garbage and keep the performing loans for yourself. I would, rationally, because that’s good business.

What happens to the average homedebtor who has fallen behind on their mortgage? Absolutely nothing. No help at all. Why? The bank has been relieved of its obligation to investors but the homedebtor has not. Wall Street profits, but Main Street remains underwater.

So what’s the alternative? How can we find a real solution to this mess? Clearly, bailing out Wall Street and the wealthy friends of Secretary Paulson will do nothing to help the average homedebtor.

We look to economics 101. Supply of houses still exceeds demand. You can change this equation by increasing demand or reducing supply. The general talking point behind the bailout is that banks will be willing to lend again – but it’s lending that got us into trouble in the first place. That’s like giving a bottle of Jack to an alcoholic trying to quit. Yes, the tremors stop, but the root problem remains.

Increasing demand through lending is a no-go. That leaves reducing supply. We have currently anywhere from 9 to 20 months of inventory in housing, depending on the regional market, and a healthy level of inventory is around 6 months, or so my realtor friends say. How do you get rid of a lot of houses quickly? One potential idea is to convert them into affordable housing under the HUD Section 8 program, helping families who had no shot at home ownership even with absurd lending policies actually get started. The downside to this idea, at least from some folks who’ve commented to me, is that middle class homeowners will strongly fight any mixing of income classes in their neighborhoods.

A second idea for reducing supply, radically proposed, is demolition of the existing homes. In certain cases, this might make sense, especially if there are entire neighborhoods that lay fallow. Dismantle them for supplies as much as possible, and convert that section of a city into a community park.

A third idea, and the one I like best, is to use bailout money to buy out foreclosures at fire sale prices and deed over the properties, many of which need repairs, to a private agency like Habitat for Humanity, which employs a more rigorous screening process than HUD and forces future homeowners to put in significant sweat equity to create a true sense of responsibility and ownership.

We also need economic growth. Look around America. Bridges, rail systems, roads, public schools, the entire infrastructure is rotting away. Instead of giving Wall Street a handout, let’s agree to rebuild Main Street – it needs it. These are jobs that are inherently American and can’t be outsourced or shipped overseas. These are also projects that pay a dividend over time – improved roads, schools, parks, and civic infrastructure contribute to both morale and commerce.

To trim the budget and pay for at least some of this, we need to get out of Iraq. Win or lose, right or left, Iraq is a money sinkhole. No matter how well you think we’re doing, we can’t afford it.

Slackershot: MoneyTo address the savings issue, I’d take the lesser portion of the bailout funds and instead of paying off Wall Street, create massive tax incentives for saving. Since Congress is clearly in the mood to spend anyway, I’d waive all taxes on savings accounts, certificates of deposit, Treasury bills and bonds, and non-investment vehicles for 2 years, encouraging anyone and everyone to sock away as much money as possible. A savings account that earns a meager 3% interest looks a whole lot better when interest earned is 100% tax free. This will also have the net effect of recapitalizing depository banks, which is something they’ve been desperately trying to do on Wall Street.

Will these ideas cure the ailing economy? No. Will they help? Yes. They address the fundamental issues of supply and demand far more effectively than giving Secretary Paulson a wheelbarrow full of cash and a hug, which is about all the current proposal entails. Only time and the free market can flush out the crap that’s in our system, but by focusing the majority of money on the power base of America – us, the taxpayers – we might get some long-term good out of this.

Consider joining the Facebook group I’ve set up to protest the current bailout proposals.

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An Alternative Bailout Proposal 1 An Alternative Bailout Proposal 2 An Alternative Bailout Proposal 3

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Comments

17 responses to “An Alternative Bailout Proposal”

  1. Cheapsuits Avatar
    Cheapsuits

    Well I can't fault you for thinking. Commendable actually. Your idea on waiving taxes on savings is easier said then done however. With increasingly less and less to sock away, Americans will opt for food, fuel and a roof versus using that money to stash away in a savings account to earn interest tax free. The tax benefit would not be that compelling at current interest rates. I would rather see the money used for savings be tax free much like a 401K. That is earned income used to invest in savings is tax free. I think that is much more attractive.

  2. I agree completely with one and two. But riddle me this, don’t you think McCain or Obama should tell us who will be their Treasury Secretary? Just a query. I mean with almost a trillion dollars on the line.

  3. I agree! I'd love to know that info too.

  4. Cheapsuits Avatar
    Cheapsuits

    Well I can’t fault you for thinking. Commendable actually. Your idea on waiving taxes on savings is easier said then done however. With increasingly less and less to sock away, Americans will opt for food, fuel and a roof versus using that money to stash away in a savings account to earn interest tax free. The tax benefit would not be that compelling at current interest rates. I would rather see the money used for savings be tax free much like a 401K. That is earned income used to invest in savings is tax free. I think that is much more attractive.

  5. I agree completely with one and two. But riddle me this, don’t you think McCain or Obama should tell us who will be their Treasury Secretary? Just a query. I mean with almost a trillion dollars on the line.

  6. I agree with you on lifting taxes on savings – and I would also raise limits on 401(k) accounts as well as SEP accounts for the self-employed.

    Cash is still king, and we all need to save it!

    mp/m

  7. I agree! I'd love to know that info too.

  8. Good ideas, Chris, but lets not forget the root cause of this mess. The feds have been hounding banks to hand out mortgages to unqualified lenders. This is not to say the banks are blameless – they took this requirement and ran with it, making the problem much worse than it should have been. But we need to get rid of those requirements, and let banks get back to sound lending practices, or this will never end.

  9. Good ideas, Chris, but lets not forget the root cause of this mess. The feds have been hounding banks to hand out mortgages to unqualified lenders. This is not to say the banks are blameless – they took this requirement and ran with it, making the problem much worse than it should have been. But we need to get rid of those requirements, and let banks get back to sound lending practices, or this will never end.

  10. An economic bailout strategy that will help Main Street, but not reward Wall Street is needed. The national approach must include a healthy dose of common sense. The voices of the citizens are rising up in a roar, but it seems that those in the ivory tower known as Capitol Hill are deaf to a chorus from grass-roots America. A bailout should not be complicated. Simplicity is essential. The following link is an elegant solution to our National dilemma.

    http://www.sentinel-consulting.com/Crisis/Simpl

  11. An economic bailout strategy that will help Main Street, but not reward Wall Street is needed. The national approach must include a healthy dose of common sense. The voices of the citizens are rising up in a roar, but it seems that those in the ivory tower known as Capitol Hill are deaf to a chorus from grass-roots America. A bailout should not be complicated. Simplicity is essential. The following link is an elegant solution to our National dilemma.

    http://www.sentinel-consulting.com/Crisis/Simplified_Bailout_Strategy.pdf

  12. How To Fix Our Banking System
    The “Genesis” Plan
    by Karl Denninger
    [email protected]

    It is clear that we must act to stabilize our financial markets. What is also clear is that if we act imprudently we will destroy our financial markets and system instead of saving it, and are likely to usher in a Depression.

    What Henry Paulson and Ben Bernanke have proposed will do the latter, not the former.
    The root cause of the current lack of trust in our financial markets is threefold:

    1. Nobody can trust a balance sheet. This is due to off-balance-sheet vehicles (which were supposed to be banned after ENRON) and “Level 3” assets, which nobody can analyze the true valuation of, as identification of the claimed assets and their valuation models are undisclosed.

    2. Credit Default Swaps (CDS) are “over the counter” (OTC) transactions with no margin or capital supervision. As a consequence nobody knows if their “counterparty” can pay. In fact huge percentages of these people can’t pay – but nobody knows who they are.

    3. Leverage. The SEC removed broker/dealer 12:1 leverage limits in 2004. Every firm that has failed – all five (Fannie, Freddie, Bear Stearns, Lehman and AIG) had leverage far in excess of 12:1. The draft bill is even more dangerous as it accelerates a provision intended to go into effect in 2011 that allows Ben Bernanke to increase financial firm leverage by dropping reserve requirements on banks to zero should he so choose. It is excessive leverage that got us here in the first place, and this bill actually makes it worse.

    The solution to the trust issues in our financial system is elegant and it will work.

    1. Force all off-balance sheet “assets” back onto the balance sheet, and force the valuation models and identification of individual assets out of Level 3 and into 10Qs and 10Ks. Enact this requirement beginning with the 3Q 2008 reporting period which begins next month. Total taxpayer cost: $0.00

    2. Force all OTC derivatives onto a regulated exchange similar to that used by listed options in the equity markets. This permanently defuses the derivatives time bomb. Give market participants 90 days to get this done; any that are not listed in 90 days are declared void; let the participants sue each other if they can't prove capital adequacy. Total taxpayer cost: $0.00

    3. Force leverage by all institutions to no more than 12:1. The SEC intentionally dropped broker/dealer leverage limits in 2004; prior to that date 12:1 was the limit. Every firm that has failed had double or more the leverage of that former 12:1 limit. Enact this with a six month time limit and require 1/6th of the excess taken down monthly. Total taxpayer cost: $0.00

    Once 1-3 are put in place then send in the OTS and OCC examiners and look at every financial institution in the United States. All who are insolvent and unable to raise private capital immediately are forced through receivership where the debt is converted to equity and existing equity is wiped out.

    With the CDS monster caged the systemic risk is removed, the bondholders provide the cushion for recapitalization (as it should be) and the restructured firm emerges with no debt while the former bondholders are now the owners (of the equity) in the resulting firm. With a clean balance sheet the restructured firms remain in business and open the next morning able to raise and attract capital. For the few firms that have an insufficient debt-holder capital cushion to successfully complete this process, we are left with two options – a capital infusion or liquidation. There will be few of these and in fact each of those firms is a regulatory failure, as we should have never permitted a firm to become so far “underwater” that the bondholder's capital is insufficient to capitalize a restructuring.

    For those firms, give the FDIC (or if an insurance company, the appropriate state and federal regulatory authorities) primary control. As the CDS monster has been caged, the primary threat is now loss to state and federal guarantee programs. If these regulators deem that this firm’s liquidation would result in an unacceptable loss to the system’s guarantee programs then recapitalize the firm as follows:

    · The government shall be issued senior preferred debt ahead of all other debt and equity in the capital structure, paying a floating coupon of 3 month LIBOR + 8% adjusted quarterly, in an amount sufficient to bring regulatory capital above minimum limits.

    · All dividends are suspended for as long as the preferred remains outstanding, and during that period no employee of the firm may receive any form of compensation exceeding that of the President of the United States for a corporate officer, and no more than that of a United States House member for any person who is not a corporate officer. At the issue of the preferred stock all outstanding deferred compensation, including options, are deemed cancelled.

    · The firm may retire the preferred at its option by repurchasing it at the issue price.

    · The appropriate regulator shall have primary authority to “call” the above debt issue at any time and force bankruptcy (along with recovery of invested amounts) should the firm fail to execute an effective turnaround
    plan.

    Finally, drop the silly shorting restrictions. Liquidity in the market stinks and this is a big part of why. Start prosecuting aggressively the rumors and other manipulation that leads to stocks both rising and falling.

    This plan will instantaneously stabilize the credit markets as balance sheets will be transparent, the CDS monster will be permanently de-fanged, leverage will be returned to reasonable levels and the forcibly restructured firms will have no debt on their balance sheets and be able to access the capital markets. Firms that would fail once they have disclosed their true liabilities and result in unacceptable insurance program costs will be recapitalized with a reasonable expectation of the taxpayer not being stuck with the bill. Systemic risk will be removed.

    Best of all, it will require zero taxpayer dollars with few exceptions, and for those instances where taxpayer dollars are required the amount of taxpayer risk would be small and well-protected.

    This plan is very similar to what Janet Tavakoli proposed on September 25th in an open letter released on the web.

    Ms. Tavakoli is an internationally recognized expert in these matters, is an adjunct professor of derivatives, and is widely published.

    This and other alternatives must be examined before our nation embarks on what may be a disastrous path. http://www.tavakolistructuredfinance.com/TSF8.html

  13. How To Fix Our Banking System
    The “Genesis” Plan
    by Karl Denninger
    [email protected]

    It is clear that we must act to stabilize our financial markets. What is also clear is that if we act imprudently we will destroy our financial markets and system instead of saving it, and are likely to usher in a Depression.

    What Henry Paulson and Ben Bernanke have proposed will do the latter, not the former.
    The root cause of the current lack of trust in our financial markets is threefold:

    1. Nobody can trust a balance sheet. This is due to off-balance-sheet vehicles (which were supposed to be banned after ENRON) and “Level 3” assets, which nobody can analyze the true valuation of, as identification of the claimed assets and their valuation models are undisclosed.

    2. Credit Default Swaps (CDS) are “over the counter” (OTC) transactions with no margin or capital supervision. As a consequence nobody knows if their “counterparty” can pay. In fact huge percentages of these people can’t pay – but nobody knows who they are.

    3. Leverage. The SEC removed broker/dealer 12:1 leverage limits in 2004. Every firm that has failed – all five (Fannie, Freddie, Bear Stearns, Lehman and AIG) had leverage far in excess of 12:1. The draft bill is even more dangerous as it accelerates a provision intended to go into effect in 2011 that allows Ben Bernanke to increase financial firm leverage by dropping reserve requirements on banks to zero should he so choose. It is excessive leverage that got us here in the first place, and this bill actually makes it worse.

    The solution to the trust issues in our financial system is elegant and it will work.

    1. Force all off-balance sheet “assets” back onto the balance sheet, and force the valuation models and identification of individual assets out of Level 3 and into 10Qs and 10Ks. Enact this requirement beginning with the 3Q 2008 reporting period which begins next month. Total taxpayer cost: $0.00

    2. Force all OTC derivatives onto a regulated exchange similar to that used by listed options in the equity markets. This permanently defuses the derivatives time bomb. Give market participants 90 days to get this done; any that are not listed in 90 days are declared void; let the participants sue each other if they can't prove capital adequacy. Total taxpayer cost: $0.00

    3. Force leverage by all institutions to no more than 12:1. The SEC intentionally dropped broker/dealer leverage limits in 2004; prior to that date 12:1 was the limit. Every firm that has failed had double or more the leverage of that former 12:1 limit. Enact this with a six month time limit and require 1/6th of the excess taken down monthly. Total taxpayer cost: $0.00

    Once 1-3 are put in place then send in the OTS and OCC examiners and look at every financial institution in the United States. All who are insolvent and unable to raise private capital immediately are forced through receivership where the debt is converted to equity and existing equity is wiped out.

    With the CDS monster caged the systemic risk is removed, the bondholders provide the cushion for recapitalization (as it should be) and the restructured firm emerges with no debt while the former bondholders are now the owners (of the equity) in the resulting firm. With a clean balance sheet the restructured firms remain in business and open the next morning able to raise and attract capital. For the few firms that have an insufficient debt-holder capital cushion to successfully complete this process, we are left with two options – a capital infusion or liquidation. There will be few of these and in fact each of those firms is a regulatory failure, as we should have never permitted a firm to become so far “underwater” that the bondholder's capital is insufficient to capitalize a restructuring.

    For those firms, give the FDIC (or if an insurance company, the appropriate state and federal regulatory authorities) primary control. As the CDS monster has been caged, the primary threat is now loss to state and federal guarantee programs. If these regulators deem that this firm’s liquidation would result in an unacceptable loss to the system’s guarantee programs then recapitalize the firm as follows:

    · The government shall be issued senior preferred debt ahead of all other debt and equity in the capital structure, paying a floating coupon of 3 month LIBOR + 8% adjusted quarterly, in an amount sufficient to bring regulatory capital above minimum limits.

    · All dividends are suspended for as long as the preferred remains outstanding, and during that period no employee of the firm may receive any form of compensation exceeding that of the President of the United States for a corporate officer, and no more than that of a United States House member for any person who is not a corporate officer. At the issue of the preferred stock all outstanding deferred compensation, including options, are deemed cancelled.

    · The firm may retire the preferred at its option by repurchasing it at the issue price.

    · The appropriate regulator shall have primary authority to “call” the above debt issue at any time and force bankruptcy (along with recovery of invested amounts) should the firm fail to execute an effective turnaround
    plan.

    Finally, drop the silly shorting restrictions. Liquidity in the market stinks and this is a big part of why. Start prosecuting aggressively the rumors and other manipulation that leads to stocks both rising and falling.

    This plan will instantaneously stabilize the credit markets as balance sheets will be transparent, the CDS monster will be permanently de-fanged, leverage will be returned to reasonable levels and the forcibly restructured firms will have no debt on their balance sheets and be able to access the capital markets. Firms that would fail once they have disclosed their true liabilities and result in unacceptable insurance program costs will be recapitalized with a reasonable expectation of the taxpayer not being stuck with the bill. Systemic risk will be removed.

    Best of all, it will require zero taxpayer dollars with few exceptions, and for those instances where taxpayer dollars are required the amount of taxpayer risk would be small and well-protected.

    This plan is very similar to what Janet Tavakoli proposed on September 25th in an open letter released on the web.

    Ms. Tavakoli is an internationally recognized expert in these matters, is an adjunct professor of derivatives, and is widely published.

    This and other alternatives must be examined before our nation embarks on what may be a disastrous path. http://www.tavakolistructuredfinance.com/TSF8.html

  14. How To Fix Our Banking System
    The “Genesis” Plan
    by Karl Denninger
    [email protected]

    It is clear that we must act to stabilize our financial markets. What is also clear is that if we act imprudently we will destroy our financial markets and system instead of saving it, and are likely to usher in a Depression.

    What Henry Paulson and Ben Bernanke have proposed will do the latter, not the former.
    The root cause of the current lack of trust in our financial markets is threefold:

    1. Nobody can trust a balance sheet. This is due to off-balance-sheet vehicles (which were supposed to be banned after ENRON) and “Level 3” assets, which nobody can analyze the true valuation of, as identification of the claimed assets and their valuation models are undisclosed.

    2. Credit Default Swaps (CDS) are “over the counter” (OTC) transactions with no margin or capital supervision. As a consequence nobody knows if their “counterparty” can pay. In fact huge percentages of these people can’t pay – but nobody knows who they are.

    3. Leverage. The SEC removed broker/dealer 12:1 leverage limits in 2004. Every firm that has failed – all five (Fannie, Freddie, Bear Stearns, Lehman and AIG) had leverage far in excess of 12:1. The draft bill is even more dangerous as it accelerates a provision intended to go into effect in 2011 that allows Ben Bernanke to increase financial firm leverage by dropping reserve requirements on banks to zero should he so choose. It is excessive leverage that got us here in the first place, and this bill actually makes it worse.

    The solution to the trust issues in our financial system is elegant and it will work.

    1. Force all off-balance sheet “assets” back onto the balance sheet, and force the valuation models and identification of individual assets out of Level 3 and into 10Qs and 10Ks. Enact this requirement beginning with the 3Q 2008 reporting period which begins next month. Total taxpayer cost: $0.00

    2. Force all OTC derivatives onto a regulated exchange similar to that used by listed options in the equity markets. This permanently defuses the derivatives time bomb. Give market participants 90 days to get this done; any that are not listed in 90 days are declared void; let the participants sue each other if they can't prove capital adequacy. Total taxpayer cost: $0.00

    3. Force leverage by all institutions to no more than 12:1. The SEC intentionally dropped broker/dealer leverage limits in 2004; prior to that date 12:1 was the limit. Every firm that has failed had double or more the leverage of that former 12:1 limit. Enact this with a six month time limit and require 1/6th of the excess taken down monthly. Total taxpayer cost: $0.00

    Once 1-3 are put in place then send in the OTS and OCC examiners and look at every financial institution in the United States. All who are insolvent and unable to raise private capital immediately are forced through receivership where the debt is converted to equity and existing equity is wiped out.

    With the CDS monster caged the systemic risk is removed, the bondholders provide the cushion for recapitalization (as it should be) and the restructured firm emerges with no debt while the former bondholders are now the owners (of the equity) in the resulting firm. With a clean balance sheet the restructured firms remain in business and open the next morning able to raise and attract capital. For the few firms that have an insufficient debt-holder capital cushion to successfully complete this process, we are left with two options – a capital infusion or liquidation. There will be few of these and in fact each of those firms is a regulatory failure, as we should have never permitted a firm to become so far “underwater” that the bondholder's capital is insufficient to capitalize a restructuring.

    For those firms, give the FDIC (or if an insurance company, the appropriate state and federal regulatory authorities) primary control. As the CDS monster has been caged, the primary threat is now loss to state and federal guarantee programs. If these regulators deem that this firm’s liquidation would result in an unacceptable loss to the system’s guarantee programs then recapitalize the firm as follows:

    · The government shall be issued senior preferred debt ahead of all other debt and equity in the capital structure, paying a floating coupon of 3 month LIBOR + 8% adjusted quarterly, in an amount sufficient to bring regulatory capital above minimum limits.

    · All dividends are suspended for as long as the preferred remains outstanding, and during that period no employee of the firm may receive any form of compensation exceeding that of the President of the United States for a corporate officer, and no more than that of a United States House member for any person who is not a corporate officer. At the issue of the preferred stock all outstanding deferred compensation, including options, are deemed cancelled.

    · The firm may retire the preferred at its option by repurchasing it at the issue price.

    · The appropriate regulator shall have primary authority to “call” the above debt issue at any time and force bankruptcy (along with recovery of invested amounts) should the firm fail to execute an effective turnaround
    plan.

    Finally, drop the silly shorting restrictions. Liquidity in the market stinks and this is a big part of why. Start prosecuting aggressively the rumors and other manipulation that leads to stocks both rising and falling.

    This plan will instantaneously stabilize the credit markets as balance sheets will be transparent, the CDS monster will be permanently de-fanged, leverage will be returned to reasonable levels and the forcibly restructured firms will have no debt on their balance sheets and be able to access the capital markets. Firms that would fail once they have disclosed their true liabilities and result in unacceptable insurance program costs will be recapitalized with a reasonable expectation of the taxpayer not being stuck with the bill. Systemic risk will be removed.

    Best of all, it will require zero taxpayer dollars with few exceptions, and for those instances where taxpayer dollars are required the amount of taxpayer risk would be small and well-protected.

    This plan is very similar to what Janet Tavakoli proposed on September 25th in an open letter released on the web.

    Ms. Tavakoli is an internationally recognized expert in these matters, is an adjunct professor of derivatives, and is widely published.

    This and other alternatives must be examined before our nation embarks on what may be a disastrous path. http://www.tavakolistructuredfinance.com/TSF8.html

  15.  Avatar
    Anonymous

    Users can search for the best mortgage rates by zip code. The site provides several free Karl’s Mortgage Calculators. User profiles and some forums can only be seen by registered members.

  16.  Avatar
    Anonymous

    Corey Rosenbloom wrote an interesting Fidelity 401k post today onHere’s a quick excerptA few number crunchers at Dow Jones have been pretty busy as of late.

  17.  Avatar
    Anonymous

    Thankfully, we don’t have to fidelity 401k leave this important process to chance. There is wisdom out there in the world to help. Our goal as parents should be to normalize our children’s emotions. There are no bad emotions, only unhelpful responses to them.

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