Posted on 09/20/2008 7:51:21 AM PDT by PhilosopherStones
The extraordinary turmoil and fear in American and other financial markets have triggered equally extraordinary policy actions and proposals in Washington and New York City. Markets have appeared on the brink of collapse, with substantial and harmful impacts on consumers, workers, investors, and businesses both large and small. And there is a great deal about the exact nature of the situation in financial markets that is unknown. Even those in government charged with addressing the crisis—such as Treasury Secretary Paulson, Fed Chairman Bernanke, and New York Fed President Geithner—lack full information.
What we know is that the nation faces a fast-spreading financial contagion and that the risk of that contagion to the broader economy warrants bold, comprehensive, and decisive actions that would otherwise not be contemplated. Under these circumstances, and given the serious threat to the financial fabric of the economy and the economic security of Americans outside the financial industry, it appears that decisive actions are warranted and appropriate. However, many important details remain to be settled, and taxpayer protections must be included.
The stunning breadth of the four measures announced by the Administration between Thursday, September 18, and Friday, September 19, indicates the extent of the concern. Perhaps the most important and most controversial measure is the suggestion that Congress create an entity similar to the Resolution Trust Corporation (RTC). Congress created the original RTC following the savings and loan debacle of the late 1980s and early 1990s. Creating another one requires action by Congress.
The three other measures did not require congressional approval and have already been put into place. These three are themselves extraordinary and raise important policy issues. They are:
* Insurance for money market accounts. The Treasury has offered, for a fee, to insure private money market accounts held at qualifying institutions. This insurance is similar in nature to the insurance provided for checking and savings deposits at commercial banks, savings and loans, and credit unions.
This measure was necessary to restore confidence to money markets that have almost seized up entirely in recent days. However, to avoid distorting markets further and to protect the taxpayer, it is important that the Treasury sets the fee at a level that will properly price the insurance, which means in part that it reflects the level of risk of the fund’s assets.
* Temporary suspension of all short selling in certain equities. Short selling is a common activity that under normal circumstances creates another avenue by which markets set prices. However, short selling tends to lead to enhanced volatility. Under normal circumstances, volatility is neither good nor bad. However, in the current environment volatility arising from short selling has added to the turmoil by distorting market corrections. Therefore, the Securities and Exchange Commission has properly suspended all short selling in the shares of over 800 financial service firms for at least 10 days and up to 40 days. It is important, however, that short selling be permitted again as soon market conditions allow.
* Significant expansion of Treasury and Fannie Mae and Freddie Mac purchases. The Treasury placed Fannie Mae and Freddie Mac in conservatorship some days ago because of their financial weakness. The Treasury has now expanded their capital so they can begin purchasing billions of dollars of securities at market prices to help other financial institutions correct their own portfolios. In addition, the Treasury will expand its purchases of mortgage-backed securities on its own account.
As a rule, the federal government should not buy up private assets as though it were a private investor, either directly or through Fannie Mae and Freddie Mac. However, if the market for mortgage-backed securities seizes up, as it has done in recent days, then direct federal intervention is warranted to help restore normal market conditions. But such interventions should occur only in the event of a market breakdown and should continue only as long as the market continues to struggle to clear.
What Was the Original RTC?
Created in 1989, RTC sold the bad assets of failed savings and loans and other thrift institutions (“thrifts”) that had been taken over by their deposit insurance fund. For the most part, these assets were made up of real estate and securities that were difficult to move in the tight markets of the early 1990s. Good assets such as the thrift’s deposits, offices, and easily sold assets were not given to RTC as they were usually sold to another financial institution at the time the original thrift failed. Between 1989 and its 1995 absorption into the FDIC, the RTC dealt with 747 thrifts with assets of about $394 billion. Overall, the cost to the taxpayers was estimated at $124 billion in 1995 dollars.
A key feature of the RTC was its use of equity partnerships under which pools of assets were partially bought by a private investor, who then liquidated the pool and split the profits with the RTC. Because the RTC’s assets were sold gradually instead of being dumped on the market all at once, the total cost to the taxpayers was significantly lower than early estimates that losses could reach several hundred billion dollars.
Regardless of whether the new RTC is structured as a part of the Treasury Department or as a free-standing temporary agency, there would be similarities to the original RTC. While the original RTC liquidated mainly real estate that was left over from failed thrifts, the new RTC would be dealing with financial instruments based upon mortgage-backed securities. Some of these could be so exotic and complex that it would be difficult to give them any realistic value. However, despite the differences in investments, both entities would be dedicated to reducing the cost to taxpayers by orderly selling large pools of investments over time rather than allowing them to be dumped into the markets and sold at distressed prices.
Principles to Guide a New RTC
Congress and the Administration should follow key principles in structuring any new RTC-like entity in order to meet the goal of stabilizing the market with the least danger to the taxpayer:
* The agency should have a limited scope and lifespan. Legislation authorizing the new agency should delineate its duties in as much detail as possible to prevent “mission creep” into other types of financial activity such as financing low-income housing, promoting infrastructure development, or anything other than dealing with the current financial crisis. While some flexibility will be required in a time of so much financial uncertainty, any substantial change in the agency’s mission should require additional congressional action and should be resisted. In addition, the enacting legislation should be clear that the new entity will have a strictly limited lifespan, after which it will be dissolved. This entity should exist only as long as it takes to orderly liquidate the assets it receives and not become a permanent part of government. The original RTC lasted for six years and was dissolved once its work was completed. Hopefully, the new RTC could complete its mission within three years and then be similarly disbanded.
* The agency should not take an ownership stake in financial institutions. While the new agency may exchange assets with private financial institutions, it should not own stock in them.
* Any net profits should go to the taxpayers. Over time, a substantial proportion of the assets held by any new RTC will likely be sold at a higher price than what the agency paid for them. In such a case, profits should go to the taxpayers to reduce the overall cost of the bailout. Under no circumstances should any profits be used to finance other public policy objectives.
* Companies should pay for this assistance. Any assets acquired by the new RTC as part of the process of taking these investments off the balance sheets of financial institutions should be purchased at a discount to their true worth. Alternately, companies using the new RTC could pay a significant fee for those services. Under no circumstances should companies receive these services for free or an inadequate price.
* The agency should operate using private entities wherever possible. The purpose of the new RTC should be limited to purchasing and holding poor quality assets, with sales being handled through private entities through either equity partnership or on a contractual basis.
* The legislation should be kept clean. Congress should not attach legislation on other subjects to the bill creating the new RTC. These include such items as increasing unemployment insurance, changing capital gains taxation, allowing bankruptcy courts to alter the terms of mortgages, or anything similar. This bill is the response to a major crisis and not an excuse for legislators to advance their pet projects.
Point though is, that a $700 Billion purchase of mortgage backed securities will ultimately not cost anywhere near $700 Billion.
These assets are backed by real-property which has a value. We just don't know what that value is. Because of that uncertainity, the current sales value is zero which has caused the current credit freeze-up.
As the housing market expands again (as it has in Cali with existing homes sales up 13.4% in August '08 over August 2007, the value of the assets that any new RTC holds will also increase, decreasing the net cost to taxpayers.
Assuming, of cours, that the new RTC follows some of the recommendation outlined above.
bttt
The first thing they should do is cancel all the multi-million dollar retirement programs of the fools that were running the companies that are going under. To let these guys get away with all this money and expect us to pick up the slack is a slap in the face of the American people.
These assets are backed by real-property which has a value. We just don’t know what that value is. Because of that uncertainity, the current sales value is zero which has caused the current credit freeze-up.
Results: Between the credit crisis, bankruptcies, billion dollar buyouts and billion dollar buyouts, the economy has emerged as issue No. 1 in the presidential race. Which candidate do you think will do the best job reviving the U.S. economy?
Poll Results:
John McCain (R) - 66.9%
Barack Obama (D) - 22.2%
Bob Barr (L) - 1.3%
None of the Above - 9.7%
Total Responses -
528
Well yeah. That and prosecute the Freddie, Fannie and CRA enablers in Congress who let this thing spin out of control in return for tons of campaing $$$.
Let’s start with Dodd, Obama, Hillary, Franks...
Nope, not gonna happen.
Obama and his supporters are doing two things which SHOULD be suicidal (but won’t be because their MSM supporters are covering for them)
1) Exacerbating a difficult situation by comparing it to the Great Depression, deflecting blame away from (Dim controlled) Fannie and Freddie.
2) Not taking a stand one way or another. Leadership demands decision making, even if later it turns out that a different decision might have been marginally better.
Obama always waits to see what the outcome is before weighing in with his opinion. McCain should hit this tendancy hard.
Very good article with concrete recommendations on something that “experts” have deemed “too big to fail”. Thanks for posting.
On the flip side has the oligarchy deemed this one TOO BIG TO INVESTIGATE?
Against all enemies, foreign AND DOMESTIC.
“For the most part, these assets were made up of real estate and securities that were difficult to move in the tight markets of the early 1990s.”
...wonder if he means SOFT markets, since properties generally have no problem moving in a tight market.
A lot of it just depends on which way the wind is blowing.
My cousin is a mortgage lender and noted as early as late summer 2007 that the ultimate mortgage buyers (Lehman in particular) were all of the sudden “Shocked! Shocked I tell you!” that no-doc loans didn’t have any... well... docs.
You start with a risk analysis that works, then one of the big boys decides arbitrarily that one of your risk assumptions is bogus. They’re simply playing CYA while leaving you holding the bag.
Care to elaborate? I could use a good laugh about now.
Seriously, let's just get Dodd.
Make an example out of him.
Whenever free enterprise fumbles the ball, government takes over. In the end government saves the day for Darwinian capitalism as it did in 1932 when Roosevelt took over the 1929 fumble. Roosevelt put the ball in government’s hands until free enterprise was again able to take over WW II postwar.
Private enterprise, relying on a domestic strong economic engine of asset production, produced an unrivaled economy for its citizens. This model was challenged by an information globalist economic model where unbalanced trade and military involvement would unleash the Third Wave of the Information Age. [Gingrich’s “To Renew America”].
So here we are. The ball back in government’s hands and private enterprise waiting for another chance while those who brought us to this have landed somewhere in a golden parachute. Who will recover for private enterprise has not suited up yet.
What I’m not hearing thus far is an energetic commitment to investigating the situation, prosecuting criminals, and holding responsible those who just plain didn’t do their jobs. We have many conflicts of interest, fraud, and other issues to sort out, in addition to putting in place measures to prevent more of the same.
Sorry, ain’t gonna happen.
Some of the worst private offenders (Mozilo of Countrywide) are already out. And while they were sleazy and unethical, they did nothing illegal.
The current heads of AIG/Morgan Stanley etc won’t get their golden parachutes.
The real crooks (heads of Fannie and Freddie and the corrupt Dems who supported them) will remain until voters kick them out of office. But people like Dodd and Franks will just keep rolling along because their voters LIKE all the pork they send them. If Rangel can hold on to his chairmanship after all he’s done, do you really think that Dodd and Franks are in danger?
That was the joke part, none of the hard stuff ever comes to pass.
It’s going to be tricky for the Dhimmis.
On the one hand, they want this crisis to play out right up to November 4th because they think a bad economy helps them.
On the other hand, if they are seen as blocking needed reform and solutions they lose big.
This is McCain’s to win by being solidly out in front on any reform while Obambi dithers about what to do.
I wish someone would start talking the issues, it's sort of like rush her, it is all about character assassination.
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