Sunday, September 21, 2008

A better plan..a non bail-out plan

Fact and Opinion… A Non bail out plan


An alternative plan that unlocks value, instead of depressing it

The Fed/Treasury have proposed a bailout plan that really isn’t a plan and may not bail anything out. The Plan is not yet fleshed out, underscoring that it is more of a marketing ploy than plan. So far Fed/Treasury actions have been ad hoc. We are led to believe they have a more systematic approach even though it has not been presented. The crux of it seems to be to dump the losses on taxpayers (a ‘bail-in’ that sloshes water out of the bank and into your basement).

Instead, I encourage you to believe that AIG ‘broke the bank’ just as money market funds ‘broke the buck.’ Bernanke almost certainly went to Paulson and said there is too much hitting the fan, the fan cannot keep operating. The Fed’s balance sheet is too stretched. So in a fit of magician’s misdirection the Fed is out of the lime light and now the ‘THE PLAN’ is in it.

If this were foreign policy it would be like Iraq or Vietnam: an effort to start something without a clue as to how to finish it, let alone how to progress. There is no mission, or objective.

This is a plan? How can you buy assets without knowing what they are worth? Yet this is the centerpiece of the RTC plan. If you pay banks what the assets are worth how does that help them? If you pay them more you harm taxpayers and subsidize shareholders. This is a plan? A plan need to unlock value!

Unintended consequences: The old RTC bought the assets of fully failed banks not chipped off portions of bad stuff from banks that remained ongoing concerns. This RTC is a different animal. We can already see the law of unintended consequences at work as the plan to BAIL OUT money market mutual funds that ‘broke the buck’ will now leave banks at a disadvantage since bank deposits are only backed up to $100,000, but MMFs are to be fully backed At each turn or new wrinkle of the law a new unintended consequence slips into gear.

A better plan, a REAL plan

A better plan is to make banks keep their assets and change the accounting rules. Eradicate the mark to market rule for securities to enable this. Then the automatic write downs will stop, even as real estate sinks. This plan unlocks the value of long run pricing. If, as the Treasury Secretary says, the fundamentals are strong, the economy will come back. So will real estate, if not all the way back. Losses can be limited, given time, and they can be made manageable. Those that made bad decisions (and their shareholders) will have to deal with them. Given the flexibility to use long run pricing the private sector can tap what the government is after using RTC: time. Earnings will suffer but bankruptcy won’t loom. Taxpayers won’t foot the bill and moral hazard will not be introduced. Presto!

Incentivize banks - A discretionary asset valuation plan (WITH REGULATORY OVERSIGHT!) would be superior by giving banks the incentive to keep troubled mortgage holders in their homes. Once someone defaulted, the mortgage would more clearly be at a loss that the bank would have to deal with. Banks automatically would be encouraged to make deals with mortgage holders to avoid this. Still banks will need to form property management arms to manage vacant properties since there will be lot of them. If RTC seized the assets then it would have to do this and I would not trust a government agent to do anything other than to sell them quickly further depressing the real estate market. RTC does not have the answers.

Use THE FORCE, LUKE, err Ben…The idea SHOULD BE to press the private market to action not to depress it and replace it. Draw it out of its immobilized state. The catharsis would be a change in how securities have to be valued. Banks could be forced to give up some of their control (like their ability to pay dividends) while they opt for the new securities valuation rule. They could opt out of it when they become ‘healthy’.

Counterparty risk! As the Treasury/Fed try plug the leaky financial dike it is all too clear that the approach remains ad hoc. Better to modify and use the system we know. The problem in this market is not liquidity as the Fed has thought. The Fed keeps increasing the dosage and it doesn’t help. The problem is counterparty risk. So give banks a chance to value assets at their long run potential and slip the noose of short term weakness off their neck. The plan could work and would be superior to whatever is being concocted in Washington.

1 comment:


Theirs lots of plans out their but very few plans will work.