Here's my angle. Right before the stimulus passed, I wrote a proposal and sent it off to my government. It was my civic duty, and I hope someone read it. I've received no reply, but perhaps someone meaningful is taking these ideas to heart if they haven't seen them already. This was part of a letter sent on February 1st to the White House, offering up a solution to US banking system's woes. Between this and a mark to model suggestion that enables banks to value assets based on present cashflows as opposed to mark-to-market of liquidation, I think we may have something viable. The markdowns of commercial properties are an extension of this story: without the ability to refi balloons coming due, properties will be forced to liquidate that will result in supply inventory levels we've never seen in our lifetimes. Are those liquidation prices justifiable marks for bank balance sheets? I think not. As we see in real life, price of an asset is directly correlated to the amount of credit available for that asset (which is minimal now). If we all had to sell all of our stock in the market tommorow at the same time, all of our assets would be worth near nothing by this same liquidation methodology. So should we mark all of our stock portfolios to nothing with that in mind? Mark to model, to a reasonable model the investing market trusts, is the only solution that makes sense. The model needs to be appropriately sold to the accounting community, on the basis of better logic. What we need now most is to stop the self reinforcing spiral, and worry less about asset prices, instead focusing on the issue of cashflow. If no bank will lend, factoring in lack of a securitization market, then the Fed must step in (now) and perform the role as the bidder for new CMBS deals going forward. Bernanke already sees this need and considers CMBS a strong candidate for the TALF program. A successful implementation of this should help stop the spiral in that part of the market. We need no nationalization of existing banks. We instead need paydown of debt, a vast increase in money supply (to facilitate that), and finally the Fed to more aggressively become a lender of primary resort (on an intermediate term basis). Bernanke needs to stop with this ridiculous politically correct (amongst free market capitalists) assertion that he does not want to support asset prices. Of course he wants to support asset prices - otherwise he wouldn't have price stability as part of his mandate. No matter the policy choice (nationalization, money printing, or an Austrian forest fire), there is an implicit transfer of wealth that will occur. The virtue of avoiding another bailout will not result in the poor or middle class collectively gaining any more wealth, simply because sacrificing bank debtholders (as Chris Whalen suggests here) via some form of nationalization will bring us another leg down of credit contraction. It is an impossible outcome to suggest that increasing bank losses via forced nationalization will result in more bank lending. The outcome will instead be less economic activity, less jobs, and in the end the only ones around to pick up the pieces will be ones with massive war chests of cash. The wealthy will get wealthier. The poor will get angrier. Wealth disparities in the global society will widen as the collateral damage grows. If the banks can't cashflow, they are broken. The Citigroups and Bank of Americas of the world, while insolvent from a mark-to-market approach, are definitely not from a cashflow approach. Let the fed solve the near term credit problem, and change the accounting rules. Finally, European banks are seeing the same problems driven by the self-reinforcing spiral that correlation in finance brings. Between bad central and eastern European debt held by western European banks, and satellite Eurozone countries unable to raise debt denominated in euros for any meaningful duration, it appears the half-hatched brilliance of a smaller country relinquishing control of monetary policy to a central economic power isn't quite brilliant. Neither is borrowing in foreign currencies to fund local debts (with the example of Poland using swiss francs to fund mortgage debt). These lessons should have been learned from the southeast Asian financial crisis a la 1998. All these countries need to resolve the spiral is resumption of old trade balances (dictated by much higher economic activity), previous exchange rates, and hundreds of other conditions that seem impossible to meet in the real world. Just as dollar holders in America will likely have to sacrifice some real value in their currency holdings, I imagine European central banks will have to cooperate and dilute to resolve these troubles. In fact, cooperation amongst all of these banks and governments will be the only solution to bear any meaningful fruit. Until that happens, the protectionist tendency we find (all of) ourselves naturally returning to is simply repeating the mistakes that worsened the Great depression. Cooperation requires the sacrifice of some pride and a leap of faith - seemingly impossible commodities to find nowadays. Now for the proposal (written and sent February 1st) sans a suggestion to change bankruptcy law: Create a "National Refinance Bank." In many ways, this could be analogized to a "bad bank," but the plan is simpler and not just targeting "bad assets." The idea is to create a one stop shop to refinance all residential mortgage debt at a fixed rate of best choice, perhaps 3-4%. It would refinance indiscriminately, no matter the present income qualifications or the amount underwater a property might potentially be. This solves a big present problem that self-reinforces the housing rout we are in, where homeowners on the margin cannot get loans. We must eliminate the negative feedback loop if we are to make progress. This refinance process would pay off all loans to the originating banks (and/or Federal agencies Fannie Mae or Freddie Mac effectively), making all mortgage and home equity loan assets held on bank balance sheets worth par. As well, all derivatives (ie credit default swaps on such debt) would likely beneficially change in value as well. The National Refinance Bank would hold every refinanced security to final payoff. At payoff (in 30 years), the national refinance bank as well as the money the fed created for it to lend would cease to exist. There is an additional macroeconomic benefit of much lower interest rate payments for borrowers (3%, lets say) as acting as a stimulus itself, as personal disposable incomes, especially within the middle class, will increase equivalent to a tax cut. Additionally, a sister program should be created similarly to refinance all commercial real estate debt coming due in a similar fashion, regardless of current credit status, extending balloon mortgage periods for another decade. This would prevent an ensuing crash in commercial real estate, and stop the self-reinforcing spiral of losses banks are currently dealing with. Where would the money come from? Much of it would have to be created out of thin air, just as the Federal Reserve will do with the present program to buy $500B of agency securities. Plenty of this refinancing will make Fannie Mae loans whole, returning these agency investors their funds, so it is sensible that an equal amount of US treasury debt will be able to be created without crowding out investment for other asset classes. This is important, as investment flows must not be crowded out. With this proposal, banks would be made whole on most assets worth zero or near it, and would now be sufficiently capitalized to lend. In fact, much of previous TARP funds will be able to be paid back to the treasury (as the new source of capitalization will give banks no incentive to keep preferred obligations on their books). The loans and excess money the government prints to do this, while being inflationary, will be structured to disappear as borrowers pay off their obligations. Just as much of new Federal reserve credit programs are "self-mopping" as the obligations are paid off by borrowers, so is this plan. It just requires a massive scale of lending, which as we all know is clearly necessary to stabilize and fix this problem. Since a final effective solution to this crisis will provide confidence in our system to foreign and local investors, I believe it will not destabilize the dollar nor result in a treasury selloff.
This is an incredibly important point.... Which ¨creation out of thin air¨ is better.... Printing money or changing an accounting rule..... ........................................................................ Another way to ¨win by the pen¨.... Start the 10 percent consumption tax only and ban the IRS imposed progressive system.... All valuations dramatically shift upwards.... Also the tax take will be higher than the current weakening failed system....
Agree... As you point out, the Fed, as well as the other CBs are already trying to do these things (see the BoE nascent asset wrap program for RBS/HBOS). My fear is that the political environment is becoming increasingly difficult and I am not too hopeful (although I am told that Barney Frank is a very shrewd guy that's can play this game like nobody else).
I desagree with your mark to model premise. The focus instead should be on increasing the efficiency and depth of markets that value assets. Additionally it would be beneficial to somehow foster an environment in which financial instituations that profit during increases AND decreases in asset valuations/money supply exist. Admittedly the government and its citizens do not have a grasp on what ails our economy, but your ideas, sir, are a ginormous step in the wrong direction.
Very interesting thread; thanks for posting. Are you the original author? Without agreeing or disagreeing, I have a couple of thoughts: - the mark to model approach: your making the leap of derivative instruments value in a liquidation scenario, and individual homes and their mortgages' individual repayment streams being liquidated. I'd like to better understand your thoughts here. First of all I don't believe that a large enough %age of loans are going into default to warrant marking at a total liquidation level. Also, even though some homes may foreclose, and thereby the loan repayment in question, only those with negative equity will incurr actual losses. The loan holder would have to mark down the NPV of the future income stream of that particular loan. I think the biggest hurdle for banks and investor is the difficulty in valueing the investments themselves, mostly given their structure (1000's of pieces of loans all bundeled together). Marking them to a CF model of those properties would be equally difficult. If someone could unravel the mortgages and re-bundle them in a way where 100% of each mortgage had a specific owner (preferably with 1st abd 2nd mortgages having the same owner) it would be easier to mark the mortgage portfiolios for expected payment streams and liquidation gains/losses. All the above is meaningless if only the MTM of the actual CDO is in question (based on the market of other CDO's). However since I dont' consider CDO's necessarily fungible (and obviousy neither do the banks), their "MtM" stays pretty qualitative.
Well thought through scriabinop. What role do you think the creditor nations play in the formation of the ongoing Fed/Treasury solutions. Do you think that China etc are left out in the cold as the news rhetoric would have people believe, or do you think that their consultation is within the folds of Washington. regards f9
Yes thats me. I do agree with you, thus the forced refi plan making everything whole, starting from scratch with the Fed taking the liability.