Don't just throw money to the bankers. Take control of the failed banks

The biggest problem with Paulson's proposal is that the solution offered is to simply buy the bad loans from the banks, leaving them in position to again start functioning is banks and make the bankers rich. Essentially the bankers gambled with their own money, lost it, and are now going to tax the American taxpayers for a $trillion so they can go back into the game.

Paulson thinks the problem can be solved by just having the government buy the bad loans from the banks with taxpayer money. Of course, the banks know which of their loans are bad and which might recover, so all they will sell to the government is the garbage. In fact, Paulson's proposal doesn't work any other way. If the banks can't convince future suppliers of capital that they retained only the good loans, they can't get the capital suppliers to supply more capital.

And what do the taxpayers get? Screwed, that's what. The taxpayers will transfer good money for bad loans, the majority of which will never be worth what the government will pay. On top of that, Paulson's proposal is carefully written so that no one even has the right to question what the secretary of the treasury does with all that money.

Sweden was in a similar situation in 1992, but they solved the problem a lot better.

Sweden did not just bail out its financial institutions by having the government take over the bad debts. It extracted pounds of flesh from bank shareholders before writing checks. Banks had to write down losses and issue warrants to the government.

That strategy held banks responsible and turned the government into an owner. When distressed assets were sold, the profits flowed to taxpayers, and the government was able to recoup more money later by selling its shares in the companies as well.

“If I go into a bank,” said Bo Lundgren, who was Sweden’s finance minister at the time, “I’d rather get equity so that there is some upside for the taxpayer.”

The only result Paulson's proposal should get is loud cries of No Blank Check! This legislative game from the Bush administration is not new. They create a crisis, then present a set of legislative plans that turn control of the government over to the (incompetent) Bush administration and say "Take it or the results of the crisis are yours!"

Not this time. Lucy is going to yank a way the football again. This time it's No Blank Check!

The bailout needs to be carefully thought out, with consideration of what the new banking system is going to look like. My analysis of Nouriel Roubini's discussion suggests that the new banking system will be all regulated banks with the government operating as the lender of last resort.

That's going to be expensive. The bankers need to pay the costs, and only government equity in the banks will allow that to happen.

Along with the government taking ownership of the failed banks (voluntarily on their part, of course. They can choose bankruptcy if they want), Chris Dodd's proposals are beginning to look very good.

Summary: Dodd Legislative Changes to Treasury Proposal
September 22, 2008

The breadth of the Treasury proposal is extraordinary: the Department is asking for $700 billion to purchase any asset without any transparency as to the process; without any oversight by any court or administrative agency; and without any commitment to helping homeowners with troubled mortgages. Senator Dodd has offered a number of proposals that will address these concerns, as follows:

Transparency and Accountability

1. Establish an Oversight Board: We intend to establish an oversight board to make sure that the Treasury Secretary is not acting completely alone.

2. Require Program Transparency: We would require the Treasury to lay out its program, policies and procedures to ensure that the new authority is not used on a completely ad hoc basis. The Congress, the markets, and the American people deserve to understand how the Treasury is using these funds.

3. Significantly Improve Reporting Requirements: We add a strengthened reporting provision to require monthly rather than semi-annual reports to Congress regarding the exercise of authority under the Act. The provision requires financial statements describing all agreements and transactions entered into. Again, transparency is good for the markets and the economy.

4. GAO Audit: In order to ensure proper use of funds, and prevent waste, fraud, and abuse, we add a new provision to require the Office to annually issue financial statements prepared in accordance with generally accepted accounting principles and to require the Government Accountability Office to annually audit the Office and to assess internal financial controls.

5. Warrants: In the case of AIG and the GSEs, the government took warrants in the companies in exchange for our assistance. We include a provision to ensure the federal government gets warrants from companies that sell their bad assets to us.

6. Minimize Conflicts of Interest: Treasury intends to hire large asset management firms to organize the purchases of the “toxic” assets as well as their sale. However, many of these firms, such as PIMCO and Blackrock, have large positions in the same assets. Those positions could be affected by the way they manage the federal government’s portfolio. The Treasury proposal largely ignores this issue. We would add a provision to require the Secretary to issue rules on conflicts of interest that may arise in connection with the administration of the authorities provided in the Act. The conflicts include, but are not limited to hiring contractors or advisors, management of assets, bidding or purchasing of assets, and employees leaving the Office to work for an institution that has benefitted from the program.

7. Integrity of Deposit Insurance: This week the Treasury Department announced that it was offering temporary, unlimited deposit insurance for funds in participating money markets. This has caused considerable concern among banks (especially smaller banks) that it will precipitate a run on the banks by large depositors, who can now access unlimited deposit insurance in money markets. We add a provision to create parity between banks and money markets in terms of insured deposits during the period in which Treasury offers the insurance.

8. Executive Compensation: We add a provision to require the Secretary to have executive compensation standards for entities that seek to sell assets through the program. Such standards shall include limits on incentives and severance and a requirement for a claw-back provision.

Assistance for Homeowners

1. Court-Supervised Loan Modifications: After a year of efforts to get servicers and lenders to modify loans, the industry’s voluntary HOPE Now program has fallen far short of what is needed. This is because of the extreme complexity surrounding the securitization of mortgages. The only way to really help homeowners keep their homes is to allow borrowers to get the mortgages on their first homes reduced to the market value of those homes through bankruptcy. Second homes already have this benefit. We expect that very few homeowners will actually have to go into bankruptcy; however, this provision will finally give homeowners and servicers some leverage so that real modifications can move forward.

2. FDIC-Management of Mortgage Assets: The FDIC has shown a commitment to modifying mortgages both to ensure long-term affordability and to protect the taxpayer. FDIC staff estimate that performing loans are worth about 87% of par, while non-performing loans are worth only about 36% of par. Modifying loans to ensure affordability increases the value of the loans. For that reason, we would require the Treasury to shift the whole mortgages and residential MBS it purchases to the FDIC to manage, and add the requirement that the FDIC modify those loans where possible. We also require other federal agencies that hold or control mortgages or residential MBS to modify whenever possible. In addition to FDIC, this includes FHFA, which controls Fannie and Freddie’s portfolios, and the Federal Reserve Bank of NY, which owns a portfolio of mortgages acquired from Bear Stearns.

3. Affordable Housing Funds: The Housing and Economic Recovery Act of 2008 (HERA) created two important housing funds – the Affordable Housing Fund and the Capital Magnet Fund. These entities were to be financed by the GSEs. Given the uncertainty of that source, we include a provision that requires that 20% of the profit of any assets purchased and sold by the Treasury through this program go to these two funds.

4. Expansion of HOPE for Homeowners: The HOPE for Homeowners program passed as part of HERA should help about 400,000 families keep their homes. However, it includes some restrictions that narrow the eligibility for the program. We propose to loosen the criteria modestly, so that more distressed homeowners can participate

It is clearly established now that the current banking problems are a result of both greedy bankers and lack of adequate oversight and regulation. Paulson and the Republicans are the politicians who inflicted the problems on America. They cannot be the ones to try to solve them. They simply don't accept that their greed and deregulation attitudes are what have caused the problems.