Speed is of the Essence, But So is the Right Solution

I have not commented much on the disastrous events that have engulfed the global capital markets since the Bear Stearns debacle. In part, this is because I am opposed to bailing out institutions that take risk for profit and must assume the risk of loss. "Moral Hazard" is a very real problem, and is part of the underlying cause of these events. In part, it is because I believe responsibility needs to include the "borrowers" who also participated in this financial pyramid scheme. And, in part, it is because I have little confidence in the regulators and legislators who are also responsible for this morass. I am continually reminded of the analogy of asking the captain of the Titanic to steer us through the next iceberg flotilla. In the end, however, the problems were so deep that something was going to be done.

So, Treasury Secretary's announcement of a massive "Bailout" was not surprising; particularly when it came on the day his ex-firm, Goldman Sachs, seemed to be on its way to the gallows. A plan to inject massive amounts of capital into the financial system by taking "bad mortgage assets" off the balance sheets of battered financial institutions was not all that surprising; even if it had not been vetted by Congress. Better to have cornered our rather weak legislators into a corner, so they could not say no. Better to come up with an approach that primarily targets the Treasury Secretary's primary constituency. Details would be forthcoming.

However, the headlines this evening suggest just how broad and insidious the Treasury's plans are. And, understand, that these new proposals were probably planned before the first inklings of the plan were leaked to the press. They went unsaid because they would have been too controversial for the first pass. No longer is the "Paulson Plan" limited to buying "mortgage assets"; nor is it limited to U.S. assets. Having brought the markets back from the brink, fear of "disappointment" is everywhere; so why not go for the gold. Include all distressed assets. For example, include loans made to finance bad-acquisitions. Include distressed loans to non-American borrowers. If a bank does not like a loan, sell it the Hank.

Understand this. We are being railroaded into a plan that is well-beyond protecting the interests of this country and its' taxpayers. It is being foisted upon us by an administration that only weeks ago promised solutions that did not hurt the taxpayer. And it is being done in a way that preaches fear in order to stop dissent or comment.

So I am going to do just that by suggesting another approach. And, I believe, this "Plan" will achieve the same result at lower cost to the American Homeowner and Taxpayer; and it should help the economy far more.

Instead of buying bad debts from financial institutions at a relatively arbitrary price, I suggest we do the following:

(1) Forgive 10% of the "Mortgage Debt" owed by every American homeowner. The percentage could be raised to help debtholders who are experiencing more "financial distress" or lowered for those better placed to withstand our economic travails. This would have enormous benefits to the economy. It would "raise" the net worth of a large part of the population. It would lower debt service costs to all mortgagors. Since, mortgage debt seems to be the root of this crisis, this would certainly help those burdened with liabilities. It would also free up income for consumption that should help get the economy back on its' feet.

(2) Obviously, financial institutions can't afford this. This is where taxpayer money comes in. Dollar for dollar, all debt forgiven to borrowers will be replaced by the government in the form of new equity capital. Our lending institutions will be better capitalized; both by the injection of capital and by the immediate improvement in the debt-paying capability of all American borrowers. Furthermore, the American taxpayer will stand to benefit from the potential increase in the value of the equity investment in each of these financial institutions. Even recent investments in the beleagured FNMA and Freddie Mac might soon pay off.

(3) Without going into it, regulation is important. And this includes ensuring the regulators do their jobs. In this crisis, blame needs to be parceled out to the Treasury, the Federal Reserve (I still believe free money is still the root cause of this crisis) and the mortgage regulators (yes, they do exist...there are even acronyms. OFHEO and FHA being two).

(4) Finally, I want to propose an idea that warrants thought. "Too Big to Fail" has been a term bandied about as an excuse to intervene. Already, you hear talk of Bank of America (with it's potential acquisition of Merrill Lynch; which I think may require a higher price), JP Morgan and Citibank as being in this class. However, this means this country may continue to be buffeted by unwarranted risk. I would like to suggest precisely the opposite concept. "Too Big to Exist". Legislate or regulate size limitations that will mean we never have to worry about concentrated risk bringing down the system. It would encourage that most important of economic ideologies, competition.

Understand, we are in a crisis. Depression is a term that may describe this. There are other potentially disastrous outcomes. By opening the printing presses. inflation is a very real concern. So too is the Dollar. The Government's liabilities streams, enormous before this sequence of events got under way, has grown enormously. And our very Constitutional system has been assaulted. I like to say "Exigency is not a legal principle". However, it has served as an excuse to trample on our constitutional processes. However, let's not be rushed or scared into taking the wrong medicine.

Let's get this right.

Comments

[joebhed]

WHERE did you say the government was going to get the money to make the bankers whole after they forgave 10 percent of the mortgage debt.

I mean, of course, you know the way we do business now, with all money being created AS DEBT by private bankers, the only place for the government to go is to the private bankers for a loan.

So, if borrowing the Equity capital from the banker, and then giving it back to the banker, so the banker can re-lend it back in the community makes sense to anybody, then, let's get on with it.

During the Civil War, the bankers refused to provide money to President Abraham Lincoln to carry on, maybe slavery was good for business.
You may recall Lincoln's comment on his two enemies - the Southern Army and the Banks.

Lincoln solved the problem with debt-free credits of government issue.
$450 million worth. Back when a million was a billion.
Do you hear that Neil?
Debt-free, government-issue credits.

Been done before, when the times required it.
Non-inflationary. That $450 mil is still with us today.
Think of the interest payment savings over 150 years.

Get outside the business school box, Neil.
Read this.
http://www.monetary.org/amacolorpamphlet.pdf
Please.

[Neil Grossman - Huffpost Blogger]

I will go and look at the reference; it's always a good day when you learn something new.

[Powderhound522]

I don't own a home. Why should I have to pay a whole bunch of MY money to reduce homeowner's debt? Is the government also going to pay 10% of my rent? Because I tell you, I could really use that extra money. How about it?

[Neil Grossman - Huffpost Blogger]

As I tried to make clear in the opening of my note, I don't agree with bailouts. Your point is spot on, people who did not become entangled in this mess are being asked to foot the bill. There has already been unfairness. With respect to institutions that have failed, equity holders have taken all the losses; but bondholders, who were paid premiums for taking non-government risk, were protected. That should not have happened. In the Bear Stearns bailout, the Federal Reserve took on to its books a significant piece of the Firms bad assets ($29 Billion). I wonder how much that has cost us. Lehman Brothers was sacrificed, but not the Mortgage Giants or AIG. However, in the end, all I was doing was trying to suggest an alternative approach, one which would help the economy. I would tweak the idea in a few ways to try and make it more fair. For example, perhaps the mortgagor would have to repay the government out of any profits earned.

[ReasonIsMyReligion]

Double amen to your citing of "too big to exist" and the Constitution being at stake, both.

[ReasonIsMyReligion]

Awesome.

I am struck by how little breadth there is in the discussions on Capital Hill right now. At heart, they have all already accepted the model of "cash for crap," and are working out the conditions.

Future regulation, debate over golden parachutes, Section 8's "32 words" and what-not are all peripheral to a needed debate over the guts of the plan.

And whether we're trying to save the Titanic by bailing. In this case, water in.

The dynamics here ought be MORE fluid.

(P.S. Love the bio. We engineers get short shrift.)

[research]

What we don't want is a run on the banks.

We must separate the "investment" banks from "safe" FDIC banks.

[WilliePilgrim]

It's funny, y'know. It seems like you know quite a bit about the crisis and yet the very first thing you suggest has nothing to do with telling the investors in these institutions (the ones that have been hauling in huge rewards over the last few years for their "betting on a winner") that they should now pay themselves to get their little gold mine out of deep distress. I'm figuring that if the investors in AIG wer told how much that was they could probably scratch it up out from under the couch cushions and not have to drive the country into economic collapse..­.or does that just seem too tacky, especieally when highly paid advisors in strategic positions in both houses are eagerly suggesting that the investors can get off scott-free.

[Neil Grossman - Huffpost Blogger]

i am not sure i totally follow your point, but i will try and answer. investors should not be bailed out. by the way, one of the problems to date has been protection to debt-holders, who should also take losses. the point of taking capital is to dilute current shareholders, and give much of the upside to the new money, the taxpayer. on the otherside, a similar thing can, and maybe, should be done. the government might make sure it gets paid back by the borrower when the home is sold, at least if there is profit. there are 2 issues here. the first assumes that intervention is going to happen, and i am trying to suggest an alternative which i think results in a better solution. one that can help the economy. maybe doing nothing is the right answer. economic problems will intensify in the short run. i think that this takes more thought than one public hearing where the participants have demonstrated by repeated errors that they are not necessarily the right people to be analyzing and crafting a solution

[sdskelton03]

My only concern is that this 10% solution would cost about the same, it isn't targeted only to the bad debt.

There are many mortgages, like mine, that are doing just fine. Why should the government pay my mortgage company top forgive 10% of my mortgage debt? Mortgages like mine aren't causing the problem.

[Neil Grossman - Huffpost Blogger]

I would congratulate you first for handling this well. I would also add detail to the outline in the Blog, which would include ways of either opting out, or making sure solid business are not forced to do something against their interests.

As I try to point out, I actually don't like bailouts. However, I accept that something is going to happen here. I am trying to point out an apporach other than the Paulson plan, which I do not believe actually helps the economy, which is more important than merely helping banks.

[Chavez08]

You talk like the money is there to pay for the bailout. What you economists/bloggers conveniently and consistently choose to leave out of your analysis is that the American people are lacking the taxable income to PAY for ANY of this.

If you recall, the Friedmanite group-thinkers eliminated 95% of the industries needed to sustain an economy in the first place.

But, hey! If you can't beat 'em join 'em. That being said, although I'm unemployed I'm going to finance a 50 foot cabin cruiser this afternoon. In case you have any concerns, - I promise full transparency.

"On the boats and on the planes,...­."

[Neil Grossman - Huffpost Blogger]

Actually, I am not an economist. I studied mathematical physics. I have been involved in the financial markets for a long time. And, I believe that economics can't violate the laws of physics. Gravity will get you sooner or later. And we have defied gravity for a long time. In fact, one of the reasons the hole is so deep is that we have avoided tackling problems for a very long time. I call it ostrich economics. One of my favorite analogies highlights this. If you remember, when the explosion occured on Apollo 13, NASA reacted almost immediately. It adjusted the orbital trajectory quickly so that the Moon could help bring the spacecraft back to earth. The longer the delay, the more fuel required. And it did not long before the spacecraft would have passed the point of no return. Unfortunately we found ourselves in the economic equivalent a long time ago.

[Chavez08]

"We don't need no water, Mister!...­"

[ElBruce]

Sounds perfect. I vote yea on the Grossman Plan.

[JohnCz]

Perhaps I don't understand the full extent of the problem but here are a couple of other solutions that I don't hear anyone proposing that equally help mainstreet as it does wallstreet.

- Convert Distressed Property Owners to Renters. Perhaps provide them up to a 2 year rental agreement to get their financial house in order. That maybe be enough for the housing market/prices to begin to recover, collect some money on these otherwise vacant properties and will minimize stress on families and homelessness. If the $700 billion is treated like a loan, we should be able to see a sizeable chunk of that $700 billion paid back to us, the taxpayer.

- Move qualified Distressed Property Mortgagees to Condos (or other smaller, foreclosed, available lower priced units). Lets assume that foreclosed homeowners are ultimately faced with renting or becoming homeless. I don't believe there is enough rental property on the market to handle the potential volume if the crisis plays out fully. We should create some sort of temporary mechanism to get credit battered (but otherwised fully employeed) folks into homes they can afford. This should stem the tide of bankruptcies and other negative effects of foreclosure. Is this fair to those who didn't overreach and didn't lose their jobs in this economy..N­o. But I think most of us would rather help our neighbor than see wallstreet get 100% of the assistance.

[ModerateDon]

What about addressing the budget deficit, debt, and savings rate of our country? Don't we need to get our financial house in order ASAP?

[Neil Grossman - Huffpost Blogger]

Don. The "broad" financial situation of this country is the topic I have most attention to. The problems here, however, are beyond imagination. (I will reference a piece I wrote called an Unbearable Burden on my blog, ThoughtNGi­ne.Wordpre­ss.Com). The numbers are multiples of the national debt; it may be pushing $100 Trillion. David Walker, former Comptroller of the US Government Accounting Office last year suggested a problem of $55 Trillion, but the economic events have raised this enormously). In fact, I think the underlying fiscal deterioration is a part of the cause for the current crisis.

The solutions will be painful and we are not good at confronting painful issues, except in crises. Maybe the financial crisis will allow a broader evaluation and adjustment of the economic landscape; but understand that it will require everyone to participate, including many segments of the electorate who in general believe they are outside the boundaries. We will see.

[All in All]

Idea/Concept number four is the key to this situation now and the salutation to help protect the Markets & Banks from causing this situation in the future!

[elsrks]

Re: #1--Forgive Mortgage Debt of EVERY American--
This is a very good idea!! the 'good obedient soldiers' thruout this debacle should not be penalized exponentially for the mistakes of others (wall st., policymakers, people who bought homes they couldn't afford)--this would benefit those who have been contributing their fair share and infuse the extra money into the economy--
Neil Grossman should be included in the "dialogue" with Paulson et al-- he's on the mark!

[ICanHasDemocracy]

10 Billion a month- spend half of that for Afghanistan and tax the fat cat .01% on their bailout parachutes 50%.
What do they spend all that money on anyway- they'll just sock it away in the Caymans or set up a trust.