There's a draft memo going around that makes proposals regarding the bailout. unfortunately it won't work. Here's why.
Here's the relevant part:
According to a bill summary, the legislation would require the FDIC to survey the banking industry and issue short-term loans (through an exchange of "net worth certificates" and bank promissory notes) to those banks that qualify. In exchange for the short-term infusion of capital, banks would "be subject to strict oversight by the FDIC including oversight of top executive compensation and if necessary the removal of poor management." As Isaac noted, this exact program was enacted by Congress during the S&L scandal of the 1980s and helped "resolve a $100 billion insolvency in the savings banks for a total cost of less than $2 billion."
According to a bill summary, the legislation would require the FDIC to survey the banking industry and insure banks additional loans by basically buying IOUs from banks that qualify. But because this program would technically be an exchange of FDIC "net worth certificates" and bank promissory notes, no money would change hands unless a bank failed. Banks could simply assume they have the capital loans from the FDIC for purposes of their own lending and balance sheets. In exchange for this short-term infusion of capital and government guarantees, banks would "be subject to strict oversight by the FDIC including oversight of top executive compensation and if necessary the removal of poor management." As Isaac noted, this exact program was enacted by Congress during the S&L scandal of the 1980s and helped "resolve a $100 billion insolvency in the savings banks for a total cost of less than $2 billion."
The tricky part of the plan deals with the accounting rules.
Right now, federal law mandates that banks assess their assets on a "mark-to-market" basis - that is, what their assets could be sold for right now, rather than what they could be sold for in the future. The theory is that during a housing and financial crisis, the "mark to market" value of mortgages is artificially low, even though those mortgages represent houses with actual value (for instance, because no one wants to buy mortgages right now, many mortgages are valued at zero on a mark-to-market basis, even though they represent homes that could ultimately be sold for value). Because what a bank can lend out is a multiple of the assets they own, proponents of the accounting change argue that the mark-to-market system is forcing banks to devalue their assets and therefore contract credit. They say that changing the accounting rule to allow banks to list their assets at an "economic value standard" (ie. higher than mark-to-market) will therefore loosen up credit.
The problem with this accounting change is that it would allow banks to leverage even more against assets whose value is still unknown. That, says some opponents, could simply push off - and potentially make more intense - an inevitable day of collapse in the banking system.
Let's take this a in reverse order.
Mark-to-market exists for a very important reasons: it tells us what an institution is worth. The whole argument that some assets are undervalued in a particular environment is true; right now there are some assets that are valued below what you could sell the for in a roaring economy. The question now becomes, what assets would sell at higher prices in a strong economy and which ones wouldn't? The answer is simple: we have no idea. And anyone who tells you they can tell is lying because there is no way to perform that analysis with any degree of accuracy. There area simply too many variables to consider. People have been trying to do that for years. In market parlance, they are called value investors. Most aren't that good.
And that leads to the second problem, which is tied to the above issue with mark to market. The plan calls for a cash injection directly into the banks. That's fine. The problem is financial institutions have been getting infusions for the last year and their stock prices keep dropping. The reason is the issue with bank's assets, which keep dropping in value, thereby requiring more cash. Essentially, financial institutions have turned into a bottomless pit, a financial black hole into which investors have been throwing money. There has already been a ton of money poured into the financial sector in the form of equity injections. And banks still need the money. If memory serves, we've already seen over $300 billion going into banks with no end in sight. In other words, there is no guarantee this will cost less than the Paulson plan.
Right now everybody wants to get rid of mark to market. The SEC just eased the rules. This is like their short-selling ban -- let's prevent the market from working like it should. Now financial institutions will be able to say, "this is really worth more because at some future date it might sell for X." And that's crap. Because that is a complete unknown.
I'm not sure what a good plan would be. But everyone seems hell bent on altering basic market rules like mark to market because they don't like the results. Tough. The rule exists for a damn good reason.