Wednesday, September 17, 2008

Bailouts, failures and my solution...

This week/month/year the financial dominos are falling.

Banks are failing, investment banks are failing, insurance companies are failing, quasi-government agencies are failing.

Secretary Paulson is running around trying to re-inforce the house of cards as hurricane force winds gust through. Bailouts left and right.

Its tragic for those whose livelihoods are being destroyed. Its shocking for those who deal with these institutions daily. It is especially disconcerting for "real" (i.e. non-financial) firms that are getting hurt by all this shenanaghans. It is anger inducing to the average Joe who wakes up each day and read about another multi-billion slug of taxpayer dollars being used to help the wealthiest individuals.

And not one whit of it is even addressing the problem. The problem is not the crisis of confidence in banks, investment banks, or insurance companies...the problem (now) is not too much regulation or the wrong kind of regulation...the problem is mortgages and mortgage backed securities!

1) The government needs to offer to buy back these toxic sub-prime and alt-A mortgages. But it should only pay pennies on the dollar for them. Putting in a floor on house prices (or perhaps more acurately a basement) will allow all the market participants to begin trading and valuing their mortgages. Also the offer should expire in 12-18 months time.

For example, set up an entity that buys toxic mortgages for 10 cents (or 5 cents or 25 cents) on the dollar. Maybe offer different prices for the different classifications of mortgages. Setting the right price is important, but I don't claim to know the right price. In essense this will allow Wall Street to begin unbundling all the mortgage pools that they've spent the last decade putting together. By putting in place a floor price (above zero) the mortgage brokers can trade the securities among themselves (if they think their MBS are worth more than the government offer) knowing that their downside is limited to the government offer.

2) Reset the subprime mortgages. This should depend in part on the price the government offers, but I'd suggest cutting the principle owed by 20-30%. In most cases, this reduced amount should be something the borrowers can repay. If they can't even manage this, then go ahead with the foreclosure since its clear that the borrower needs to find a home they can afford.

3) Set-up a sensible regulatory framework for generating mortgages going forward.

This plan gives the lenders a route to offload bad mortgages that nobody will (currently) touch. Yes it is a "bailout" but at 10 cents (or whatever price) on the dollar, it is more of a life preserver than a golden parachute.
This plan offers homeowners at risk a chance to keep their homes. It will reduce, substantially, the number of foreclosures going forward.
Finally it puts in place regulation that prevents this from happening again.

Yes taxpayers would be on the hook. Yes some people might game the system. But at least we would have a system and some certainty about the system going forward.


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