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Sunday, September 21, 2008

MFIT: The Treasury's New Private Equity Venture?

Introduction: I wanted so badly to criticize Obama's economic proposal for dealing with this crisis, however Senator Obama refuses to present a plan of his own and instead chooses to criticize what everyone else does. He chooses to use words like staggering to describe the bailout as if the public couldn't wrap their arms around the $700 billion without him calling it things like "staggering". It is very easy to be a critic like Senator Obama but as President, he won't have that luxury.

That said, the centerpiece of John McCain's plan to counter act the financial crisis is the Mortgage And Financial Institutions Trust. Here is all the pertinent information.

The MFI Is An Early Intervention Mechanism That Will Help Financial Institutions Avoid Bankruptcy And Expensive Bailouts While Protecting Their Customers. The MFI will minimize the use of taxpayer money by having an orderly process to address the market crisis. Working with the private sector and regulators, the MFI will help identify troubled institutions and take action to strengthen them before they become insolvent.

The MFI Will Provide Troubled Institutions With An Orderly Process To Identify Bad Loans, Provide Funding And Eventually Sell Them At A Profit. This will get the Treasury and other financial regulators in a proactive position instead of reacting to one troubled institution after another.

The Structure Of The Mortgage And Financial Institutions Trust (MFI):

The MFI Will Be Part Of The U.S. Department Of The Treasury. The MFI will be managed by a board of directors consisting of at least the Secretary of the Treasury, Federal Reserve

Chairman, Chairman of the FDIC and two public members. The Secretary of the Treasury will be Chairman of the Board. Under the MFI process:

Troubled institutions will voluntarily come to the MFI.

The MFI will provide liquidity loans at reasonable interest rates. The MFI will receive warrants for controlling interest in troubled institutions.

Troubled financial institutions that enter the MFI will keep operating as private companies with the help of the MFI.

The MFI will supervise the sale of loan assets at market prices and purchase them as necessary.

The MFI will eventually, and at its discretion, sell the loans to the private sector.

The MFI will have a predetermined tenure during which to dispose of the loans.

The MFI will return all profits to the U.S. Department of the Treasury and taxpayers.


I see three main problems with this idea.

1) I want a smaller government not larger.

This won't merely add another department to the Department of Treasury, but it will add a very powerful one. This is a consultant, investment banker, and private equity firm all in one. Powerful agencies like the Federal Farm Board are the prototype for what the MFIT would likely turn into. Imagine a department of the government with the power to save U.S. companies from themselves and you will see what scares me.

2) The MFIT would create moral hazard.

Here is the key part.


The MFI Will Provide Troubled Institutions With An Orderly Process To Identify Bad Loans, Provide Funding And Eventually Sell Them At A Profit. This will get the Treasury and other financial regulators in a proactive position instead of reacting to one troubled institution after another.

There are of course already companies within the private sector that do this. They are called investment bankers, consultants and private equity firms. As such, these troubled firms would come to the government after visiting one of these or even worse, instead of visiting one of these. Then, with the full back of the U.S. government, they would then be able to sell off their assets or get loans at rates they would never get without the backing of the U.S. Treasury. That's not merely a motivation for troubled companies, but a motivation for any company.

3) This is exactly the sort of idea that winds up getting corrupted.

This department will be so close to big business that it will be too close. This portion of the department will have a financial motivation for corruption.

The MFI will return all profits to the U.S. Department of the Treasury and taxpayers.

The more profit they make the more powerful they will become. The government will now be in bed with business on everything from bad loans, bad assets, and bad acquisitions. Like I said, the possibilities for corruption are endless. If a President or Treasury Secretary are on top of things, that's one thing, but what happens when they aren't.

For those three reasons, I believe this is a well meaning idea that is fatally flawed.

2 comments:

Anonymous said...

Mike this thing is a nightmare. It essentially creates a 4th branch of gov't with absolutely no checks or balances. Ok, one check. A blank one.

I have a question for you. The Community Reinvestment Act became law in 1977. Obviously, it opened the door for the subprime mess but cannot have been the sufficient cause. When did things really start to go nuts? When Greenspan kept lowering interest rates?

Thanks,

wahabicorridor

mike volpe said...

I am definitely of the opinion that Greenspan is most responsible for this, however things went out of control about 2005. That's when the so called 620 state/stated to 100% loan became popular. This is a loan in which a 620 credit score, in the bottom fifty percent of all credit scores, could state their income, or lie, state how much they have in the bank, or lie, and do all of this while putting zero percent down. Of course, all of this got started when he dropped rates so furiously. As the market got hotter and hotter banks lowered their guidelines until they just simply became ridiculous.