Saturday, September 27, 2008

Avoiding a BAILOUT: Open up the Fed Window

The fundamental question as to whether or not this bailout must go forward is whether or not we can force these Wall Street folks to hold onto these mortgages without a bailout. If there is simply no way to avoid a financial meltdown without a bailout, then frankly we have no choice but to bailout Wall Street. I believe there is a viable alternative and that's why I am against this bailout.

I have several problems with this bailout but not least among them is that the Department of Treasury is NOT an investment bank. Yet, what this bailout will affectively do is use taxpayer money to perform a largely investment banking function. On the other, on of the primary functions of the Federal Reserve is to act as the lender of last resort

The lender of last resort serves to protect depositors, prevent widespread panic withdrawal, and otherwise avoid damage to the economy caused by the collapse of an institution. Borrowing from the lender of last resort by commercial banks is usually not done except in times of crisis. This is because borrowing from the lender of last resort indicates that the institution in question has taken on too much risk, or that the institution is experiencing financial difficulties (since it is often only possible when the borrower is near collapse).

In the United States the Federal Reserve serves as the lender of last resort to those institutions that cannot obtain credit elsewhere and the collapse of which would have serious implications on the economy. It took over this role from the private sector "clearing houses" which operated during the Free Banking Era; whether public or private the availability of liquidity was intended to prevent ’runs’ on the banking system. In the United Kingdom this role is undertaken by the Bank of England, the
central bank of the United Kingdom.HSBC is an example of a non-central bank that has acted as a lender of last resort on several occasions.


If the Federal Reserve serves one of its primary functions, I believe that we can avert disaster while also making sure that Wall Street takes full responsibility for their mistakes. What opening up the window does is give these firms time.

One of the things that everyone needs to understand about all of these Mortgage Backed Securities is that ultimately they aren't nearly as worthless as they are currently being seen as. While they are being backed by mortgages that are full of folks that can't or won't pay, those mortgages are backed by something tangible, real estate. The problem is that not only does no one know just how many bad loans there, but also no one is sure just how much further real estate will fall. If you have a bunch of bonds full of bad borrowers and the underlying real estate behind them continues to fall, that is an awful combination.

If we open up the window, and combine this with several pro growth strategies, that can stimulate the real estate market, that will give the market enough time so that real estate settles down. Once real estate settles down then there will be buyers for these bonds. That's because even a foreclosed property fetches 60-70% of its value. If an investor can fairly predict how much the real estate is worth, they will make sure to pay enough for these bonds to leave themselves a profit.

So, first the Federal Reserve opens up its window. Banks borrow to make sure they can stay afloat. Then, we enact several proposals. First, for the next three years any withdrawal from any retirement account can be done tax free and free of penalties as long as the money is used to purchase real estate. Second, we bump up the write off for real estate interest from $2000 to $5000. Then, we end the FASB 157 so called marked to market and replace it with a three year rolling average. This will stop panicked selling of assets that would need to be written down. Finally, we suspend the capital gains tax for any investment purchased in the next three years. This will give extra incentives for financial sharks to step in and buy these bonds. These things combined should give the banks enough time to stay afloat until the real estate market steadies out. Once it steadies out, they can sell these assets at a price that will keep these firms operational. None of them will ever be the same. They will take a giant hit. Our market will continue to face a certain amount of illiquidity for a long time, however we won't have artificial liquidity created by government intervention.

3 comments:

  1. "those mortgages are backed by something tangible, real estate."

    Possibly, but you had better check into a recent State (ohio?) Supreme Court ruling on such mortgages and their severed deeds.

    It could very well be that the new GSE's freddie and fannie bought a lot of payment expectation yet few titles to property.

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  2. First of all, neither fannie or freddie are new. Second of all, what they buy are NOT MBS. They buy their own bonds that are underwritten by them. Their bonds have problematic mortgages as well, however they buy only good loans and thus, they will hav a lot less trouble selling their bonds off.

    MBS are the sub prime equivalent of what Fannie/Freddie buy.

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  3. Mike, heads up. It looks like Fortis will fail Monday.

    http://weeklystandard.com/Content/Public/Articles/000/000/015/636zbhel.asp

    wahabicorridor

    ReplyDelete