Wed Oct 1st, 2008 at 05:02:44 PM EST
So, Monday a bail-out package described by opponents as excrement on toast went down to defeat because after getting compromises to make it, in my view, worse, the Republican leadership could not then deliver enough Republican votes to get the thing passed "on a bipartisan basis".
Like they are unwilling to take unpopular votes to protect business interests? What was more than a decade of votes against the Minimum Wage about, then?
So, the first step is to see if the non-finance sector business lobby has been on the phone with the Rebel Replicants, cursing them a blue streak for screwing the pooch so badly before the Christmas shopping season. Perhaps they are, and so perhaps they will toe the line.
And if not, then the Democrats can turn to putting together a Beautiful Financial Rescue Package that the caucus can support. So, what would that look like?
The Problem to be Solve
I've done one or two diaries on bits and pieces of this:
A Midnight Thought on Whether a Bit of Keynes can Fix This Mess
Mea Culpa: The Fed May In Fact be in a Financial Mess.
Close the Barn Door after the Horse Broke His Leg. (Agent Orange)
Solvency Crisis: Fed VP Called it in May ... but didn't NAME it.
How a Little House Threatens Pension Funds and Insurance Companies (Agent Orange)
The Political Sweet Spot on Rescuing Main Street from this Mess (Agent Orange)
... but the upshot is fairly straightforward.
We are facing a solvency crisis, because financial firms, including commercial banks, held assets on their balance sheets at inflated credit ratings.
The inflated credit meant they had far more exposure to a drop in the value of their financial assets than they should have had, and so some of the institutions were sliding toward insolvency. So now everybody wants to sell this junk, not enough people have the ability, let alone the desire, to buy it, pushing the market value of the assets down, dragging more firms into insolvency.
Insolvency is when your obligations exceed your assets. But the Fed and the Treasury have been pretending for a year that its a problem of liquidity, and all of their "solutions" were providing more liquidity.
Its like someone coming into the emergency room with an infected wound, and they put in stitches and send them on their way ... it covers up the problem, but it does not fix it.
Is the Crisis Real?
From the gray lady (h/t Matthew Yglesias):
Cities, states and other local governments have been effectively shut out of the bond markets for the last two weeks, raising the cost of day-to-day operations, threatening longer-term projects and dampening a broad source of jobs and stability at a time when other parts of the economy are weakening.
Lots of people use "The Shock Doctrine" to argue that this is trumped up. But in a trumped up crisis, Lehman Brothers does not fold. Rather, what "The Shock Doctrine" should tell us is that one of the first reactions to the crisis will be for the Corporate Sector to use it as a distraction to grab for things they want.
So, yes, of course there are those trying to leverage this crisis, which is very real ... and indeed an entirely predictable and predicted outcome of taking financial deregulation to extreme lengths ... into yet more long term benefits for Megacorps.
But its a real crisis. And the advantage in facing down the Shock Doctrine during a real crisis is that there are a very large number of real businesses that are at risk of going bankrupt during the current recession, if the Finance Sector is not there to tide them over.
What Rescues firms from Solvency Crises?
You can only re-capitalize from borrowing if you can turn around and generate surplus income from those funds ... and finding enough good income in the middle of a recession to keep up with asset values in free fall, that just is not going to happen. So that route is out, at least short term.
So Santa Paulson's original plan was to buy shaky assets at inflated prices, re-capitalizing firms on the "Ho, ho, ho, Merry Christmas" principle.
The third way to re-capitalize a firm is to give an equity stake to the source of the funds. Then the existing shareholders lose out, but they lose out more if the firm goes belly up.
Dodd's plan was to have the firms hand over warrants, so when the Public Trustee loses money on those assets, it would be an interest-free loan for the real long term value of the asset, and an equity stake for the size of the overpayment.
But why should these firms get interest-free loans because they were too greedy and handed out as income what should have been kept as prudential reserves? Whether or not the ratings companies gave inflated ratings, managing risk is their business and they blew it.
So I think its more beautiful to have the purchase of shaky assets tied to the up front acquisition of an equity stake.
What Should the Size of the Rescue Be
Paulson says he needs $50b per month. SO $100b up front, and $100b on approval of Congress in a late November lame duck session, would, in Paulson's estimation, tide us over. Stick the number on Paulson.
What Should the Content of the Rescue Be
I've describe before the non-voting Preferred Share. It has a face value interest rate like a bond ... but its a dividend, so that when the company is running a loss, it doesn't have to pay the dividend. Unlike a debt, on it cannot drive a firm into bankruptcy. But like a debt, voting shareholders cannot take a dividend for themselves unless they have paid the Preferred dividend in full.
And of course, the firms that are actually rescued should end up refunding the cost of their part of the rescue. So set the Preferred Share Dividend Rate at the Treasury Rate for the bonds to finance the purchase of the dividend, plus 3%.
So, the Public Trustee buys a dollar of Public Preferred Shares alongside every dollar of shaky assets. Plus, the company gives warrants for additional Preferred Shares, to make good any losses on the shaky assets.
The Bail-out, as part of the compromise, makes the weakest possible concession to the idea of limiting executive pay. The Preferred Shares have a condition attached that, whenever the firm is not paying the Preferred Dividend, the only executive compensation allowed that is more than 10 times median income are common stock options maturing in five years or more.
There two beautiful things in there at once. First, corporate American has a direct stake in median incomes. And second, the greed of management is dragged out of the "next quarter's results" mentality, and into the performance of the firm in the actual time of strategic plans made and beginning to bear fruit.
If Ms. Fiorina had been paid mostly with Hewlett Packard stock options maturing in five years time, she would have reached the point of having to quit just to save the value of her stock options ... no golden parachute buy-out on the risk of staying and destroying more shareholder value would have necessary.
I'll add another rider ... because a lot of time income is taken out as part of Mergers and Acquisitions activity rather than dividends ... the Public Trustee must approve any Merger and Acquisition activity unless the Preferred Shares have been fully paid for two fiscal years.
With Executive Pay and freedom to engage in Mergers and Acquisitions hinging on paying the Preferred Share Dividend, firms will pay that dividend if they possibly can.
Houses:Everything Else, Fifty:Fifty
Finally, the real kicker. Dean Baker has a beautiful program for coping with the foreclosure crisis that is called "Own to Rent".
Someone is facing foreclosure on a house in a depressed housing market. The mortgage broker granted that loan without even bothering to check if it could be repaid, because the assumption was that the house could always be sold for a gain if necessary to someone else.
Oops, when you ASSume you make an ... oh, well, you know the rest.
Open up a new foreclosure route. If the owner is willing to hand the title back, they can continue to stay in the house as a renter, paying a rent based on the current fair market value of the house. That right is attached to the title, until they surrender it.
An economic assessment is made of the value of the property with this rider attached, and the Public Trustee takes over the title from whomever owns the mortgage, including a "structured investment vehicle", replacing it with 10 year Treasury Bonds. The structured investment vehicle takes its loss on the value of the house, but on the other hand the risk of that part of its cash flow is substantially reduced.
The authorization includes explicit authorization for any investment vehicle allowed to hold mortgage assets to accept Treasury Securities in their place at an assessed current market value, including the loss from the Own to Rent rider.
The Public Trustee would be allowed to sell those properties, but mortgages against those properties could only be held by depository institutions in sound financial shape.
Given the extent of the foreclosure crisis, if Secretary Paulson thinks that his buddies on Wall Street need $100b in financial capital to keep going for the next two months, then let $50b be to re-capitalize financial firms that are over their heads, and $50b to rescue home-buyers who have gotten into mortgages over their heads.
Because 50:50 is a Beautiful Ratio.
Releasing it into the Wind
OK, there you go, the Beautiful Financial Rescue Plan.
Because, much as I love Xelander, at the rate he seems to be going, we are not going to be able to bank on his rescue plan ...