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The Phoenix Solution: fire and rebirth

by ARGeezer Wed Sep 24th, 2008 at 12:37:58 AM EST

This bailout demand from Paulson makes no sense as stated.  It has been suggested that the true purpose is to provide a stealth recapitalization of the Fed, as Bernanke has traded most of its cash and treasuries for toxic paper and it is in danger of default.  They might not even have enough to guarantee Paulson's stock in Goldman's!   That would be a true emergency.

The Fed should not be in the business of making good every insane deal Wall Street ever devised.  To even start to do so would require either printing massive amounts of dollars or imposing very significant taxes on the wealthiest 0.5% of US citizens.  They and the various trusts are the only sources of immediate cash on that scale in the  USA.  Foreigners probably won't lend it to us at any affordable rate.  They have more sense than that.  I think this US government would default on its obligations before it would go after the assets of its wealthiest citizens.  Money is supposed to flow to these worthies, not be extracted from them.

Rather than continuing down this road to disaster,  we should prepare a recovery plan.  If even a part of the $700 Billion being proposed for a Wall Street bail out were used to provide equity capital for new banks, we could "thaw the financial system."  These banks should be required to operate under 1970 banking regulations.  At a ratio of $15 of loans for every $1 of equity, $530 Billion would back over $8Trillion of new loans.   That should get the economy functioning again.  Businesses could get operating capital, consumers could finance purchases,  people could get home loans.  There should be plenty of sadder but wiser bankers available to staff these new banks.  Let Schumpeter's "creative destruction" go to work on Wall Street.  Wall Street has become a giant leach on the body politic.  This would be like taking a giant car cigarette lighter to that leach, like I used to do after swimming in the creek in Oklahoma in the 1950s.  The leach lets go.  Why $538 Billion? One bank for each senator and representative.  All would be heroes.  Christmas could be saved.

There is going to be damage from the bursting of this bubble.  As it has been leveraged at up to 30 to one it probably cannot be avoided.  The only thing to do is to recognize the damage, which we have so far refused to do, and put in place new, functioning institutions that can allow recovery to begin.  That is only made worse if we spend $1 Trillion trying and failing to guarantee bad bets leveraged at 30 to 1.  These bets may total as much as $50 Trillion.  Other countries should do the same.  That is all anyone can do.  But it is easier to do if we have not first flushed $1 Trillion or more in a failed attempt to deny reality.

I am no economist, so let those who are have at it.  This is the body of a fax I composed to send to US Senators and Representatives that either represent me or who have purview over matters pertaining to the collapse and proposed bailout.  Please forgive the lack of citation links.  This is intended more as a perspective piece than as an analysis.  Reading many of the links provided by Mig and Jerome today has further convinced me of the self serving insanity of Paulson's current proposal.

It needs to have scorn and ridicule heaped upon it.  Above is my own feeble attempt to do so.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 12:43:27 AM EST
Sorry to be so late in commenting on this very reasonable solution, ARgeezer.
As a fellow non-economist, I think it's important to recognize what's important in social problem solving.
Being an "expert" often gifts you with great depth of knowledge about a narrow slice of reality. But it also saddles you with a vocabulary to work with (or against), conceptual baggage that often is a hazard to real solutions, and a position to defend.
Good policy is made by generalists who selectively and rationally employ experts--but keep them on a short leash.

That said,---I like the idea of a parallel banking system, but I doubt the political feasibility. As ThatBritGuy has pointed out, one of the jobs of banks is not only to allocate credit, but to distribute and to determine credibility. We allow this failed system to do this, so we should not be surprised when the banks view with little enthusiasm our ideas about replacing them with a less parasitic system. And unfortunately, it would take a rip-roaring, pistol-waving revolution to pry the financial whizbangs out of their secure buildings--or a good fire.

Do I smell smoke?

Capitalism searches out the darkest corners of human potential, and mainlines them.

by geezer in Paris (risico at wanadoo(flypoop)fr) on Fri Sep 26th, 2008 at 11:11:31 PM EST
[ Parent ]
Seconded, ARG.

Your Diary deserved more attention than it apparently got.

Personally, I'd use the $700bn capital as a guarantee base for new unsecured credit creation, and for direct investment in distressed mortgages - the "Debt/Equity swap" I bang on about intermnably....

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Sep 27th, 2008 at 06:21:44 AM EST
[ Parent ]
Thanks Chris and fellow geezer in Paris!  I posted it late at night Central Standard Time and others in Europe were probably at that very time working on their posts which covered similar ground.  I really cannot complain when superb writing by Jerome, afew, and others grabs all of the attention.  It is not personal and I wouldn't want to compete with them.  But I do think that my proposed solution at least places the question of the opportunity cost of spending $700 Billion in what is likely to be a failed attempt to save financial parasites in the context of what alternative uses could certainly do.

I have updated the plan, cut the size of the proposed equity loan in half and re-contextualized the argument in terms of what has subsequently happened, but the faxes continue to flow.  I suspect this is the least used avenue of communication to congress. If nothing else, I hope to seed the idea widely amongst staff.

The reason this very reasonable approach is unpalatable to congress at this point is, as geezer in paris noted,  due to the nature of campaign finance.  It may be that a squandered $700 Billion is the cost of getting real attention in January for campaign reform.  I just got a strong letter on the subject published in the Arkansas Democrat Gazette.  I am gratified to see others on ET recognizing what a crucial issue this is.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sat Sep 27th, 2008 at 09:56:03 AM EST
[ Parent ]
As you all say, the vodoo terminology, in the name of failed science, only causes more obscurantism and fear, which is what they want for the public.

The amount and the timing make no sense:  This is only the ´initial´ amount!
The authority granted makes no sense:  It-is-an-outrage!
It scares the shit out of me.

Our knowledge has surpassed our wisdom. -Charu Saxena.

by metavision on Sat Oct 4th, 2008 at 01:31:05 PM EST

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