Economic Earthquake Relief for the Wall Street Banks? A Modest Counter-Proposal

In his blog The Economist's View professor Mark Thoma of the University of Oregon writes:

"I’m starting to think that the Fed should drop the term part of the TSLF – trade permanently for risky assets (with the haircut sufficient to provide some compensation for the risk), bonds for MBS, money for MBS, or whatever, and don’t limit trades to banks.

The Fed would act as risk absorber of last resort. Why should it do this? There has been an unexpected earthquake of risk, a financial disaster on the scale of a natural disaster like Katrina, and the government can step in and sop some of it up by trading non-risky assets (money, bonds, etc.) for risky assets at an attractive risk-adjusted price. To limit the amount, this could also be done through auction with a ceiling on how much will be traded, except unlike the current auction it wouldn’t be a repo and it wouldn’t be as limited in terms of who can trade and what can be traded.

What am I missing? Moral hazard and worries about the next time? I’d still fix this first, worry about moral hazard later, perhaps through regulatory changes down the road that (hopefully) limit the opportunities for such behavior."

Now, before you dismiss Dr. Thoma's idea out of hand, first consider that several eminent economic professors and members of Congress have gone even further in espousing this, so it must have merit. Bradford deLong, professor UC Berkeley, and former Treasury Secretary and President of Harvard Larry Summers have recommended saving the banks for the good of the nation, deconstructing any question of moral hazard: Beware Moral Hazard Fundamentalists and The 'Somebody Must Suffer' Caucus Should Chill. Fed Governor William Poole has also weighed in with a pronouncement of papal proportions: The Fed is Without Moral Hazard. William Buiter in The Financial Times The Fed as Market Maker of Last Resort: Better Late Than Never. Even Paul Krugman is flirting a with some good spirited 'face slapping' and perhaps a little 'asset goosing' in order to help us to simply move on. .

But it was the thoughtful and moderate Dr. Thoma who has stumbled on the genuine solution to our current economic crisis.

"Don't Limit the Bailouts to Banks."

Think about this for a minute. An act of God, "an unexpected earthquake of risk, a financial disaster on the scale of a natural disaster like Katrina" has assaulted our nation. Are we going to sit around and let people suffer thirst, heat prostration, and gunfire while seeking shelter, as we did in New Orleans that last time an act of God took away our punchbowl?

Rather than risk a flood of jingle mail, let's allow the Fed to cut a check to EVERY homeowner in the full amount of the house in which they are the full time occupant (no need to encourage speculators). This way, they can be compensated for this act of God that threatens to reduce the value of their net worth. We can use the current assessed value for property taxes as our benchmarks.

But let's not stop there.

What about all the large ticket consumer products that people purchased with their hard earned credit that have simply not met expectations, through absolutely no fault of their own?? That big screen TV that is now outdated because it doesn't support 1080p? (how were WE supposed to know about THAT!). What about those crappy refrigerators, washers and dryers that no long function and are OUT OF WARRANTY? We bought two Maytag appliances (just before they were acquired by Whirlpool) that had major failures within 16 months, and required substantial labor costs to fix them even though they were obviously mis-designed and of poor quailty.

What about people who have suffered the earthquake of bad investing, and can show losses on their brokerage accounts, and carryovers on their income tax forms? Not to mention those whose cars are just not up to snuff, or have been damaged in accidents and are insufficiently insured? Should they be made to suffer? Are we that cruel? Costco will take almost anything back if you have a receipt. Is the United States government less sophisticated than a discount store (with great quality products AND plenty of free samples for the afternoon nosh).

Working with local municipalities we can set up 'economic relief centers' where we can:

TAKE IT ALL BACK! LET'S EXTEND THE BAILOUT TO EVERYONE! THE U.S. (that's US) DESERVES A 'FRESH START.'

And let's not limit it to houses and consumer durables, which are only a percentage of our GDP. What about the service sector? We're a service economy now. What about the man who spends a CONSIDERABLE amount of time and expense and personal energy trying to score with some likely hottie, only to STRIKE OUT! Should he be punished for falling victim to the earthquake of reality? And what about a woman who marries a prince charming, but who turns out to be a shiftless dud? You still have the original marriage certificate? He may have to take a 'haircut' which he probably needs anyway, but why should you have to live with your clouded judgement? Ever gotten stuck with some sour milk, bad dope, a lousy movie that had a good rating? Oh, you didn't realize that the upright conservative you voted for was going to squander your Social Security on crony capitalism? And dare we mention the faux pas of the century...... the Iraq War?

But the banks are too big to fail! And we're not! And if we don't give them what they want, they are going to make us miserable like they do to Third World countries, have done to us before. Oh yeah, before they had the laws changed there were lots of small banks, but they got organized into a few powerful behemoths! That's the difference.

SAVE THOSE RECEIPTS PEOPLE!

Note: The above is satire in the nature of The Colbert Report. It pokes fun at some very intelligent and sincere people who are merely raising some questions worthy of discussion and debate. This is NOT a polemic nor should it be. Just in case you missed the obvious reference in the title and in the florid exaggeration. But there are a lot of folks discussing this in a very serious way, and you need to be aware of it since it has quite a bit of support, and ultimately YOU pay for it with a devalued US dollar and/or higher interest rates on official debt.

And yes, we have come up with a proposal we think is better. At the Crossroads of the Packaged Debt Crisis

SP 500 Bear Market Update: Daily Charts: March 11

We have been posting SP 500 bear market update charts, in which we compare the current 2007-8 bear market with the last bear market and recession which we had in 2000-2002. We have been doing this on the weekly charts.

The problem with the weekly line chart is that it really doesn't catch the intra-week volatility one sees in bear markets, with steep declines and snapback short covering rallies. The advantage of course is that it is easier to see the matching and the 'big picture' of the market moves.

Since intra-week volatility hit a five year record in the Dow moonshot today, we thought it would be useful to show a DAILY chart which compares the same two bear markets in the same way, with time and price percentage roughly mapped to the same values. It just shows the fluctuations with much greater detail than the weekly charts.

Here it is:

US Treasury Debt 'Riskier' Than the German Bund For 'the First Time Ever'

U.S. Treasuries Riskier Than German Debt, Default Swaps Show
By Abigail Moses

March 11 (Bloomberg) -- The risk of losses on U.S. Treasury notes exceeded German bunds for the first time ever amid investor concern the subprime mortgage crisis is sapping government reserves, credit-default swaps prices show.

Contracts on 10-year Treasuries traded at a record 16 basis points earlier today, compared with 15 basis points on German government notes, according to data compiled by BNP Paribas SA. In July, U.S. credit-default swaps were at 1.6 basis points, compared with 2.5 basis points on bunds.

Federal Reserve Chairman Ben S. Bernanke announced plans today to lend as much as $200 billion of Treasury notes in exchange for debt including private mortgage-backed bonds to avert an exodus from the securities that threatens to deepen the housing slump and economic slowdown.

``The U.S. government is not immune from the consequences of the credit crisis,'' said Fabrizio Capanna, BNP's head of high-grade corporate trading in London. ``Support for troubled financial institutions in the U.S. will be perceived as a weakening of U.S. sovereign credit.''

The Fed is trying to ease investor concern that a decline in house valuations and record foreclosures will add to losses for companies including Freddie Mac and Fannie Mae, the two biggest providers of U.S. mortgages. The $4.5 trillion of agency mortgage securities is about the same size as the market for Treasury notes.

Credit-default swaps are used to speculate on the ability of companies or governments to repay their debt and offer a benchmark for pricing securities. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A decline indicates improvement in the perception of credit quality; an increase, the opposite.

Hoarding Treasuries

A basis point on a credit-default swap contract protecting $10 million of debt from default for 10 years is equivalent to $1,000 a year.

Investors and securities firms have hoarded Treasuries during the credit crisis because they are considered the safest and most easily traded securities, reducing yields on two-year notes to the lowest since 2003. Yields on Treasuries have been lower than on German bunds since October.

U.S. yields rose today by the most since May 2004 to 1.77 percent from 1.5 percent on Bernanke's plan.

To contact the reporter on this story: Abigail Moses in London Amoses5@bloomberg.net

Last Updated: March 11, 2008 13:47 EDT

Fed Man Says: STOP!

Bank Stocks Rally on Fed Move
Tuesday March 11, 11:23 am ET
By Dan Seymour, AP Business Writer

Bank Stocks Rally As Fed Offers to Swap Super-Safe Treasury Bonds for Mortgage Debt

NEW YORK (AP) -- Bank stocks spiked Tuesday after the Federal Reserve offered to swap $200 billion of ultra-safe Treasury bonds for some of the troubled investments roiling Wall Street.

The offer is designed to make it easier for banks to raise cash. By temporarily trading no-risk Treasurys for mortgage bonds that have become toxic on Wall Street, the Fed is giving banks collateral they can use to borrow money.

Over the last few months, lenders have developed a distaste for risk and uncertainty, and numerous markets where banks typically raise cash have frozen up. It is easy to borrow money using Treasury debt as collateral because the U.S. government is considered the most creditworthy borrower in the world.

"It takes a lot of the pressure off the short-term funding side of the major brokers," said Sanford Bernstein analyst Brad Hintz, who used to be chief financial officer of Lehman Brothers Holdings Inc. "What the Fed is doing is attempting to break the back of uncertainty in the repo market and ensure that no major financial institution goes down."

Hintz said a bank failure today would be far more problematic than it would have been 20 years ago. Through a complex series of contracts and swaps, Wall Street has created a nexus of interconnected risk, he said. The Fed needs to ensure no banks go bankrupt because they are so dependent on one another, he said.

Shares of investment banks, which were clobbered by a seizure in certain corners of the bond market Monday, recovered much of their value Tuesday.

Lehman Brothers climbed almost 7 percent, while Morgan Stanley, Goldman Sachs Group Inc., JPMorgan Chase & Co., Merrill Lynch & Co., and Citigroup Inc. all spiked more than 4 percent.

The Philadelphia Stock Exchange KBW Bank Index, which tracks 24 banks and lenders, surged nearly 5 percent. The dollar jumped, and "safe havens" such as gold and Treasury bonds, which investors have been flocking to in order to shelter their investments from the credit crisis, posted declines that have been rare in 2008.

Douglas Peta, market strategist at J. & W. Seligman & Co., said he is not convinced the money banks borrow will be put to good use.

Banks are struggling, and Peta said rather than lending the capital they raise the companies may use it to bolster their own balance sheets. This is good for the companies themselves, he said, but would not help financial markets.

"That's the equivalent of taking money and stuffing it under the mattress," he said. "What we're looking for is money to be lent."

The Fed has tried to stem the sell-off of a range of debt, particularly home loans, by cutting interest rates.

This approach has not worked, said LibertyView Capital Management President Rick Meckler, because companies that are borrowing at lower interest rates are still not using it to buy risky investments.

Despite lower interest rates, many lenders are still under pressure to dump their investments to buttress their finances or repay their own lenders. This selling has yanked down prices for many kinds of investments, he said, which in turn forced more selling.

Meckler said by coming up with more creative ways to inject liquidity into financial markets, the Fed will hopefully relieve some of the pressure on lenders to sell their assets.

"You were really in a vicious cycle," he said. "This is an attempt to break that cycle."