A Real Rescue Plan

by Asher B. Edelman

In April of 2008, I wrote, originally as a proposal for the Obama campaign, the following short outline of a recovery plan. Some of it seems to be coming to pass. However, I have not yet seen mentioned that the recklessly issued debt will be purchased at fair market value rather than at face value. To purchase at face value would be an assault on the American taxpayer, which would only benefit the perpetrators of the mess. There has been no specific mention as to how to help those injured or destroyed by reckless lending and usurious interest rates for homeowners and other small borrowers. Rates must be adjusted to reasonable levels.

Only if these two important issues are addressed and solutions put in place will a plan work. It would be a move towards fairness, perhaps the first one during the disastrous reign of the current administration. Use your influence to convince your representatives in government to pursue fair market value purchases and interest rate adjustments for the injured.

The current liquidity crisis reveals the urgent need for a bold new idea to save the system. This is no time to be throwing $30 billion at the problem and hoping it will staunch the hemorrhaging, because $30 billion will seem minor when the losses add up to, perhaps, a hundred times that figure. Here is a straightforward plan that will produce immediate results, even profits, for the federal government and the individuals caught up in the current mess. This plan will not only create liquidity, but will also eliminate financial guesswork. There will be clean balance sheets and no further worries about the hidden investment time bombs that could deepen the crisis. It will be fair and completely voluntary-no mandates, no amnesty for “evil” speculators (the principal will be paid back on most every mortgage). It will generate an income stream for the federal government, and even open a chance to reap substantial profits over time as mortgages are redeemed. People will get to keep their homes! If the present agenda is to find a fair route of stabilizing the whole nation’s finances and not just satisfy constituencies on Wall Street or in Washington, this is a broad-based plan that works from day one and promises substantial rewards well into the future.

Face it, there is no institutional liquidity under the present setup.  I define institutions to include banks, insurance companies, hedge funds, investment banks and foreign institutions that do substantial business in the United States. The financial institutions who own mortgage-backed and other junior securities are stuck with them. Even if the assets have value, even if the banks were careful, they are all hedge funds, investment and commercial banks– in the same boat -sub prime paper is illiquid.  Shortly, the market for prime securities will become illiquid.  Bad debt often drives the future of better debt badly! The Commercial banks are not cut out to rescue this kind of mess. They are too much part of the problem.  It is time to discard all concepts of what the bailout total ought to be. What is needed is a window to provide private institutions with liquidity. It is time for the government to get into this business by buying non-liquid, mortgage-backed paper for realistic discounted market prices. Private institutions get their liquidity, and live to fight another day. The speculators will have to “pay” for their bad behavior, realizing their losses, and those who over-borrowed will remain responsible for the principal of every mortgage.

Who can do this? Managed by the executive branch, a federal agency can not only buy these assets, but will also have the option of reducing individual mortgage rates to their original levels. In the end it can profit handsomely as mortgages purchased at a discount can grow to full value with nurturing. The transfer from institutional balance sheets will force the worst of the debt out of private institutions, many of which gauge borrowers with escalated rates that started at 6%, are now creeping past 10%, and, in cases of default, can top 18%. The government can use a combination of the existing institutions, FannieMae and FreddieMac, along with, perhaps, a new vehicle devised to actively move in and out of the market. It ought to be set up under the aegis of the executive branch and, instead of 30,000 Federal bureaucrats, it should be staffed by 100 efficient finance grads under one expert market-maker.  Perhaps Goldman Sachs can provide us with yet another leader for this operation.

The results:

  • Immediate liquidity in the system
  • Speculators realize losses but live to fight again with clean balance sheets
  • Homeowners get another chance with less than onerous rates to work towards full payment for their homes.  They also get flexibility in timing principal payments
  • Government acts even handedly across the spectrum of needs while earning profits for taxpayers
  • Thoughtful long term regulation of these types of investments and the liquidity needs of the system should be evaluated while the system is on the mend.


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