Bailout Nation (43 page)

In September 2008, I offered a housing proposal (“Fixing Housing & Finance: 30/20/10 Proposal”
⁸
) that provided a way to reduce foreclosures
and
lower home prices at the same time. Call it the “30/20/10” solution:

There is no reason why those people who are underwater but current would not qualify for such a program. This plan would allow housing market prices to normalize, keep those loans that are savable from going into default, and avoid moral hazard. Note that this requires little if any taxpayer money. If you really want to motivate the banks to do this, however, Uncle Sam has to either guarantee some portion of the loans or provide low-interest-rate loans to the participating lenders.

A few other government actions are needed: The interest-free balloon loans should be made tax free; the lenders also need to be able to set aside these loans without taking a markdown immediately. The defaults (if any) wouldn't hit until 10 years hence. Banks should be permitted to carry these balloon loans not as a liability, but as a current nondelinquent loan (i.e., an asset).

T
he mad attempt to avoid any and all foreclosures is counterproductive. The foreclosure process is how an overpriced market returns back to normalcy. That is what is now happening, and excess interference will only slow down the eventual return to a healthy economy.

—John Maynard Keynes

 

 

B
ear Stearns opened the floodgates. Once the bailouts began, there was no end to them. Citigroup took $25 billion, and came back for another $20 billion, plus $250 billion in guarantees on its toxic assets. Bank of America—its name more appropriate now than ever—was also a three-time supplicant, getting the same $45 billion as Citi, plus $300 billion in guarantees. AIG has been back to the well four times—and counting—for a total of $173 billion of bailout green, so far.

Another hard lesson learned: Once executives get a taste of corporate welfare, they want more. Do you have any idea
how hard it is
to earn $30 billion in a year? Flying commercial—or even driving—to Washington, D.C., for an afternoon of hostile Q&A is a lot easier than having your company make $30 billion. The return on investment (ROI) on the day trip is
fantastic
.

The queen of corporate welfare is AIG. In addition to its multiple bailouts, it more or less threatened to blow up the rest of the world if more money wasn't forthcoming. In a special report to the Treasury Department titled
AIG: Is the Risk Systemic?
, AIG claimed that without a fourth bailout it would collapse, triggering a “chain reaction of enormous proportions” that would likely “bankrupt the entire system.” Oh, and if you don't give us more money, we won't able repay the $135 billion we already owe the U.S. taxpayer.

It is casino capitalism at its finest. Heads, we win; tails, you lose.

T
he endless maw that the Treasury Department keeps feeding appears insatiable. First under Hank Paulson, now under Tim Geithner, the trillions in bailout monies paid out is beyond absurd—it is asinine.

With the conditions at the country's biggest banks deteriorating rapidly, the nation needs to move beyond the half trillion dollars paid out to the 10 largest banks so far. The money already dumped into the black holes of just the two largest financial institutions far exceeds their net worth. And in exchange for this foolish investment, taxpayers have received a small stake in each: at first, 6 percent of Bank of America and 7.8 percent of Citigroup (eventually converted into 36 percent). How an investment of 120 percent of a company's market capitalization yields only a
minor
ownership stake is simply beyond my comprehension.

There has to be a faster, fairer, cheaper, more efficient way out of the current credit and financial mess. There is, and it is called receivership—but you may know it under its more common name, nationalization.

The solution to the banks' problems, as well as this ridiculous investment posture, is relatively simple: Identify the banks that are insolvent, and temporarily nationalize them. Appoint new management, and give them six months to spin out 10 percent of each of the separate viable pieces, with the taxpayer retaining the rest as passive investors. Bank of America can spin out five major pieces: BoA, Merrill, Countrywide, a toxic holding company, and the rest of its holdings. The toxic assets put into the toxic holding section get wiped off the bank's balance sheet.

The derivatives exposure gets wound down (counterparties are unsecured creditors—except, for unfathomable reasons, in the case of AIG).

Stockholders get wiped out, as that is what occurs when you invest in a company that goes bankrupt. Bondholders take a haircut, and end up owning a piece of the new firm. Perhaps in exchange for fresh capital, they can have a preferred position in buying the new firms' bonds. As opposed to the small pro-rata share they would have gotten in liquidation, they get a convertible preferred in the new debt-free firm, as well as an opportunity to lend to the new banks at a generous convertible rate.

In January 2009, Adam S. Posen, deputy director of the Peterson Institute for International Economics, noted:

It seems to be the least onerous, least offensive way to halt the downward spiral of America's largest financial institutions.

The current bailouts have shown themselves to be expensive, ineffective, and replete with moral hazard. Not only are we wasting vast sums of money, but we also are rewarding the incompetent management teams that created the mess in the first place. As this book was going to press, Treasury was forced to intervene to prevent AIG from giving out nearly $450 million in bonuses to “pay executives in the business unit that brought the company to the brink of collapse last year,” according to the
Wall Street Journal
.
²

How is it possible that the same collection of financial nincompoops who caused this problem not only are
still
in the employ of AIG, but somehow think they are entitled to
performance bonuses
?

P
erhaps we should be looking to Sweden. Lars Jonung served as chief economic adviser to Swedish Prime Minister Carl Bildt from 1992 to 1994. That was when “the Swedish solution” was implemented.

The former professor at the Stockholm School of Economics sees the United States as having two options: go Swedish or turn Japanese:

The alternative is the Japanese model. When that country's economy crashed and its real estate bubble burst in 1989, Japan allowed banks to carry the bad assets on their books for years. They failed to take the painful write-downs or raise appropriate capital. The subsequent period is known as Japan's lost decade.

P
erhaps the word
nationalization
scares some people, as if that is what would turn the United States into a banana republic. Why don't we call it by a more user-friendly name? How about “FDIC-mandated, prepackaged, government-funded Chapter 11 reorganization”?