More Bank, Less Bucks: A Four Point Plan for the Rescue from Institutional Risk Analytics

These guys really seem to make sense. I'm no expert in this stuff, but they have a straight-out plain-spoken common-sense way of talking that makes me think they are down-to-earth people who really know their stuff.
Also I like that guy in the suit looking out the window on their website.  Reminds me of Detective Columbo, which seems appropriate.

Institutional Risk Analytics

More Bank, Less Bucks: A Four Point Plan for the Rescue
October 6, 2008

"Public opinion made [Herbert Hoover] the villain of the Great
Depression. In fact, the 31st president was a visionary -- but a hopelessly
inept politician… Until early 1931, midway through his presidency, Hoover had
waged a vigorous offensive against the Depression. International events pushed
him back onto the defensive. His overriding goals became damage control and even
national economic self-preservation, as it became clear that the Depression was
not just another cyclic valley, but an historic watershed. Hoover came to
believe that the root cause of the Great Depression was the Great War."

Don't Blame Hoover


Stanford Magazine


David M. Kennedy

Jan/Feb 1999

Watching the financial rescue legislation grind along to
a conclusion reminds us that democracy is not meant to be efficient or pretty.
The end result also makes us think of how our ancestors dealt with the
Great Depression. We think not of FDR, who most Americans associate with the
solution via the New Deal, but of President Herbert Hoover, a tragic figure but one of the
greatest technocrats to ever hold the office of the presidency

Hoover knew what was happening in the country in the early 1930s. He created many of the mechanisms that would be used to deal with it, including the Reconstruction Finance Corporation. But due to
poor communications and other factors, Hoover could not marshal sufficient
resources to act effectively. We've written about the attempts by Hoover to
negotiate with Henry Ford in the days leading up to the collapse of the Detroit
banks in early 1933 in a past issue of The IRA ("How's My Bank or Why One Rating Just
Isn't Enough"), but by then Hoover had been fighting the Depression for over three years. He wrote in the third volume of his memoirs, The Great Depression:

"If we had possessed adequate banking laws and a sound
financial system, we should never have needed the Reconstruction Finance
Corporation, the Home Loan Banks, and the half dozen other government props to
credit, which we were compelled to introduce later on… Our whole economic system
naturally divides itself into production, distribution and finance. By finance I
mean every phase of investment, banking and credit. And, at once I may say that
the major fault in the system as it stands is in the financial system… In this
system I am not referring to individual banks or financial institutions. Many of
them have shown distinguished courage and ability. One the contrary, I am
referring to the system itself, which is so organized, or so lacking in
organization, that it fails the primary function of stable and steady service to
the production and distribution system. In an emergency its very mechanism
increases the jeopardy and paralyzes action of the community… That it has been
necessary for the government, through emergency action to protect us (while
holding a wealth of gold) from being taken off the gold standard, to erect
gigantic credit institutions with the full pledge of government credit to save
the nation from chaos through this failure of the financial system, that it is
necessary for us to devise schemes of clearing-house protections and to install
such temporary devices across the nation, is full proof of all that I have said.
That is the big question. If we can solve this, then we can take in hand the
faults of the production and distribution systems - and many problems in the
social and political system. But this financial system simply must be made to
function first."

  It doesn't surprise me that they like Hoover. Seems right, somehow.

Here's our suggestion as to how to get the job done to
maximum effect for financial institutions and the larger economy.

First, the Treasury should become a market maker in both the assets and equity of solvent financial institutions. By being prepared to purchase illiquid assets, guarantee same or buy preferred equity
from solvent financial institutions, the Treasury can immediately put a floor
under viable but liquidity constrained financial institutions that are being
driven into default.

  Assuming, of course, that there is no plan afoot to drive them into default and/or into the gaping maw of Citi Bank of Goldman Morgan. They are obviously less cynical than I am. I applaud their optimism and practicality.

Second, the Treasury should display all of the assets held by the rescue fund in real time. Each day, the Treasury should conduct an auction for all of the assets in the fund. It is up to the discretion
of the Treasury whether to accept or reject any bid, but the aggregate results
of the daily auctions should also be published in real time, thereby creating an
indicative market for pricing these assets. Likewise, any preferred equity sold
to any financial institution participating in the program should be displayed in
real time and put up for bid. As former Fed Chairman Alan Greenspan said of the
GSEs several years ago, everything that can be sold should be sold - but at a
price that suits the objectives of the Treasury

  Touchingly optimistic. Real-time transparency. Maybe if Obama wins and his transition team is running the show, otherwise fuggedaboudit. Still, even if they are dreaming, by providing one of many preferable alternatives to the Hanke-Panke plan (which were never to my knowledge mentioned in the media or in Congress), and now that the H-P heist has taken place, providing a sort of critique-in-advance of its implementation, they are fighting the good fight.

Third, while the Treasury needs to run the market process, the FDIC should be given overall authority to manage the assets acquired or preferred equity purchased by the Treasury that is not immediately
sold. The FDIC has the operational experience and personnel to act as general
contractor for the Treasury, and in turn can direct the work of the tens of
thousands of FDIC personnel, other regulators and contractors from the top
accounting, consulting, forensic and IT services firms around the world who
already are being marshaled behind the FDIC's bank resolution efforts.

  I'm definitely with them here. I have no use for the Hanke-Panke crowd at this point, but have nothing against the FDIC. Let them run the show, and maybe the odd hundred-billion here and there will be saved from falling into the pockets of Friends of Hank.

Fourth, the whole point of this legislation is to use the credit of the US to buy time to resolve troubled assets, but the Treasury should not be shy about hitting a reasonable bid or making its fiscal operations aggressively
transparent and inclusive. By letting the markets begin to operate
under the aegis of the Treasury as market maker, it is possible to reverse the
current deflation in asset values and public confidence.

In order to achieve this end, limitations on short selling against financial institutions need to be removed. The best way to discipline unsafe and unsound short selling activity is to enforce existing rules on capital and margin requirements, or tighten same, as with the proposal by theState of New York to begin regulating the sales of credit default swap protection against hedged positions starting January 1, 2009. Once the Treasury creates a capital backstop behind the major banks, the pressure from short-sellers will lessen.

For the continuous auction process to function, the Treasury
and the participating institutions need to see both the longs and the shorts.
Likewise, whatever compromise approach is used by the SEC to modify the
accounting treatment of assets under the fair value accounting rule should be
reflected in the Treasury's auction process. That way we're all on the same
page, yes?

 Yes. Definitely.

It may strike some of you as odd for The IRA to be urging the
government to buy equity in private banks, but as we have argued in numerous
venues over the past several weeks, the probable realized loss rates facing US
banks in the next four quarters are well above 1989-1991 peak levels. The US
government can get involved now, in a way that keeps the majority of assets in
nominally private hands and encourages private capital to participate, or we can
recapitalize these banks in a receivership at 100% public expense. We think the
choice is obvious from a financial and public good perspective.

Just plain-speaking common sense.

As Hoover reflects in his memoirs, the problems facing the US
financial system then and today are practical, not political. If the next
President and the next Treasury Secretary want to fix the economy fast, make the
asset purchase program favor the sale of new equity first, then asset
guarantees, then finally the outright purchase of bad debt at significant
haircuts. The amount of public expenditures under an
equity-focused program will be less because instead of increasing the negative
weight of collapsing leverage, we can again make leverage our friend and help
expand bank balance sheets and the economy via new public and private equity
infusions.

  This sounds like a good long-term plan. I'm not sure it addresses the acute crisis in the credit markets, or rather lack thereof, but maybe it does. I'm no expert, in fact I'm very much learning as I go along, but if I understand the situation correctly a lot of otherwise perfectly viable business are going to start hitting the wall soon, missing their payrolls and falling behind on payables (and seeing the same thing happen to their receivables), if they can't get the affordable commercial paper that they live on. I imagine there are some businesses run by people like me who hate debt so much that they always have piles of liquidity available for normal operations, but probably not many. So while keeping some of the banks alive is all well and good, it is pointless if they don't immediately start providing normal credit both to businesses and individuals. If they won't,then to Hell with them. Any systemically essential enterprise, whether it provides credit, water or electricity, should be seized and government-operated as an emergency measure if they are threatening public health, wealth or stability.
 
  This may sound farfetched and probably is, but when you think about it, every corporation and taxpayer already has an account with the Feds, so the Feds could simply grant credit directly to individuals to pay their mortgages and to businesses to maintain their operations, and simply make the funds disbursed a long-term-payable debit on their tax accounts. Call it whatever you want, it may be preferable to the oncoming wave of bankruptcies and defaults that appear inevitable unless credit flow is resumed. Not that I like the idea, because governments are generally relatively inept compared to well-run enterprises (but there are some areas such as health care where efficient government operation has a much better cost-benefit profile), but given the alternative it's worth a try.

  Unless of course the alternative, an "economic Pearl Harbor" as Warren Buffett called it, is the culmination of a plan rather than an unforseen consequence of unrestrained greed. We should know within the next month or so.