Tell the Banker: "NO DEAL" Howie!

As I have written in my past few posts, all Americans have an interest in maintaining a sound banking and financial system. This is the intended objective of the "bail out" legislation which failed to pass the House vote today by only 12 votes. Subsequently, the DOW industrial stock market index dropped by almost 800 points, the worst one day drop in history. However, after having looked at the bill, I conclude that the that those who voted against the bill were correct today, despite the need for action. However, I don't agree with most of the House Republicans who are pushing a mortgage insurance program as a private sector solution as their alternative.

I think this is a bad bill because it appears to be a mishmash of policies from both the right and the left without a focus on the problem. First, the bill gives wide discretion to the Treasury Secretary to purchase the mortgage backed securities. The hope is that he will purchase these at "bargain basement" prices and after a holding period be able to sell them for a profit. There are several problems with this: First, the underlying assets, ie the houses in foreclosure are still falling in price and in many cases their value is difficult to determine. Hence the value for the security is hard hard to determine, making any price paid by the Treasury simply an arbitrary price. The second issue is that he can write regulations to determine what constitutes a "conflict of interest" which will allow him to potentially hire the same Wall Street firms or their successors to help structure the transactions and dump all the bad loans on the government. This is a prescription for foul play. Another reason that this is a bad bill is that in order to gain the Republican support, they give the Treasury Secretary the option to establish the insurance program. Buying insurance for non-performing securities or ones that were poorly underwritten in the first place is like buying insurance for your house after it is half burned to the ground. Further if the primary problem is liquidity, ie the banks don't have the capital to lend to one another and their customers, then they surely can not afford to pay insurance premiums out of their limited available capital.

Congressional leaders further compromised this bill with another Republican led provision by giving authority to the SEC Chairman to relax the accounting rules that require firms to mark to market the value for the securities on their books. This will only make the problems worse, because they will value these securities for more than their worth. Then, they don't have to raise additional capital to meet their capital requirements. Additionally there are other technical provisions in this bill that deserves further scrutiny than the compressed time frames that Congress was given to properly consider this legislation: Changes to Federal Truth-in-lending requirements and Good Faith Estimates, limits on executive compensation, provisions limiting judicial review, provisions for the Secretary to arbitrarily renegotiate the terms of existing loans, establishment of an Office of an Inspector General and penalties for anyone who misrepresents coverage of FDIC insurance. Some of these, particularly establishing an Inspector General are perhaps good, but others may have unintended consequences without undergoing a more through review. Some of these also seem like they may have been inserted for or by industry lobbyists.

Thus, this bill did not seem to provide the solution that are needed: inject liquidity into the system, isolate the non-performing mortgage assets problem, and protect the taxpayers for their investment. Meanwhile,while Congress wrestled with this bill, the market again took care of another major problem: Citbank bought the ailing Wachovia Bank which once again demonstrated how a solution could be structured.

I would go back to the drawing board and look at models that have worked: Recent transactions whereby private investors, including Warren Buffet, have purchased preferred stock and options for common stock in exchange for their capital investment in under capitalized institutions. Also, the recent liquidations of large financial institutions by the FDIC to healthy ones, could be a model. The government would set up a bank holding company to park failing institutions until they could dispose of their non-performing assets or be spun off to a healthy institution. Add in some reasonable oversight, an inspector general, and criminal sanctions for anyone who defrauds the government, and perhaps the problems could be addressed.

The credit problems are real, but everyone should also understand that even with a well structured bill, it should be the case that people and businesses who have poor credit should not be able to get a loan on favorable terms. This is precisely the problem that got us in this mess in the first place so we don't want to replicate it. The other reality is that we are likely headed, if we are not already there, into a recession. This bill should not be passed with the idea that it will reverse this natural part of an economic cycle. Some tightening of credit standards is a part of the solution to this systemic banking problem. There are no easy solutions, but sometimes Howie, you have to say "NO DEAL" and today was one of those times.