Tuesday, September 30, 2008

No BAILOUT Act

I found the summary on Pete Defazio's web site. I assume language of the bill is being drafted and does not exist in a fleshed out form at this point.

The first three points are technical rules about trading which I do not understand the implications of. But the meat of the Bill is in the 4th point which proposes a paper shuffle to infuse assets into the banks balance sheets without actually giving them any cash. This is the way it is worded in Defazio's summary,

For those entities that qualify, the FDIC should purchase net worth certificates in these institutions. In exchange, these institutions issue promissory notes to repay the FDIC, counting the amount “borrowed” as capital on their balance sheets. This exchange provides short term capital, with not cash outlay. Interest rates on the certificates and the FDIC notes should be identical so no subsidy is necessary.
This is the option that Paul Krugman favored before reluctantly signing on to the Paulson Plan.

Krugman uses the example of Wachovia buy-out to explain how this works.

First, a real-world example, the rescue of Wachovia. The FDIC got Citi to take over Wachovia’s assets and liabilities with a deal under which the feds limit the losses — they will cover any losses on mortgage paper over $42 billion — in return, basically, for receiving a share of ownership, in the form of warrants and preferred stock. No actual money changed hands, which illustrates a fundamental principle: recapitalization doesn’t mean laying out real money, at least initially — it just means having taxpayers take on some of the risk.

A large-scale recapitalization would probably take the form of a giant swap of debt for equity: the Treasury would issue several hundred billion dollars’ worth of bonds, and give them to financial firms in return for preferred stock. The bonds wouldn’t have to be sold to outside buyers — they would simply be credited to firms’ balance sheets.

The effect would be that if the financial firms did well, taxpayers would share in their good fortune via those stock holdings; if firms did badly, they could meet their obligations by selling some of those bonds, which would cut into the value of all their stock, including the stuff Uncle Sam owns. So as in the case of Wachovia, what’s really happening is that the taxpayers are taking on some of the risk.
I don't pretend to understand all of this. But, if the banks can be recapitalized without the government borrowing 700 billion dollars and handing over the cash to a bunch of greedy and corrupt sons of bitches then it has to be a better alternative.

The idea that we might borrow, or print, 700 billion dollars out of thin air scares the hell out of me. I am truly worried about what this will do to the value of our dollar. Hyper inflation is a real phenomenon, just ask South Americans, and it is not pretty for anybody.

We must defeat this bailout and the only way we do it is by proposing something better. What are you all reading out there?

Anybody in finance that cares to jump into the conversation and shed some light on these options your input would be welcome.

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