As our government tries to wrestle with the details of the single largest buyout of economic assets in the history of the world -- necessitating raising our statutory debt limit by over $1 trillion -- I think that we need to consider a couple of things.
First, the buyout is bad economic policy. Does that mean we shouldn't do it? No. Economic policy does not always meet up with reality.
For example, a large part of the mess this week -- especially in terms of Lehman Brothers and Merrill Lynch -- was because of an economic policy called "mark to market". This policy requires asset holders to mark the values of assets to their lowest marketable value on their balance sheets. In many cases, asset holders marked these values to ZERO. In a market of bonds and off-book investment vehicles that are not regulated, asset values are the only collateral that investment banks possess. No collateral, no ability to borrow short-term operating debt to build more assets. However, many of these assets DO have value. The houses that these mortgages were written on obviously have more value than ZERO. Point: Economic policies do not always meet up with reality.
The simple fact is that the bailout is going place yet another obligation against future tax receipts, even if a large number of these bonds and mortage-backed bonds end up being re-sold and the government can recover even a fraction of their overall value. Given the impending collapse of Social Security, and the massive burden of entitlements like Medicare Part D on the Federal Budget, this will magnify the impact of any tax increases in out years.
Second, while the buyout may restore confidence in the US financial markets on the part of institutional traders, central banks, and large investors, it does not inspire or restore confidence on the part of Main Street. Americans are well known for (largely) being common sense people: you take your risks and you pay the price. But there are a lot of Americans -- hardworking Americans, who pay their bills, pay their mortgages, and make sacrifices to avoid going into debt -- who see little common sense or fairness in letting substandard borrowers and businessman with little or no honor off scott free.
To that end, the bailout must include several provisions to restore the confidence of Main Street:
1) Banks that sell bad loans to the government must dismiss their entire board of directors, and their Chief Officers. Those people should not be able to work in, or serve on the board, of any bank, thrift, savings and loan, or other financial institution for a period of seven years. Furthermore, no employee should receive any severance beyond unemployment insurance.
This needs to include Franklin Raines, Jim Johnson, and Jaimie Gorelick -- three key leaders at Fannie Mae who deliberately "cooked the books" during their tenure in order to guarantee massive bonuses and payouts.
2) Borrowers of sub-prime and Alt-A loans should only be allowed to renegotiate loans on their primary residences, or residences that have current renters living in them as their primary residence. Furthermore, if the mortgage is on a primary residence, they should be required to live in that residence for a minimum of seven years or until that loan is paid out in full. (Exceptions, of course, would be made in the case of divorce, death, or transfer of employment.)
3) Banks that sell their bad loans to the Government should be required to sell "good" loans as well, giving the Government entity a stock of profitable loans as well. I would recommend that the "good" loan values be in the amount of 20% of the total "bad loan" portfolio sold.
4) The Graham-Leach-Bliley Act of 1999 -- which repealed provisions of the Glass-Steagall Act and allowed bank holding companies to provide insurance, investment, and commercial banking services -- should be repealed.
5) The short-sell uptick rule -- removed by the SEC in 2007 -- should codified in law, and the power to change it should be removed from regulatory agencies.
6) Banks that wish to continue offering sub-prime or Alt-A loans must operate under the following conditions: a) payments shall not exceed 33.3% of borrower's after-tax income on a monthly basis; b) no interest-only loans, and a minimum downpayment of 7% (non-financed) on any sub-prime or Alt-A loans; c) portfolio shall not exceed 7% of current deposits; d) loans must be held by originating bank for a period of 24 on-time payments before being sold and/or repackaged (note: 24 payments resets if finance rate changes interregnum); d) loans must carry mortgage insurance for a period of 1/3 of loan maturation; e) banks shall be required to collect, confirm, store, and re-confirm documentation of income and assets for the period of the loan; f) sub-prime and Alt-A loans may only be issued to legal residents of the United States; g) must publish a monthly report on the health of the total loan portfolio to all depositors; and h) sub-prime and Alt-A loans may only be issued for primary residences.
7) We should flip the "tax deductibility" of interest, and make the current equity -- for which there is no outstanding debt against -- tax deductible (up to a certain level, of course). In other words, when you purchase a home, and you put 25% down, that value is tax deductible on an annual basis, not a percentage of the interest paid. This would discourage the practice of using the home like a credit card -- flipping one equity amount (grown by an increase in overall market values, not paymnets) into another mortgage, and encourage long-term home ownership and responsible action on the part of buyers.
Any bailout cannot just be about putting a band-aid on the problem. We need to change the way that we handle finance and derivatives vehicles in this country. This current fiscal crisis is a problem of asset deflation and price inflation: products get more expensive to purchase even as our ability to purchase those products goes down. It was caused by outright stupidity, shameful ignorance, abject greed, and a stupid economic policy -- George W. Bush called it the "Ownership Society", but decades ago as Democrats pressured banks into lending more to "sub prime" borrowers. But we must also hold accountable those who got us into this mess.