Former Top Officials Propose Bankruptcy Reorganization of Financial Sector

promoted by roxy original publication date/time:2008-09-18 09:06:10 -1000 (HI time)

This proposal "Resurrect the Resolution Trust Corporation" was offered as an op ed in yesterday's Wall Street Journal. It was written by three former ranking officials with responsibility for financial affairs. They are Paul Volcker, Chairman of the Federal Reserve under Carter and Reagan, Nicholas Brady Secretary of the Treasury under Bush's father, and Eugene Ludwig, Comptroller of the Currency under Bill Clinton.

The three share the advantage of being old enough to remember a world in which derivatives did not exist, and in which "moral hazard" meant protecting depositors by limiting what financial institutions could do with their money.

This link will take you to their proposal:

http://online.wsj.com/article/SB122161086005145779.html

(If it doesn't work you could try through the blog Calculated Risk) I found it through Eurointelligence.

I know there will be a lot of people who will say "how can you support this, don't you know who these people are." Of course I do. I'm also old enough to remember what they did, and I remember writing plenty of pieces of invective attacking both Volcker and Brady: Volcker for his interest rate policy, and Brady for the so-called Brady Plan reorganization of Latin American debt. I had especial fun once with a piece directed at Brady called "When you float a trial balloon make sure it isn't made of lead."

But anyway all that's water under the mill, I hope. The three of them are criticizing Paulsen and Bernanke now for exactly the right reasons, I think. They write:

right now the system is clogged with enormous amounts of toxic real-estate paper that will not repay according to its terms. This paper, in turn, is unable to support huge quantities of structured financial instruments, levered as much as 30 times.

Until there is a new mechanism in place to remove this decaying tissue from the system, the infection will spread, confidence will deteriorate further, and we will have to live through the mother of all credit contractions. This contraction will undercut the financial system, and with it, the broader economy that so far has held up reasonably well.

There is something we can do to resolve the problem. We should move decisively to create a new, temporary resolution mechanism. There are precedents -- such as the Resolution Trust Corporation of the late 1980s and early 1990s, as well as the Home Owners Loan Corporation of the 1930s. This new governmental body would be able to buy up the troubled paper at fair market values, where possible keeping people in their homes and businesses operating. Like the RTC, this mechanism should have a limited life and be run by nonpartisan professional management.

And,

The pathology of this crisis is that unless you get ahead of it and deal with it from strength, it devours the weakest link in the chain and then moves on to devour the next weakest link. A deteriorating financial system, diminished economic activity, loss of jobs and loss of revenues to the government is enormously costly. And the cost to our citizens' well-being is incalculable.

Crisis times require stern measures. America has done well in the past to face up to economic turmoil, take strong measures, and put our problems behind us. RTC-like mechanisms have worked well in past crises. Now is the time to take a similarly forceful step.

The three are proposing an orderly liquidation of the problem through what I would call a bankruptcy reorganization. This is opposite to the argument that insists we have an ever growing liquidity problem (not enough credit in the right places at the right time and at the right price). What they are talking about does happen to be what is needed now. It is what Paulsen and Bernanke have refused to recognize and tried to avoid for more than the last year. It is why I wrote that little squib yesterday about Bail'em and his Ass. The three former officials are proposing an approach which would work, and buy time for further necessary steps.

I believe it is an approach which should be supported by people who are beginning to fear that everything they have worked for might be at stake, and really also to doubt what kind of future there is going to be if things continue to unravel the way they have over the last year.

I hope that others will agree with this proposal, given the respect which is without doubt accorded to its authors, men undoubtedly of the highest professional competence and probity, and help circulate it. It will for sure be opposed by the radical wings of the body politic. But hey, what would a chicken be without wings? Sorry, this is the US, not France. What would an eagle be without wings?

I'm not a fan of "let it all come down". Nor do I think it is right to sit back when there are things that can be done. Nor do I think it right to remain silent when things are being done that are wrong or unjust, or both, like the bail-out nonsense. I just don't think with Paulsen and Bernanke in charge there is an alternative. This proposal changes that and can also give Congress something to work on quite both quickly and effectively, if they get the back bone to do it.

0
No votes yet

Comments

It is within SEC control to suspend trading for up to 10 days on any particular company or even a group of companies. Start there. Repeat as necessary until either the markets respond with some level of sanity, or our electeds - in conjunction with the regulators - craft legislation.

If nothing else the shutdown may provide enough breathing room to keep stable companies from being pummeled irrationally.

Gonna repeat the comment I made in Welshman's commentary below:

about the price tag of the bail out... back in July when we were talking about the Plunge Protection team and magically stock market corrections... and the RTF was being discussed...by Mark Gongloff of the WSJ.

Like S&Ls? Paying the Tab For a Cleanup

At some point banks may run out of funding sources or willing buyers for their misfit loans. A three-letter solution is already on the lips of many investors: RTC.

Resolution Trust Corp. was established during the savings-and-loan crisis of the late 1980s and early 1990s. The clearinghouse sold off some $394 billion in assets of 747 failed S&Ls, costing the taxpayer about $76 billion, according to the Federal Deposit Insurance Corp.

Potential losses in this crisis are far larger, with estimates of $1 trillion or more being bandied about. Taxpayers won't be on the hook for anything close to that. But their bill could make the $124 billion they paid, in total, for the S&L crisis seem a bargain.

Back in the summer when I was reading the Kevin Phillips book, Bad Money, I was a lot smarter on this stuff.Privatizing Profits and Socializing Losses.

I have been listening to the argument about RTC's on British television tonight.

I agree with your conclusion on the merits of the concept. I dislike the fact that bankers will love it, as it means that the consequences of their bad lending policies will be removed at a stroke from them. These are extraordinary times, however, requiring extraordinary measures. I would like to see the terms surrounding the government taking onto itself these toxic loans to be tight and, whilst speed is all important, I would like to see a quid pro quo in terms of the re-institution of much tighter regulatory measures. That said, yes, this s a good proposal.

I'd be curious to know if anyone has thoughts on how the Swedish Banking Crisis was handled and how that might influence what's happening today.

One thing that took place--as firms were placed under control of the government, the boards were fired.

I'm not seeing much in the way of accountability for Wall Street. Without accountability there will be no confidence. Without confidence, the credit markets will remain frozen.

(oops. I missed Chris's comment down below.)

There is a discussion thread on this at www.nakedcapitalism.com tonight, and a google search on "paulsen rtc" produces a growing list of congressional supporters, beginning with Barney Frank of the Financial Services committee, and including Chris Dodd.

The question of what a "fair market price" turns out to be will have something to do with the real meaning of the word "toxic". Nothing is one of the most flexible words in English because everything is something, even when we call it nothing. The participants can't value it. So there needs to be some body which can set up an appraisal over time to collect and see if any residual non-toxic value has survived.

But the US is a debtor. Our creditors need dollars to buy Treasuries and agencies. The transactions are packaged and hedged and "insured", and each layer of the transaction can be traded independently, round the world, round the clock.

Where the trading volume is shows where further problems are lurking. Is this for nations to work out, or some supra-national type thing? I think the core of it is whether countries want to go back to a real fixed exchange rate system instead of dollar pegs (imperial preference?) or these fixings by ways of commodity ratios (barrels of oil per ounce of gold) which are used by Arabs oil producers, Russia and the ECB.

There will be a lot of people over in your neck of the woods who would object to fixed exchange rates, and everything that goes with it, because it will mean significant changes to the way British financial markets work. I think there will be people in China, India, continental Europe who will not object in the same way as along as there is some kind of tie, in the form of trade agreements, with multi-year time frames, to commodities and technology transfer. These agreements will ensure food and fuel supplies on the one side and jobs in capital goods producing countries on the other. Win-win. No need for speculation on peoples' livelihoods.

It may be that until these issues begin to show up, the toxic stuff will just get deposited here and the international depositors will hope to get favored treatment from Bail'em and Ass. But the more that happens, the more likely, I should think, would be some kind of discussion between states, rather than supra-national stuff.

There is a military dimension. I believe the oil price retreat also indicates a lessening of the war danger, even if Bush might be tempted to let his hair grow and play Samson in his final days. These kind of discussions will need some kind of assurances, and establishment of bona fides, and confidence measures, on the security front.

A good place to start would be making good what was stolen from the contractors of Iraq after the invasion. There also needs to be a serious discussion of Afghanistan, and how to help them do something other than grow dope.

Bush has indeed left the world a terrible mess.
One can only imagine what his mother would have said if it had been one that could have been deposited on her living room carpet. Unfortunately no one has had the strength to stand in for his mother to get him to clean up the carpet.

liked what I read:

The only successful example of dealing with a financial crisis is Sweden, which did not try to prop up troubled banks, but instead nationalized them, wiping out equity, brought in new top executives, and recapitalized them. The cost of failure was high to the incumbents and the solution was comprehensive, not piecemeal.

And the problem with this is, what, one of scale?

Nationalizations kind of used to go with the Labour Party in the UK. The continental Social Democracies tended to go for a different approach. Nationalization tended to pay off equity and creditor interests of failing, under-invested and obsolete businesses and while keep the failing obsolete business running. British Rail was a wonderful example of that compared to SNCF Deutsche Bahn and Sweden and Denmark.

The proposal here is from a different way of doing things, and they did refer to the FDR deal on mortgage debt that was part of the 100 days package. In that case swapping non-performing 5-yr balloon notes (think interest only ARMS) for 30 year fixed worked for both home-owner and bank, and over the 30 years (33-63) value was restored.

How that can be done with toxic derivatives is another matter, but they still need to be taken off bank balance sheets. The cancer needs to be separated from the body. "Fair market price" ought perhaps to have something to do with getting a banking system back which handles peoples deposits and company receivables and payables and payroll accounts safely and without risk, like they used to under Glass-Steagall before it was repealed. After all there is a need for a banking system. But not to pay off this bunch of freaky losers who created the mess.