I have restrained myself in proposing a bailout strategy for the U.S. financial markets in the hopes that Washington would come up with a solution. Ever the optimist, it now looks like they will agree on a package albeit the wrong one. With elections "approximately 40 days" away we have few people in Washington with the integrity to put politics aside. I applaud McCain for suspending his campaign, but I doubt that this time even he can forge a good, workable compromise. A bit of history before I present my solution.
In my life time this is the third real estate meltdown I have been through. First there was the REIT crisis in the late 1970s, then there was the savings and loan scandal in the late 1980s which resulted in Resolution Trust Company (RTC) and now we have the mortgage derivative "mess". In each of the three cases real estate financing was combined with financial engineering to over stress the market by executives who ignored risk analysis in favor of greed (in many forms). In the case of the REITS, it was special tax legislation that lead to poor lending practices. In the savings and loan debacle, it was junk bond financing. In the current situation it is derivatives combined with leverage which have done us in. In summary, as financial markets become more and more sophisticated, these tools are used to over stress the real estate market in the U.S. Just like the sun comes up each morning, Wall Street over stresses the real estate market with the newest tools about every 15 years. It is only a matter of time before this nonsense re-occurs.
There are two possible solutions:
- Death penalties--like in China--for gross negligence that puts society in jeopardy (could also be applied to drug manufacturing executives that kill innocent people, etc.)
- A more gentle alternative--reinstate the Resolution Trust Company. The RTC would have the authority to takeover institutions that do not meet minimum capital requirements or have serious liquidity issues. Could be used for all forms of financial institutions (banks, hedge funds, investment banks). All senior management would be fired with no golden parachutes as a condition of the takeovers. RTC worked well before so we should try it again.
Both of my solutions ignore the common people who are defaulting on their mortgages. This is not the important issue. The issue is to restore confidence in the U.S. credit markets. Financial institutions need to know that the other financial players they deal with are creditworthy or under the management of RTC. I think we should start with $250 billion in capital for RTC and see if it has a positive effect. I think it will. Am I smarter than Hank Paulson, Secretary of the Treasury--no--but I am not a politician either and therefore I can propose a rational, staged approach to the problem rather than a dramatic, newsworthy solution.
A bit of proper regulation can come later. First time I have agreed with President Bush in eight years. Given the current economic mess, I think Bush is now the undisputed worst U.S. President in history. Ulysses Grant and a few others were in the running, but this latest debacle clearly puts Bush at the top of the list.