[stoney]

New House Alternative Bailout Proposal
http://www.thenation.com/blogs/jstreet/366574/house_progressives_propose_bailout_alternative

A number of house progressives who voted against yesterday's bailout bill, including Pete DeFazio, Donna Edwards and Marcy Kaptur, have just held a press conference unveiling their own proposal. Text below. Commentary to follow:

DRAFT

No BAILOUTS Act

Bringing Accounting, Increased Liquidity, Oversight and Upholding Taxpayer Security

1. Require the Securities and Exchange Commission (SEC) to require an economic value standard to measure the capital of financial institutions.

This bill will require SEC to implement a rule to suspend the application of fair value accounting standards to financial institutions, which marks assets to the market value, no matter the conditions of the market. When no meaningful market exists, as is the current market for mortgage backed securities, this standard requires institutions to value assets at fire-sale prices. This creates a capital shortfall on paper. Using the economic value standard as bank examines have traditionally done will immediately correct the capital shortfalls experienced by many institutions.

2. Require the Securities and Exchange Commission to restricting naked short sells permanently
This bill will require SEC to implement a rule that blocks naked selling, selling a stock short without first borrowing the shares or ensuring the shares can be borrowed. Such practices many times harm the companies represented in the sales and hurt their efforts to raise capital. There is no economic value produced by naked short sales, but significant negative effects.
3. Require the Securities and Exchange Commission to restore the up-tick rule permanently.
This bill will require SEC to implement a rule that blocks short sales without an up-tick in the market. On September 19, 2008, the SEC approved a temporary pause of short selling in financial companies "to protect the integrity and quality of the securities market and strengthen investor confidence." This rule prevents market crashes brought on by irrational short term market behavior.

4. "Net Worth Certificate Program"

This bill will require FDIC to implement a net worth certificate program. The FDIC would determine banks with short-term capital needs and the ability to financially recover in the foreseeable future. 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.

Participating banks must be subject to strict oversight by the FDIC including oversight of top executive compensation and if necessary the removal of poor management. Financial records and business plans should be subject to scrutiny while participating in the program.
In 1982, Congress approved a program, known as the Net Worth Certificate Program, that allowed banks and thrifts to apply for immediate capital assistance. From 1982 to 1993, banks with total assets of $40 billion participated in the program. The majority of these banks, 75%, required no further assistance beyond the certificate program.
5. Increase the FDIC Insurance limit from $100,000 to $250,000.

The bill will require the FDIC raise its limit to provide depositors confidence that their money is safe and help eliminate runs on banks which are destabilizing to the industry.

 

[Toshi]

part 1 was already sneakily implemented by the SEC today, if i read the nytimes correctly.

http://www.nytimes.com/2008/10/01/business/01audit.html?_r=1&ref=business&oref=slogin

 

[ohio]

This seems like proper action in the long term, but are the net worth certificates enough to float banks in the short term?

Also, how does it handle outstanding naked shorts?

Finally, any points you disagree with or anything additional you would include?

 

[Westy]

6: Ban pants in banks. Releasing the burden of pants on the banking industry will free up huge amounts of capital.

 

[dante]

Wow, I'm no economist, but there's not a whole lot I agree with there.

1) This has to be the DUMBEST idea I've heard. When I go to get a loan and have to list my assets (house, car, whatever), I have to list what they're worth NOW. I can't say "I bought my house in 2004 and paid $700,000, so that's what it's worth now", I'd get laughed out of the bank. This whole mess is because no one is being clear on what crap they're holding, and this is going to allow them to mark it at.... ?

2) Thought this was already in place...

3) Ok, this will help targeted attacks on certain institutions, but is it *really* going to do that much long-term?

4) Hmmm? Still digesting this one.

5) Sure.

something tells me *nothing* is going to get done anytime soon...

 

[stoney]

Wow, I'm no economist, but there's not a whole lot I agree with there.

1) This has to be the DUMBEST idea I've heard. When I go to get a loan and have to list my assets (house, car, whatever), I have to list what they're worth NOW. I can't say "I bought my house in 2004 and paid $700,000, so that's what it's worth now", I'd get laughed out of the bank. This whole mess is because no one is being clear on what crap they're holding, and this is going to allow them to mark it at.... ?

MBS are just bonds. They have an inherent cashflow value when held to maturity. This is actually a VERY good idea.

2) Thought this was already in place...

This is "in place", but not enforced. It also is only protecting financials, as that is the only place people are looking. If this was in place, the market, ex-financials would be doing much better.

3) Ok, this will help targeted attacks on certain institutions, but is it *really* going to do that much long-term?

Yes!!!!! This is VERY important. Short-selling in a bear raid is a self-fulfilling prophecy. The uptick rule prevents shorts from piling onto a downward slide. It slows downward swings, which can bankrupt ANY company. This was instituted after the 1929 crash.

4) Hmmm? Still digesting this one.

Instant confidence in banks. Not a real brain burner there.

5) Sure.

something tells me *nothing* is going to get done anytime soon...

What I would like to see added are provisions to close all outstanding naked short positions within 6 months, and those who affected the trades are liable for their delivery, whether they are still managing funds or not. My retirement funds should not be funding your 24 room estate in Greenwich. That would lead to a short-term market climb AND clean out the slop. Sure a LOT of HF's would go under, but that's what happens when you partake in illegtal activites.
I would also like to see regulation as banks have, imposed on HF's. Limitations on speculation in commodities (50% of capital vs current 5%). Enforcement of the 'spirit of the law' when it comes to margin requirements, NSS, and financial products in general. Just because you found a loophole doens't mean it should be exploited. Penalties of a min 2x the potential profits for illegal activites. Mandatory jail time.
No more loan securitization. Loans need to stay on the books of banks. This will limit lending from local banks, but it will also keep people honest to what is available to be loaned out. Removal of "fair/low income housing" requirements. Much of this was caused by govt intervention requiring quotas on loans to underqualified borrowers.

For the larger part, I agree as this is a start but there is much more to do.

 

[ohio]

What I would like to see added are provisions to close all outstanding naked short positions within 6 months... That would lead to a short-term market climb AND clean out the slop.

It would also cause a plummit in value of stocks that are heavily long by HFs as they try to cover their shorts. The net may not be an short-term climb, but 6 months or a year seems a reasonable amount of time to smooth it out and let those smart folks solve their problems.

Can you point to a link that explains Economic Value Standard? I'm not really understanding how it establishes a price...

 

[stoney]

It's a basic cashflow model. A bond is worth par of let's say 1,000,000. You currently are getting a 5% coupon. At the end of the bond's life, you will have received a 5% cpn monthly for 30 years, AND your capital back.
The current problem is that without a market for these securities, because they tie up so much cash, people are not willing to pay a fair value (read par).
By holding to maturity, the bond is still valuable, even with defaults. It's just that in the current short-term (read <1-2 years of 30yr maturity) it has minimal value.

 

[dante]

It's a basic cashflow model. A bond is worth par of let's say 1,000,000. You currently are getting a 5% coupon. At the end of the bond's life, you will have received a 5% cpn monthly for 30 years, AND your capital back.
The current problem is that without a market for these securities, because they tie up so much cash, people are not willing to pay a fair value (read par).
By holding to maturity, the bond is still valuable, even with defaults. It's just that in the current short-term (read <1-2 years of 30yr maturity) it has minimal value.

but what is the actual value, and can we even put a price on what it "should" be worth? yes, *if* held to maturity, and *if* the underlying mortgages don't fail, then they'd be worth their face value. those are two MASSIVE ifs, and to be perfectly honest, I don't trust the banks when they say "it's ok, *these* mortgages are good ones and the people who have them will continue to pay. this all comes down to transparency, and banks owning up to what they're holding. if a bank is transparent, and openly admits what is backing that MBS, there should be a reasonable expectation that someone will buy it for what it's worth. if a bank has an MBS with a *real* default rate of 10%, you can't tell me someone wouldn't jump at the chance to buy that at $.10 or $.20 on the dollar. the problem is the bank says "trust us, it's worth $.90 on the dollar", nobody (including me) has any faith that that's worth $.90 on the dollar. now, instead of that bank having to mark that security at what everyone *else* thinks its worth (free market), they're able to mark it at face value (correct?) when in fact it's worth a LOT less.

I'll say it again, it all comes down to openness and transparency. If no one knows what some toxic security is actually worth, of course they're going to demand a lower price when they buy it, and banks should have to price it accordingly. Yes, it hurts banks balance sheets if they're going to hold it to maturity and get that money back, but I can't think of a way to actually price these things that doesn't allow for blatant, BLATANT abuse and misrepresentation...

 

[stoney]

You need a Bloomberg. You can actually see the underlying on any securitized mortgage products. I look at it regularly. It's really not as bad as people are assuming. Even if we factor in a standard 30% default rate, we can pretty acurately calc value.

 

[ohio]

It's a basic cashflow model. A bond is worth par of let's say 1,000,000. You currently are getting a 5% coupon. At the end of the bond's life, you will have received a 5% cpn monthly for 30 years, AND your capital back.
The current problem is that without a market for these securities, because they tie up so much cash, people are not willing to pay a fair value (read par).
By holding to maturity, the bond is still valuable, even with defaults. It's just that in the current short-term (read <1-2 years of 30yr maturity) it has minimal value.

Is it wrong to interpret that as saying that long term holdings are being discounted for the opportunity cost of tying up cashflow? If so, I feel like that's a real cost. Conceptually, what Dante is saying makes more sense to me... I trust the market to accurately price these toxic assets, as long as they can fully trace them.

Edit: I should add that I'm not working with much knowledge here beyond basic micro/macro principles. I have one term of b-school corporate finance and a bunch of friends in banks and HFs. This is all a lesson for me, so thanks for contributing.

 

[dante]

Is it wrong to interpret that as saying that long term holdings are being discounted for the opportunity cost of tying up cashflow? If so, I feel like that's a real cost. Conceptually, what Dante is saying makes more sense to me... I trust the market to accurately price these toxic assets, as long as they can fully trace them.

Edit: I should add that I'm not working with much knowledge here beyond basic micro/macro principles. I have one term of b-school corporate finance and a bunch of friends in banks and HFs. This is all a lesson for me, so thanks for contributing.

so, it's not quite that simple. yes, these things need to get discounted since it's payable over time, and there is a cost associated with that (just like if you take the lump sum of a lottery ticket instead of the payout over time, you get less money). the problem is is that there is another factor in this, which is rising foreclosures and non-payments / restructuring. NOBODY wants to own these toxic securities. banks want to unload them (at a high enough price) to free up capital so that they can lend to more people and make more money. nobody wants to buy them since its a huge risk, though, and so theoretically these are worth much less than realistically should be. so banks are content to hold them and hope that they end up losing less than they would be able to get on the free market at the current time. the mark-to-market problem comes up when banks have to disclose their assets when they're looking to borrow money. if they have to discount their assets to $.20 on the dollar (current price, lets say), they have trouble raising capital, can't lend money, and can't make money.

so neither the full discount is appropriate, nor is the full face-value. the question becomes where in between those numbers should they be priced at?