Treasury Secretary Geithner presented his new financial rescue plan on Tuesday, which impressed no one. The plan was confused, unfinished and intellectually contrafactual. In this posting, I will expand on my solution to the banking crisis, which involves a system of what are called “covered bonds” along with the creation of new banks.
After the plan was introduced and poorly received, Geithner defended himself by saying that there was “no historical precedent” to this crisis. Nothing could be further from the truth. Simply giving the banks taxpayer money to spend as they please, a.k.a. the “Bush/Paulson/Geithner solution” is what lacks a historical precedent, simply because it’s so infinitely stupid.
Geithner, along with what seems to be the entire American political and economic establishment seems to be completely in the dark in terms of economic research and economic history. I’m saying that there are many precedents to this crisis, and that there are many precedents on how to solve it.
There are 2 main, related problems that must be solved as soon as possible:
1. the banks are insolvent, and
2. the mortgage securitization market is dead
The banks are insolvent because they own worthless assets that nobody wants to buy. Geithner’s plan involves trying to convince private investors to buy these worthless assets, but the reason they’re worthless is that these same investors didn’t want to have anything to do with them in the first place.
The assets are like rotten apples in a fruit stand, and however much such apples are promoted, I think it’s pretty safe to say that few people will ever by them.
The mortgage securitization market is the market where banks sell off mortgages to private investors in the form of mortgage-backed securities, which is the same thing as the assets I mentioned above.
Nobody wants to participate in the mortgage securitization market anymore because housing prices have imploded, so the market is dead with little chance of being revived any time soon. In other words, if housing prices don’t go up, the mortgage securitization market will continue to be dead.
Now to my suggestions of solutions to these problems. In a catastrophic banking crisis, the solution has in the past been either nationalization or the creation of new banks.
Nationalization is the more common solution, but if a bank’s debts are five times its market value, what is the point of rescuing it by nationalizing it? Spending five dollars to make one dollar doesn’t make a lot of sense… In light of the banks’ situation, nationalization would be the least severe destiny awaiting them. It would, however, be extremely expensive for the taxpayer.
Because the U.S. Government is ideologically opposed to nationalization, my bet would be that Bank of America and Citigroup (along with many smaller banks) will have the same fate as Lehman Brothers.
Instead, I believe that the creation of new banks is the appropriate solution. This was done in the 1800s in the United States during a catastrophic banking crisis. Under this plan, the government would simply set up a new bank, inject it with money for lending and write strict rules on how it can operate. That would instantly create a stable, prudent and dependable bank.
The government would then sell off 49% of the shares to private investors and keep running the bank according to prudent standards until the crisis is over. At that point, the bank can be sold off completely.
Instituting a system of covered bonds would be a good solution for the mortgage market. This is a very stable system that has been used for hundreds of years in Europe. Basically, all the banks would get together and put all their mortgages in a giant pool.
Under this system, the mortgages remain on the banks’ balance sheets. It is a collaborative effort, as well as being a system where each bank has to take responsibility for its own lending practices. This system encourages prudent lending standards by all participants, stabilizes the housing market in general, and improves the trust in the financial system.
We need to think in new ways about the crisis, which Geithner acknowledged in his speech, but he is so ignorant that he does not know of any solutions like the ones I just described.
Moreover, I advise that the winner-takes-all voting system should be destroyed.