By Shah Gilani
Contributing Editor
While it's clear from the current credit crisis that our financial system is at a critical juncture, it's just as clear that there's no agreement over how we should fix the problems we face. The reality is that neither the plan put forth by U.S. Treasury Secretary Henry M. "Hank" Paulson Jr. - nor any of the addendums offered up by Congress or the lobbyists - will resolve this crisis.
The key culprits are the structured financial products that reside on the balance sheets of banks, dead investment banks, insurance companies, hedge funds and all manner of other duped and unsuspecting investor entities worldwide, as well as the proliferation of the unregulated $62 trillion credit default swaps (CDS) market.
Because all these securities, and in the case of credit default swaps, bilateral contracts, are impossible to value and impossible to guarantee, no one trusts them. As a result, everyone is afraid of these securities and contracts.
Banks are currently not lending to one another because they are afraid that the next round of write-downs and losses may imperil some of their trading partner banks to which they formerly lent billions and billions of dollars to every night. If the answer were really as simple as adding liquidity, the Federal Reserve would have lowered the Fed Funds target. But that won't work. It's a vicious cycle that's eroding banks' faith in one another, and worse, our faith in our banks.
Unfortunately, I don't see the Treasury Department's much-needed rescue plan being effective without actually addressing the pricing of - indeed, the very existence of - credit default swaps and collateralized debt obligations. As well intentioned as it is, the Treasury plan will create more problems than it solves and will eventually saddle taxpayers with so much debt that it will tank the dollar. It could even put the U.S. government's AAA investment rating at risk. That would be calamitous.
I have a modest proposal that I'm calling the Money Morning Plan, because it potentially heralds a new dawn in the credit crisis, addressing the problems from the bottom up, and not from the top down. The bottom line is that my plan will end the credit crisis quickly with potentially little or no cost to taxpayers. And those are the two most important benefits of all. I present my plan as an open letter for public debate.
- Contributing Editor and credit expert Shah Gilani outlines a bailout plan that could ease the banking crisis at a minimum cost for U.S. taxpayers. It's a complicated issue, no doubt. Please take a look at the "Money Morning Plan" below. If you believe some (or all) of these points make sense, we urge to pass them along to your state's representatives, as the Congressional dialogue is now in full force and time is of the essence. Just
click here to get a listing of your state's representatives.
An open letter to U.S. Treasury Secretary Henry M. Paulson, Federal Reserve Chairman Ben S. Bernanke, Distinguished Members of Congress, and the American Taxpayers:
Dear Ladies and Gentlemen,
How we respond to the upheavals in our financial markets will define the American character at home and in the eyes of the world. With our cherished history of free markets and entrepreneurial spirit, we should guide ourselves as we always have, trusting our collective financial interests to our Constitution, which created a government by the people, for the people. Trying times are not a mandate to foreswear our personal, financial nor collective economic interests to any lobby or government other than one that protects all our rights, especially the right to not be taxed unfairly or unjustly.
The proposed Treasury Department rescue plan before Congress has not been presented without due consideration. There are, however, other proposals that merit our collective contemplation. As a taxpayer and investor, I am proposing an alternative plan for open discussion. We need to act quickly, but we need to act responsibly.
Respectfully;
Shah Gilani
Contributing Editor
Money Morning
www.moneymorning.com
The Money Morning Plan
- Establish an empowered, not overpowering, regulatory apparatus to rein-in structured products and establish protocols for the creation and tradability of financial products based on real-world economics and hedging considerations. Products must be transparent, easily valued and rated on a universal ratings model.
- Establish regulated standards to support the universal ratings model and allow free-market competition for providing rating services based on a "pooled-income revenue model," whereby all issuers that either want to be rated, or that are required to be rated, pool funds on a per-volume, pro-rata basis and ratings providers are paid blindly for rating services.
- Immediately stop the issuance of credit default swaps without mandatory reserve requirements and safeguards typical of what insurance regulations already require of legitimate insurers. Net out all existing credit default swaps to tighten counterparty risk and unwind positions that cannot be secured by issuers meeting adequate reserve requirements. Eliminate virtual insurers.
- Only allow issuance of credit default swaps up to the actual outstanding dollar value of corporate debts and loans outstanding. This will ensure legitimate hedging and eliminate undue pressure on outstanding debt issuers.
- Create a class of "eligible (mortgage-related only) securities" that constitutes problem securities. Leave all eligible securities on the books of existing holders.
- Have eligible security holders identify to the U.S. Federal Reserve every eligible security by CUSIP and face amount. Only the Fed will have knowledge of institutional and investor positions. This will allow the Fed to correctly assess the risks at hedge funds and others with "significant operations" without exposing their positions to competitors.
- Create a new accounting domain in-between "held-to-maturity" and "available-to-trade" where only eligible securities, as of a predetermined valuation date, can be accounted for at their value on the predetermined valuation date and not further subject to fair-value (marked-to-market) accounting, while held.
- Mandate all holders of eligible securities mark-to-market inventories on a predetermined valuation date, preferably as soon as the Fed expects all eligible securities to be registered with it. Those who have recently marked their securities have already taken their write-downs; those who haven't will have to. If the totality of the resolution represents a bona-fide solution, investors and speculators will bid up eligible securities to own them before the predetermined valuation date, because of newly ascribed accounting advantages of holding eligible securities.
- Reduce the haircut on the reserve requirements for all eligible securities covered by this plan. Since valuations have already fallen precipitously, reducing reserve requirements on eligible securities would additionally enhance their value as balance-sheet assets with upside potential.
- Have both the Fed and Treasury determine a liquidation or receivership outcome for holders suffering from insolvency as a result of accurately marking-to-market their holdings on the predetermined valuation date in the event bankruptcy would result in further systemic problems. This scenario would be cheaper and quicker to manage than what's in store for us under the present Treasury draft, and it allows the two to assess the potential fallout of insolvent entities prior to their exposing the financial system to resulting disruptions. Hedge funds would not be saved.
- The Fed must establish and manage a conservative, transparent pricing model for eligible securities based on actual underlying cash-flow measures, projections and model specific criteria. Absolutely no trading would be allowed over-the-counter or otherwise on any of the eligible-securities specific pricing models or indexes.
- The Fed, with a firm handle on all eligible securities and a transparent-pricing methodology, would have to take in any and all eligible securities as collateral against Fed borrowings from the discount window or through its dealer facility.
- "Servicers" managing underlying mortgages on behalf of trust entities, under which securitized pools are created, must be empowered to alter and modify terms and conditions of underlying mortgages in conjunction with originating banks or lending institutions.
- To incentivize banks and lending institutions to modify existing mortgages and to incentivize homeowners to stay in homes with upside-down mortgage-to-appraised values, eliminate all capital gains on appreciation of newly appraised homes when they are sold by either homeowners, banks or lending institutions.
- Create tax-advantaged scenarios for banks and homeowners partnering in the reduction of delinquent obligations whenever loans can be brought to a performing status.
[Editor's Note: Contributing Editor R. Shah Gilani has toiled in the trading pits in Chicago, run trading desks in New York, operated as a broker/dealer and managed everything from hedge funds to currency accounts. In his just-completed three-part investigation of the U.S. credit crisis, Gilani was able to provide insider insights that no other financial writer or commentator could hope to match. He drew upon the experiences and network of contacts that he developed through the years to provide Money Morning readers with the "real story" of the credit crisis. It's a perspective on the near-financial meltdown that you'll find nowhere else. If you missed Gilani's investigative series, Part I appeared Friday, Part II ran Monday and Part III was published yesterday (Wednesday).]
News and Related Story Links:
- Money Morning Special Investigation of the Credit Crisis (Part I):
The Real Reason for the Global Financial Crisis…the Story No One's Talking About. - Money Morning Special Investigation of the Credit Crisis (Part II):
The Credit Crisis and the Real Story Behind the Collapse of AIG. - Money Morning Special Investigation of the U.S. Credit Crisis (Part III):
How Complex Securities, Wall Street Protectionism and Myopic Regulation Caused a Near-Meltdown of the U.S. Banking System. - Wikipedia:
Henry M. "Hank" Paulson Jr. - Wikipedia:
Credit Default Swaps. - Investopedia:
Credit Derivatives (Bilateral Contracts). - Wikipedia:
Structured Financial Product. - Wikipedia:
Haircut. - Money Morning Market Commentary:
Dear Ben: To Save the U.S. Economy, Here Are the Moves You Need to Make Now. - Wikipedia:
Securitization. - Wikipedia:
Asset-backed security. - Money Morning Market Analysis Series:
Inside Wall Street: Why Hocus-Pocus Accounting Will Perpetuate the Capital Markets Credit Crisis (Part I). - Money Morning Market Analysis Series:
Inside Wall Street: The Hocus-Pocus Accounting Tricks That Will Perpetuate the Capital Markets Credit Crisis. - Wikipedia:
Subprime Lending. - ISO.com:
Virtual Insurers Will Thrive in a Wired World, Says Futurist at ISO's AISG INSTECH98 Conference. - Wikipedia:
Structured Finance. - Wikipedia:
Collateralized Debt Obligations. - Money Morning Market Analysis:
Why Mark-to-Market is Bad News for Shareholders. - Wikipedia:
Tranches. - Wikipedia:
Counterparty. - Money Morning News Analysis:
The Government's Financial Crisis Fix-it Plan Sends Stocks Soaring, Though Some Argue There's no Quick Fix for this Disaster. - Wikipedia:
Hi-Yield Debt (Junk Bond). - Wikipedia:
Mark to Market. - Chest of Books:
Eligible Security. - Wikipedia:
Mortgage-Backed Securities - Money Morning Market Commentary:
Sen. Dirksen: Allow Me to Introduce You to Standard & Poor's. - Money Morning Special Investment Report:
Foreign Bondholders - and not the U.S. Mortgage Market - Drove the Fannie/Freddie Bailout.
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.
[…] should have taken the lead in this firefight to offer up an alternative plan. It just so happens there was a really good one out there. The problem is that it wouldn't serve the "Masters of the Universe," the […]
I have tried reading this Plan several times and get bogged down. To complicated! I say go after the individuals who profited from doing all these "deals" like an old fashion street hold up and mugging – just call it a tax, but take their entire net worth and pay down the debt. Then scrap the "greenbacks" and start printing "bluebacks" that are backed by gold and give everyone, including foreigners, so many cents on the dollar and get a fresh start. We need to sweep all of Washington and Wall Street clean and give the country back to middle class America (Main Street) and watch the country bounce back.
[…] Note: Money Morning Contributing Editor and credit expert Shah Gilani has outlined an alternative bailout plan that is designed to ease the banking crisis at a minimum cost for U.S. taxpayers. It’s a […]
[…] hedge fund manager who is now a Money Morning contributing editor, and who last week crafted an alternate bailout plan that he presented to readers of this global investment news service. Then, when markets overseas saw what was actually forthcoming, the markets in Asia and Europe sold […]
This plan would also fail.
Here is the best solution:
1. Let the markets fall and stabilize without further intervention.
2. Congress to legislate a sound money supply by writing
the appropriate legislation and Constitutional
amendments to:
a. Abolish the Federal Reserve
b. Establish a 100% gold backed money supply.
c. Follow through with a campaign of abolishing market
intervention.
d. Abolish reserve banking.
With this plan, stabilization will occur within five years.
[…] former hedge fund manager who is now a Money Morning contributing editor, and who last week crafted an alternate bailout plan that he presented to readers of this global investment news service. Then, when markets overseas saw what was actually forthcoming, the markets in Asia and Europe sold […]
I appreciate what seems to be a neutral "expert' providing a lot of information (not to mention the plan) that I have now read and heard others affirm in (in very short terms).
I first heard one of the Senators from Vermont speak of CDS's and propose a tax on the top 1 percent (as I recall) to solve the problem, but that would still be a bailout scheme, and not really fair across the board – Jesus, I bet the majority of those people had nothing to do with it (stacking the deck with no table underneath).It seems (albeit with my limited understand) that your plan makes much more sense and addresses what I've heard other economic advisors describe as a "credit contraction". So I feel confident that this is a politically neutral real solution, I also heard a Republican Congressman (I believe) suggest cutting capital gains to "inject capital into the " to wit I thought "how altruistic of you, cough, cough".
Anyway, thanks…….I bet I know more about finance than the vast majority of "average citizens" and even a hell of lot of our "elected officials"…..it's scary now that I see how little most know about any of this.
Thanks,
Rob Putens
[…] que tratar de salvar a Wall Street directamente). Pd. ya he encontrado el famoso Money Morning http://www.moneymorning.com/2008/09/25/credit-crisis-5/ Los primeros 12 puntos son de regulación financiera y de fijación del valor real de los activos […]
[…] Money Morning Special Report: How to Fix the Credit Crisis (Part IV): Dear Hank: Here’s How to End the Credit Crisis at No Cost to Taxpayers. […]
1. Abolish the FED.
2.Direct the Treasury Department to issue U.S. Notes (exactly like Lincoln’s Greenbacks) to pay off the National debt.
3. Increases the reserve ratio private banks are required to maintain from 10% to 100%, thereby terminating their ability to create money, while simultaneously absorbing the funds created to retire the national debt.
4. America returns to an age of prosperity. Individual wealth rises over time. Instead of working your entire life just to have a central bank devalue your illusionary (paper) wealth, you have real wealth that is not subject to inflationary measures.
[…] Money Morning readers with the "real story" of the credit crisis – and to propose an alternate plan of action. It's a perspective on the near-financial meltdown that more than 140,000 readers have already read […]
Notwithstanding the soundness of Mr. Gilani’s Money Morning Plan, even if immediately implemented in its entirety at home, money’s firmly rooted complexities are far too universally, or at least internationally, woven together.
So, because the global financial “grid of trust” has been fatally breached already, any effective remedy to this financial emergency would require immediate unanimous international implementation of the Money Morning Plan.
This will not occur.
As I am sure Mr. Gilani is quite sincere and optimistic about his study, I am a normal citizen who finds the details to be a little too complicated to understand.
I would like to submit a free, 3 1/2 video to explain the entire history of the world banking system, including the last half hour solution to eliminating the ENTIRE National Debt, without civil war, recession or depression. I know you have to take a break thru the whole video to understand everything, but the final solution is incredible. The free video, "The Money Masters", is on the following website, ……click below.
http://video.google.com/videoplay?docid=-515319560256183936
The Money Masters main website has drafted a complete program which can be introduced and submitted to Congress in it's entire form for your review called the "Monetary Reform Act". Their website is listed below.
http://www.themoneymasters.com/
Thank you
The only problem will be this:
The biggest financial firms will muscle their way to the front of the line to gain maximum return. To believe the orderly accounting of derivatives will unfold in full transparency is a pipedream.
The best "securities" will be dealt with first. Considering there are $900 trillion or so of these out there, based on maybe $30 Trillion of originally securitized debt, means the losses are beyond comprehension. There will be no way the strongest will be held in check, and they will lie to get first dollar.
Think about it, more than $800 Trillion in bets on the performance of $30 Trillion (auto loans, student loans and credit card debt have been securitized in a mad rush to swap with the Fed facility windows). If the losses are only 10%, and that is outrageously optimistic, that means at least $80 Trillion in losses.
Corporations will go to any lengths to get someone else to eat that.
Even lie to congress.
[…] Money Morning readers with the "real story" of the credit crisis – and to propose an alternate plan of action. It's a perspective on the near-financial meltdown that more than 140,000 readers have already read […]
This plan is obviously more thought out than the Paulson plan. It shows a level of understanding of the problem & institutions involved that our politicians and many people simply do not have. Politicians would want to be able to explain this plan to Main Street in two sentences or less (five words total, if possible). Even Karl Rove couldn't do that.
How could we get these ideas to our representatives? I think it's important for alternatives, such as this Money Morning Plan to be presented to our political leaders. Is there an easy way that Money Morning has (or can) developed to allow readers to simply cut, paste & forward an e-mail to whomever we want? I think that would be a huge service you could provide.
Finally, about the world joining us in our solution to this global problem. If the U.S. put out a well thought out plan instead of a rushed emergency response, I feel that many countries would adopt at least parts of this plan to address their countries' issues. There are some intelligent, common sense ideas included in this plan which others could build their own "bail outs" around.
I agree with everyone so far, but realize that America's assets are on sale for 60 cents on the dollar & when you take the poor exchange rate into consideration, well you can figure the rest out. Our nation's only way out of this mess is to defend & support the dollar. It will show that the country is smart about it's currency & fiscally responsible to international investors as well! After all, no country has ever recovered by devaluating their currency, ever! It is imperative that investment banks hold these securities to maturity & CDO's are also in need of proper regulation, like any other instrument of debt. I have never heard of a security like this being created & controlling trillions of dollars, being unregulated by S.E.C. & allowed to have no way of being accounted for…! The government's only responsibility is to protect the depositors of any U.S. banking institution & not the banks assets or the debt market. The government can do a Dutch Auction for assets of any institution, if they fail. The threat of this will force banks to work their problems or positions out together, rather than facing the gauntlet. Last, the government will act only as a backstop for assets that have no bid. These assets will go into a trust & be auctioned later, after the market has absorbed the creme of the crop. Like an R.T.C. deal for securities.
Excellent strategy for evaluating the credit instrument with oversight otherwise too much power in one mans hands
Also GAAP accounting princilpes must be utilized & adhered to and new regs mandated to measure compliance
[…] Editor R. Shah Gilani – a former hedge-fund manager and currency trader who this week proposed an alternate plan that wouldn’t burden taxpayers with billions in federal debt – said it will be tough to evaluate TARP until all the details are […]
[…] Money Morning readers with the "real story" of the credit crisis – and to propose an alternate plan of action. It's a perspective on the near-financial meltdown that more than 140,000 readers have already read […]
Regrding mortgages:
Regarding mortgages, it may be best not to let the banks off the hook, but to establish private, for profit servicing entities having direct access to a Federal agency such as SBA or Commerce Dept for purposes of reporting, control and operational standard. Said establishments would work with troubled lenders to re-categorize troubled mortgages and REO's into another category stisfactory to State regulatory ratios. Subsequently, the newly formed businesses would re-form the existing mortgage to enable mortgagors to retain ownership of their homes, provide income to the banks as derived from "leased to own properties", and recapture of delayed income on re-financing or re-sale at a future time when the economy recovers. I would willingly work with any party who wishes to carry the cncept further.
[…] Editor R. Shah Gilani – a former hedge-fund manager and currency trader who this week proposed an alternate plan that wouldn’t burden taxpayers with billions in federal debt – said it will be tough to evaluate TARP until all the details are […]
[…] to cost taxpayers little or nothing – we’ve created ways to send Gilani’s credit crisis plan along to lawmakers and the state governors from all 50 states. We urge you to check this story […]
[…] The Money Morning Plan […]
[…] who recently penned a five-part investigative series on the U.S. credit crisis – including an alternate bailout plan that he says would’ve cost taxpayers very […]
[…] whole world’s watching,” said Gilani, who last week put forth his own plan the resolve the current fiscal predicament. “The proposed plan will be voted on, not just by Congress, but by a quorum of the […]
[…] former hedge fund manager who is now a Money Morning contributing editor, and who last week crafted an alternate bailout plan that he presented to readers of this global investment news service. Then, when markets overseas saw what was actually forthcoming, the markets in Asia and Europe sold […]
The “best” of plans will not work, now.
There has been too much burning, so the “atmosphere” of “thick smoke” is painfully “blinding” and “suffocating”. Authority figures can’t “see” what to do. So there is “unprecedented” confusion.
Plans, per se, imply “order”. And “order” requires consensus and “time” which has all but run out.
Will “order” finally “emerge” from “chaos”?
As a former mortgage-backed securities portfolio manager, I enthusiastically endorse this plan.
It is a 'work out' not a 'bail out' and addresses the root causes not just the end results.
[…] Note: Money Morning Contributing Editor and credit expert R. Shah Gilani has outlined an alternative bailout plan that is designed to ease the banking crisis at a minimum cost for U.S. taxpayers. It's a […]
"Experts" are making this too complicated. Any time you have a commissioned-paid human, its going to lie and cheat to make a buck, even if that means changing the rules, so their activities are no longer deemed lying and cheating. Take that out of the system and you have more honest yet less motivated humans. The face of the brokerage world would change overnight and the subprime problems solved, on future loans, the moment you make it so that a broker is salaried with a fat paycheck and is educated on, and told to train homeowners, on how to have a budget and a positive cash flow. It might also help to actually follow regulations and punish the clever-self serving. But that would make too much sense.
Also, I dont support creating another government unit called the Department of Redundancy Department, to regulate the regulators. FHA screwed up and they know it, giving out hand slaps to brokers with ungodly high amount of customers in default. Then making it easy for the same loan pushers to sell FHA loans in no time at all. It even worse with non-FHA loans.
Derivatives are simply a crime waiting to happen. First the S&L, now this. The USA is officially now an economy predicated on educated gambling, but derivatives + a commissioned broker and guess what you got? A crime and some poor uneducated person 1,000 miles away with ruined dreams and their children without the same opportunities as others.
The "experts" suck when the problems are obvious and nothing is done. We clearly knew, CLEARLY KNEW, in 2003 that if we followed the current path we would have an economic meltdown. No one did a thing, because we couldnt think of another way to keep the economy alive. So we left the credit tap on encouraging malinvestments. But on a very human level I understand. Try being the FOMC and telling a bunch of laid off people why you cooled off the economy just to innoculate the world from irrational exuberance. The common people never understand and the FOMC would get hugh pressure from the politicians who would stand to lose votes over the issue.
Let me make myself clear hind sight on this is not 20/20. We knew what we were getting into and now I have to laugh as brain dead humans blame Bush, ignoring the actions of the FOMC, that in the most simple terms, stole prosperity from the future to keep the public happy. The is a reason why Greenspan has to defend his lose credit policy every time he gets put in a room full of economists. People should start asking why that is a common theme at his speeches.
Its about time we start teaching in highschool that the US has a newer (made in 1913) governmental unit that is not offset by other 3 units (House, Executive branch, Supreme Court), has no audits, no over site, who is heavily influenced by the president who appointed them: the US Central Banking System. The CPI is a joke; they know it. The Unemployment rate is a joke; they know it. And the fact that they hide M3 is also a joke. The Central bank is a necessary evil, I will at least agree on that.
The time has come!
“Necessary evils” can no longer be “necessary”.
Whatever the problem is, there is this obstacle in the path of putting forth a solution: How can this plan, or any other alternative, be presented to the political leaders? and get a fair evaluation. I happened to have heard about a FairTax act. It has been sponsored by a congressman since 2005 and it has a radio show host pushing it. Have you heard a word from anybody there in DC ?
[…] Dear Hank: Here's How to End the Credit Crisis at No Cost to Taxpayers (tags: financial crisis credit 2008 us) […]
[…] Money Morning readers with the "real story" of the credit crisis – and to propose an alternate plan of action. It's a perspective on the near-financial meltdown that more than 140,000 readers have read in […]
Dan you answer this question? Is the money from the taxpayers going to satisfy the CDS's as their contracts get triggered so in effect the texpayers money is being used to pay off the bets and not really add anything to the economy? or are they a last hail mary pass to stave off the triggering of these contracts, since once they are triggered there is not enough money is the whole world to pay them off? thanks
[…] former hedge fund manager who is now a Money Morning contributing editor, and who last week crafted an alternate bailout plan that he presented to readers of this global investment news service. Then, when markets overseas saw what was actually forthcoming, the markets in Asia and Europe sold […]
[…] years to provide Money Morning readers with the "real story" of the credit crisis – and to propose an alternate plan of action. It’s a perspective on the near-financial meltdown that more than a quarter-million readers have […]
[…] Money Morning readers with the "real story" of the credit crisis – and to propose an alternate plan of action. It's a perspective on the near-financial meltdown that more than a quarter-million readers have […]
[…] provide Money Morning readers with the "real story" of the credit crisis – and to propose an alternate plan of action. It’s a perspective on the near-financial meltdown that more than a quarter-million readers […]
[…] sent an open letter to U.S. Treasury Secretary Henry M. “Hank” Paulson Jr., in which Gilani detailed a bailout plan that would have cost taxpayers nothing. Readers forwarded that Money Morning plan to their congressional representatives, asking that they […]
Dear Mr. Gilani:
I admire your efforts to articulate “The Money Morning Plan” as a proposal to solve our global credit crisis that we are facing currently. Sadly, your plan is not the answer to the present credit crisis. It may, however, preclude the future credit crisis… but that is in the future. And the future may be tens years down the road and a lot different [financially] than what it looks like to-day. So, let me address each and every item of your comments, statements, ideas, facts and proposals. Here we go…
STATEMENT:
“Dear Hank: Here’s How to End the Credit crisis at No Cost to Tax Payers”.
OBSERVATION & COMMENTS:
I totally disagree with you on the above statement. It has the sound bites and is certainly catchy, but it is not true. Some body is going to pay for this financial mess. And no matter whom it is, in all probability that entity is going to be a “Tax Payer”. As the saying goes: “there are no free lunches”! Somebody will pay… sooner or later. It may be the Investment Banks, Commercial Banks, Insurance Companies, Hedge Funds, Pension Funds, sovereign governments or wealthy investors… here in the US or abroad. Thanks to the American innovation and aggressive marketing, everyone, from individual investors to governments all over the world, fed on these toxic financial derivatives without fully understanding the risk to their capital. It may have different name and may come in different shapes or forms, but the erosion of asset value and the capital base is the core issue at hand.
The cesspool of “structured financial products” and “credit default swaps” were created through the process of financial engineering where the economic function of these derivatives is to transfer risk, for a fee, from those who do not want to bear it to those who are willing to bear risk. These structured financial products were created, packaged and marketed by the issuers [like Lehman and Merrill Lynch] for the sole purpose of “transferring risk” in exchange for future enhanced cash returns. These risk based financial derivatives were sold to all types of investors all over the world as investments with enhanced returns. The insurers like AIG insured these risks based financial derivatives and got on the hook for the capital value of such financial derivatives.
Buying and selling assets, whole or in part, is investing. Whereas buying and selling these financially engineered derivatives are nothing but speculation. Speculation is like two edged sword… it cuts both ways. And in a free market society like ours, if you live by the sword… then you must die [financially] by the sword as well.
Now, with almost all of asset class under water [in value] the risk taker is on the hook to make whole the lost value [in trillions of dollars] of the underlying asset. In the free market society like ours, the issuer [or the insurer] of such financial derivates will be on the hook to make whole the principal value of the asset. The issuers of such financial derivatives [like Lehman and Merrill Lynch] and the insurers [like AIG] are financially choking on this massive risk they assumed in return for hefty fees. The issuers and insurers took on massive amounts of risk and multiplied this risk many folds [like 30 times] by un-controlled leveraging. In good time this meant huge profits for the issuers, insurers and their fat cat executives. However, in bad times like the present, it could be the death knell for many of our financial institutions.
Buying and selling assets, whole or in part, is investing. Whereas these financially engineered derivatives are nothing but speculation. The sole purpose of these derivatives is to transfer risk, from those who do not want to bear it to those who are willing to bear risk. Speculation is like two edged sword… it cuts both ways. And in a free market society like ours, if you live [and profit] by the sword… then you must sleep [or die financially] by the sword as well. In the free market society, with no government intervention, we should let these fat, greedy and short sighted pigs [the speculators] play in the cesspool of their own creation and die [financially] in it. This applies to all speculators… the issuers… the insurers… and the investors all over the globe who came to feed on these speculative financial derivatives without fully understanding the risk to their capital.
The lean, mean, prudent, strong [financially] and men of long term vision for the future of their company [and this country] will emerge as survivors. The treasury secretary should then take these survivors by the hand and feed them the TARP money to lend out to businesses and consumers. That’s my way to solve our current credit crises, and I’m sure millions of other US taxpayers will agree with me. But that’s not going to happen, because there is too much pressure on the FED, from interest groups [like issuers and insurers]; big institutional investors; sovereign governments; and large businesses, to do something.
The politicians will trip over each other to demand that the President and the Treasury Secretary do something… like throwing trillions of dollars in TARP money at the financially insolvent issuers, insurers and fat cat institutional and private investors. Since that won’t be enough, they will also demand trillions of dollars in risk transfer from issuers [and insurers] to the tax payer. So, that’s where we are.
From the government and the tax payer’s point of view, there are four ways to solve our current credit crises:
1. Do nothing and let the free market work it-self out.
2. Do something to free-up our credit markets
3. Reform, transfer risk to tax payer, and flood market with free [at 0%] money.
4. The Money Morning Plan
Since I am responding to your “open letter”, I’ll focus only on “The Money Morning Plan” proposed by you. In a nut-shell, your proposal goes like this, more or less: “look in the rear view mirror and chart the course for the future”. Now that doesn’t solve our immediate dilemma of current credit crises.
I can take each and every one of your proposals [item by item] and point out the facts, flaws, fallacies and fiction. There are some good “islands of ideas” and are certainly of value and worth considering. However, collectively these islands of ideas do not propose a comprehensive solution because there are no connecting bridges [or links] of thought proposed or articulated… for going from here to there.
If you like, I can communicate my views, opinions, and comments in this public forum or privately via e-mail.
Anant Goel
In addition to the above comments, let me quote two paragraphs from Bridgewater Associates that I think sum up the problem in a rather brilliant and clear way, and which I wholeheartedly agree with:
"The root problem is that debts that were incurred to finance assets at high price levels remain in place at their original amounts even though the assets that they financed are now worth far less. Debt that was incurred to finance extrapolated high incomes remains in place at its original amount even though incomes are now much lower. And, debts that were incurred to finance loans remain in place at their original values even though the loans that were made cannot be repaid. Until the debts are brought in line with the assets and the income, there is no moving forward no matter how much liquidity is provided or how eloquent the speech. And, until this happens, the self-reinforcing nature of the debt squeeze will only reduce incomes and asset values further."
"There is no easy way out of a debt restructuring. Someone will have to bear the cost of prior bad decisions. The people who should bear the cost are those who made the bad decisions to make the loans or those who financed the people who made the loans. They intended to profit and would have profited if they were right. But they were wrong, so they should lose. The government needs to allow the losers to lose and focus their actions on minimizing the knock-on effects of their failure on people who didn't do anything wrong (to minimize systemic risk). They should then take action to minimize the future exposure of the innocent to the future dumb decisions of the small minority, because no amount of regulation will ever eliminate dumb decisions, so you have to plan for them (through much lower bank leverage limits to cushion losses, bank size limits and non-bank entities playing bank-like roles to improve diversification, safety nets to prevent losers from poisoning the whole system, etc.)."
I could have not said it any better.
Anant Goel
congress needs to: ABOLISH THE FEDERAL RESERVE;ABOLISH MARKET INTERVENTION;ABOLISH RESERVE BANKING…..how we got here forestated.
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