Discussion and information on selected policy issues concerning tax, foreign relations, energy and other significant policies. The intent is to provide data and analysis that will assist in determining the appropriateness of the policy. Any posts containing rants, personal attacks on officials or other posters or which do not concisely present a point of information will not be published.
The current structure of the bailout of the investment and commercial banks being discussed involves the US government purchase of distressed mortgage backed securities which has a cost estimate of approximately $700b. However, it will not be possible to save these institutions without the US government also purchasing perhaps trillions of dollars worth of other financial instruments such as synthetic CDO's (collateralized debt obligations), actual and synthetic CDS's (Credit Default Swaps), auction rate securities, covenant lite loans and foreign transactions. Especially in the case of synthetic CDO's and CDS's, these were instruments that were closer to casino bets than financial transactions.
If the government does not structure the bailout carefully and correctly, there is nothing to prevent these investment banks from using their new found cash and borrowing abilities to create new investments that get us back into the same situation while making some very wealth people much wealthier with only the taxpayer losing.
An alternative to the approach being discussed is to setup a new Government Sponsored Entity (GSE) that would purchase only the financial instruments that will help the US economy. Remember that Fannie and Freddie were initially setup as GSE's and that Fannie was sold to private investors in 1968 to fund the Vietnam war. Let the investment banks go into bankruptcy, the new GSE would purchase at very low prices the appropriate assets required to keep banking and lending operating in the US and the stockholders and managers of the bankrupt institutions would not benefit. The advantages of this approach are:
- The taxpayer would not have to purchase trillions of synthetic instruments.
- The taxpayer would not have to purchase assets that are owned by a foreign country.
- The issue of encouraging this type of action in the future via moral hazard would not be an issue.
- The taxpayer would gain when the GSE was spun off into new financial institutions via an Initial Public Offering (IPO).
- The essential assets held by the banks would be purchased at a lower price.
- The new GSE would not have to be concerned with investor law suits.
The exact same operating practices that required a bailout of Long Term Capital in 1998 created the problem that we are currently facing in the investment banks. The investment banks, many of whom were involved with Long Term Capital in 1998, knew better but failed to act responsibly.