Bailout Tweaks I would like to see

Now that the bailout has apparently been negotiated, re-negotiated, and agreed on, I have a couple of twists I would like to see added (if Congress wouldn’t mind).  Please remember that I am a Real Estate Broker.  I do not have years of financial background and I am sure there are some reasons that what I propose won’t work.  I just think that some people in the world of financial managment need a big 2×4 upside the head.

First of all, as much as I don’t like it, I think the bailout is necessary.  However, I also don’t want the people who had the biggest hand in this mess getting off easy.  I believe the consequences of funding the bailout will be felt across all areas of the economy.  Here is a proposal to lessen the impact and maybe even turn a profit for the governement.

My idea is to do exactly what the government has planned, but with only 1/2 the money.  I believe that the following limitations should be put on the use of that money:

• Mortgages taken back by the governement should first be those attached to Primary Residences and commercial properties (appartments, stores, etc).  The banks that were lending money to investors on a speculative binge buying multiple homes without any of their own money should not be rewarded as this speculative buying is at the heart of the crash. 
• Money should be made available in several separate $50B “auctions”.  Banks would bid the lowest they are willing to take for their notes the government would then be buying at the largest discount possible discount.

The rest of the money $350B would be broken into 10 $35B pools.  The government would appoint a “Distribution Executive” to select 10 groups that would be allocated this money for a period of 10 years.  The Distribution Executive would be a non-political person with exceptional judgement in financial matters who is rich enough to not be influenced by bribary.  I would choose someone along the lines of Warren Buffet.   Here is the catch with these groups:

• Management expenses for the entire group may be taken from each groups $35B and must not total over $2.5M a year.
• They would operate as banks or as investment vehicles investing only in US based mortages or government paper.
• At the end of 10 years, the government gets it’s $35B (less the $25M in managment fees) back, plus 5% interest a year.  Of the profits above that, the government gets 75% of the profit, the management group gets 25%. 
• They must invest first in discounted government backed securities.  Right now, there are perfectly save securities trading at deep discounts (30-40%).  If these are purchsed by these groups, it will provide quick liquidity for the markets and instant profit to the groups.
• The groups asset base would then be in excess of $35B (face value of the discounted notes purchased).  They would be allowed to borrow from the treasury at a much discounted ratio of 5X assets (no more 12-30x leverage for the banks).  This would make about $200B per group available for lending to homeowners and small businesses. 
• Loans would be insured by the US Govt. but strictly regulated and non-speculative (owner occupied or investor with 25% down, etc). 

An obvious flaw with this plan is that the inital $350B to take over existing bad mortgages is not sufficient to keep all the existing banks afloat.  I don’t care.  I want some of them to go out of business.  There needs to be some consequences from their reckless history. We are going to start 10 new banks that can pick up the slack from the irresponsibly run institutions.

This plan would pump over $2T in liquidity into the markets over a 3-6 month period. 

At the end of the 10 years, the groups will either be broken up (if the group can make 8% a year return (a slam dunk with the discounts they will get on the initial paper), they will return $68B each to the Treasury while making themselves over $7.5B).  The impact on the market of breaking up these groups would be huge and so it would have to be phased and the groups may be allowed to continue to operate as stand-alone companies once they have put their required profits into the Treasury. 

 Ok, so this isn’t perfect and there already is an agreement.  But, it felt good to get it off my chest!

Explaining the Bailout

This is a reprint of my Monday Morning Coffee that goes to 1,000 people each week.  I received enough favorable comments that I thought I would post it as a blog.

Good morning!

I hope you had a great weekend. At least it was time to catch our breath after last week’s whipsaw action. The Treasury came out with a proposal (which you have heard about at length by now I am sure) that would provide $700B (that’s $2,000 for every taxpaying American) to bail out the banks. The way it works is surprisingly simple:

Banks are allowed to lend up to 30 times the amount of good assets they have. So, for every $100,000 in CD’s, checking accounts, etc., they can loan out $3,000,000. However, every bad loan for $500,000 that they have, is $15,000,000 that they can’t lend out. The Treasury is proposing to take those bad loans from the banks so that they can lend money again.

The effect is that then the government has about $700,000,000 in bad loans. The theory is that the government can absorb these bad loans because they have the ability to print money (which will be highly inflationary). The other benefit of this program is that the government can help troubled homeowners by stopping the foreclosure process and sitting on these loans until values come back and the homeowners can either sell or re-finance.

The problem I see with this is that with the loans that are starting to default now (the so called Alt-A loans) the borrowers used stated income and negative amortization. Meaning, not only has the loan balance been going up to the point where some of the homes are worth only 70-80% of the loan, but the payment has doubled and there is no way for the borrower to make the payment. So, unless the government is going to cut the rate back to 1% for these borrowers, they aren’t going to be able to make the payment. If the government does decide to offer these borrowers a 1% rate, the borrower still has to make the payment (and if they owe 20% more than the house is worth, why wouldn’t they just walk away, wait two years and buy a new house at foreclosure prices?)   

It looks to me like the government will be doing two things with this program:

1.      Taking back a lot of houses that people walk away from.

2.      Borrowing money (selling bonds) at 3-6% to loan to homeowners at 1% and sticking the taxpayer with the bill (that will grow much larger than the initial $700,000,000).

I am going to admit that I don’t have a great answer for the problem. I just know that the Treasury is being advised by some very smart people (some of whom owe allegiance to various industry associations such as banks and Realtors). I just hope that this is the best program for the country and not just the best program for their associations.