A Ray of Hope in Treasury Plan to Take Ownership of Banks: But Will The Government Do the Right Thing?

Posted on October 9, 2008

I find some ray of hope in the recent announcement that the Treasury is finally considering taking ownership stakes in banks. Nationalizing, or in some way recapitalizing, the large commercial banks in the US, if done correctly, would, I believe, end this financial crisis and restore confidence to the system very quickly (though of course it cannot avert a recession). My hope is that an immediate takeover of banks will transpire over the next few days.

It’s a simple solution, but for various reasons, Paulson and Bernanke have refused to act quickly on this solution, despite the fact some European countries are now taking this path and despite the fact that such a solution has worked magic in other financial crises. Instead, the Fed and Treasury are intent on using textbook economics (Bernanke) and cronyism (Paulson) to destroy the financial system. Unfortunately, their plan is backfiring and I think a government takeover of commercial banks in this country, and the start of completely clean slate, is now our only way out of this financial (and soon to be social) disaster.

Here’s what the government should, and I hope will do, in the next few days to avert a further meltdown of the financial system, which could lead to major shortages of basic products (see this link). There’s still hope that some degree of moral sentiment will sweep over our current leadership and they will do the right thing. But, don’t bet on it.

Here’s what should happen, in order of priority:

  • All current CDS contracts should be declared null and void by government fiat. These fraudulent contracts are destroying the financial system. If you are a counterparty, tough luck. The game is over. There is no reason to sacrifice the entire financial system, for the benefit of a few.
  • Tell all the bank creditors (including Pimco) to get ready to take a haircut on their debt, as there is absolutely no reason why creditors in financial institutions have any more right to recover their money as equity shareholders. If equity gets wiped out, they should wipe out debt also (ala WaMU). Everyone starts again. Nothing wrong with that. It’s the only way right now.
  • Take over a few large banks and immediately offer a blanket guarantee of all deposits, no matter what the size, at those banks, averting a “bank” run, and actually attracting a huge amount of deposits worldwide into those banks.
  • Force those banks, which they takeover, to lend, and thereby break the credit crunch. Where is all the trillions in financial aid going right now? The banks are currently a blackhole. The money needs to be freed up. The only way to do that is by sheer force. If you own the bank you can force lending. Right now, the government is powerless. They hand over a trillion dollars and it simply disappears. Banks are hoarding cash? What kind of lunacy is this? The whole business rationale of a bank is to lend money. If they don’t lend, they should close up shop and go into another business. If they want to remain in the banking business they should be forced to lend.
  • Fire all the senior management at banks, and begin to investigate, and recover money from past management who blatantly robbed the US financial system thru phony derivative contracts, like CDS, (this includes, of course, Paulson who made his billions as CEO of one of the key architects of our financial mess).
  • Fire Paulson and Bernanke immediately. If Paulson wants to keep his job, and really believes in his rescue plan, perhaps he can pony up $1 billion of his own money to buy toxic securities that he believes are undervalued. Goldman too should pony up billions to buy up these supposedly valuable paper assets.
  • Close the stock markets for a day or two, and outlaw short selling on all securities. The shorts have made enough on this panic already, and they should now be required to buy back stock in order to prevent a complete financial collapse, which would ironically destroy them as well. There is no sense in which betting on a financial collapse and the end of our economic system, makes moral or economic sense at this juncture.

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