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In his haphazard attempt to demonstrate his competency for managing the economy, Sen. McCain effectively demonstrated his complete lack of competence.

Last week, Senator John McCain announced a proposal to resolve the financial crisis.  The entire proposal is as follows:  

The Purpose Of The Mortgage And Financial Institutions Trust (MFI):
The MFI Is An Early Intervention Mechanism That Will Help Financial Institutions Avoid Bankruptcy And Expensive Bailouts While Protecting Their Customers. The MFI will minimize the use of taxpayer money by having an orderly process to address the market crisis. Working with the private sector and regulators, the MFI will help identify troubled institutions and take action to strengthen them before they become insolvent.
The MFI Will Provide Troubled Institutions With An Orderly Process To Identify Bad Loans, Provide Funding And Eventually Sell Them At A Profit. This will get the Treasury and other financial regulators in a proactive position instead of reacting to one troubled institution after another.
The Structure Of The Mortgage And Financial Institutions Trust (MFI):
The MFI Will Be Part Of The U.S. Department Of The Treasury. The MFI will be managed by a board of directors consisting of at least the Secretary of the Treasury, Federal Reserve Chairman, Chairman of the FDIC and two public members. The Secretary of the Treasury will be Chairman of the Board. Under the MFI process:
Troubled institutions will voluntarily come to the MFI.
The MFI will provide liquidity loans at reasonable interest rates. The MFI will receive warrants for controlling interest in troubled institutions.
Troubled financial institutions that enter the MFI will keep operating as private companies with the help of the MFI.
The MFI will supervise the sale of loan assets at market prices and purchase them as necessary.
The MFI will eventually, and at its discretion, sell the loans to the private sector.
The MFI will have a predetermined tenure during which to dispose of the loans.
The MFI will return all profits to the U.S. Department of the Treasury and taxpayers.

Sen. McCain has repeatedly said that he dislikes the size, scope and interventions of the federal government into the free market system.  After John McCain, the Deregulators, spent his entire political career taking authority away from regulators entrusted to prevent this kind of financial mess, he is now saying they are inadequate to handle the task of controlling "greed."  He blames regulator’s incompetency for this crisis and does not take his fair share of the responsibility.  So how does Sen. McCain plan to save us from "incompetent" regulators? By making more of them.  

In essence, Sen. McCain’s solution to this very complex and vast financial crisis is to create another federal agency.   However, his proposed new agency, the Mortgage Financial Institutions Trust (MFI), does not create rules for the market participants who led us into the current crisis.  Instead, the MFI blows up the size of the federal government and regulates bureaucrats.  
Aside from the political irony and hypocrisy of Sen. McCain’s paltry, woefully inadequate, and misdirected proposal, it provides more questions than answers.

The first part of the proposal states:
"The MFI Is An Early Intervention Mechanism That Will Help Financial Institutions Avoid Bankruptcy And Expensive Bailouts While Protecting Their Customers. The MFI will minimize the use of taxpayer money by having an orderly process to address the market crisis. Working with the private sector and regulators, the MFI will help identify troubled institutions and take action to strengthen them before they become insolvent."

  1. How early would the MFI intervene?  One of the biggest problems within the financial markets has been a lack of transparency.  No one seems to know the how balance sheets of large banks actually operate.   Even executives at these large institutions have a hard time explaining what the risk profiles of their debts are.   The best and oldest rating agencies like Moody’s and Standard and Poor’s, all got it wrong.  They created projections for income and default rates that did not come to fruition.  As result of a lack foresight and understanding of the true risk of these exotic instruments, rating agencies rated them very highly - often AAA.  In other words, no one knew if or when the mortgage bubble would burst.  So unless Mr. McCain has a crystal ball that’s smarter than the best minds of Wall Street, "early" is not an adequate word to describe the time horizon for this kind of crisis.  
  1. Mr. McCain also suggests that the MFI will be able to minimize the use of taxpayer dollar as bailouts.  So, where will the MFI get its money from if not from the taxpayers?  Should the MFI had actually existed before Bear Stern went down, it would still have to pony up the same amount of money that the feds are ponying up now to bailout these troubled banks.  The MFI would have nothing to do with the level of debt that these banks are carrying.  Nowhere in Mr. McCain’s proposal is there a provision that limits the leverage levels of banks.  If anything, it could do opposite.  Should there be a MFI, banks would have very little incentive to maintain a reasonable debt to asset ratio because if they are over-leveraged and do not have sufficient cash to service those debt, they would simply go to the MFI for a bailout.  More importantly, the bailout would not make headlines or raise eyebrows because that is what the MFI is supposed to do.  It could become a part of the banking system normal operating procedure – i.e.:

• banks speculate and raise far more debt than they can handle,
• they don’t have enough cash on hand to service those debts,
• the go to the MFI for a bailout,
• and once the bailout is complete, they go back to the market to do it all over again.

  1. Sen. McCain also believes that the proposed MFI will be able to" identify troubled institutions and take action to strengthen them before they become insolvent."   There is a conundrum here.  Again Sen. McCain is a big proponent for deregulation.  Moreover, the current financial crisis can be harkened back directly to the deregulatory measures that former Senator Phil Graham introduced in the Senate and passed with the help of John McCain.  Together, Senators Phil Graham and John McCain help foster a political culture that distrusts government.   As a result, firms like Bear Stern, Merrill Lynch, AIG, IndyMac and others were able to commit excesses without the watchful eye of regulators.  So in this context, how does Sen. McCain propose to identify troubled banks if he does not include regulations for transparency? More importantly, should Sen. McCain wise up and include in the MFI language that requires firms to be more open about their businesses, there would be no need for the MFI.  The MFI would then solve one of the fundamental problems in Wall Street: lack of transparency.

There is more confusing language to the proposal.  Sen. McCain says, the MFI will be responsible for identifying troubled banks.  However, further into the proposal he also says, "Troubled institutions will voluntarily come to the MFI."  If it is voluntary, the Feds can’t possibly be expected to be proactive.  They would depend too much on the banks to decide when things have gone awry.  No CEO or CFO whose bonus depends on the success of their firm’s stock price will admit that his firm is in trouble; he would risk millions of dollar, the ridicule of his peers and the wrath of the media, shareholders, and general public.  
Also, if the MFI does work on a voluntary basis, what if a bank refuses to admit its mistake and does not accept a bailout?  In this complex and tightly interwoven financial market, one bank going down can take down many other banks with it.  So, it may be that Sen. McCain’s proposal actually facilitates a collapse of the financial markets instead of preemptively saving it.  

  1. Another concerning element to the MFI proposal is that it suggests Sen. McCain has little understanding of how the Feds and Treasury actually work.  The proposal insists that the MFI would allow the Feds to be proactive instead of reactive to other future financial crisis.  However, the Federal Reserve was designed to be the "Lender of Last Resort."  It is an institution that banks go to when they can’t find other sources of cash to maintain solvency.  They are inherently reactive.  He may be confusing the Fed’s manipulation of the overnight bank lending rate as proactive tool for guiding the economy with Federal Reserve and Treasury’s role as the lenders of last resort.

Should the Feds suddenly become proactive participants of the markets, they would be undermining the principals of a "free market economy."  Moreover, if the MFI is chartered to buy bad debts at low prices and resell them when the market recovers at higher prices, MFI itself become a sort of a nationalized investment vehicle like a mutual fund.   For such a capitalist, it’s strange how Sen. McCain seems to have fallen in love with very socialist ideas.

  1. The proposal also suggests no federal conservatorship of troubled banks, such as what the Feds did with IndyMac.  According to the proposal, "...troubled banks that enter the MFI will keep operating as private companies with the help of the MFI."  What does "help" me? If the MFI continues to allow banks on the brink of failure to continue to operate as private companies, is the MFI not asking the banks to fail?  The point of federal conservatorship of failing banks like IndyMac or AIG is to ensure past mistakes that led to those failures are not repeated.  If the MFI allows a private company to continue to operate as it had done in the past, then there is no guarantee that the bank will achieve and maintain solvency.  

Because we are a free market society, Conservatorship is a tool that the Feds rarely employ.   However, during a time of crisis as we are in now, it is an important tool.  Sen. McCain’s proposal seems to want to eliminate that tool.

  1. More bizarre language: "The MFI will eventually, and at its discretion, sell the loans to the private sector...The MFI will have a predetermined tenure during which to dispose of the loans." Which is it? Does the MFI have the discretion to sell the loans whenever it sees fit to do so or will it be mandated by some regulation or law to dispose of it during some "predetermined tenure" of time?
  1. The proposal also seems to forget rating agencies.  What happens to Moody’s, Standard and Poor’s, Fitch, and others under the MFI?  These rating agencies are responsible for assigning risk to debt obligations like mortgage backed securities and CDOs.  If there is a MFI whose job it is to buy these debts, then there is no real risk with these debts.   If there is no risk to these debts, then we don’t need rating agencies to determine and assign risk.  Every privately issued bond becomes as secure as a treasury bill.  In which case, interest coupons on corporate bonds would likely go down.  This means a lower return for corporate bond holders.

In essence, the proposal for the MFI is an attempt to eliminate risk by forcing government to guarantee or insure all bank debt.  What’s worse is that the proposal has no language requiring banks to pay some premium for this historic and unprecedented insurance service.  This is a dream come true for banks.  They do whatever they like with no downside risk.

In his haphazard attempt to demonstrate his competency for managing the economy, Sen. McCain effectively demonstrated his complete lack of competence.

Originally posted to Medhanie on Tue Sep 23, 2008 at 06:15 AM PDT.

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Comment Preferences

  •  The connection also goes deeper. Bush in this (0+ / 0-)

    financial bail out, as in the Iraq war debacle has out Reagan'd Reagan and out Thatcher'd Thatcher in bankrupting the system so that there is/will be no money available for government programs such as healthcare, libraries, public housing efforts, education etc for the foreseeable future. This is the core of Reaganomics.

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