Or, Dear Wall Street, Fix your shit now or else.
I think I've got a free-market solution to the present crisis. I used to work at one of the ibanks in question, and I'm also a law student. What follows is a cost and intervention minimizing plan to incent and coerce Wall Street into cleaning its own house that won't cost $700BN and won't give sweeping powers to the administrative branch.
- Assemble a list of bidders. They should include domestic banks, foreign banks, hedge funds, private equity funds, and real estate trusts above a certain size (say, $100M, the threshold for QIB, qualified institutional buyer, status).
- Announce that the Taxpayer Holding Corporation hereby immediately and irrevocably offers to buy any tranche of any structured product (CMBS, CLOs, CDOs) backed entirely by domestic residences for half of a penny on the dollar (0.5% of face) on a date three to six months hence.
- Announce a schedule of bonus depreciation for financial firms that write off investments in these products. If you write down your structured products portfolio, you get extra tax breaks. If you screw it up and over-aggressively write down, having to re-raise it later will earn you a penalty of 200% back taxes. But, if you write off expected losses by, say, the end of the quarter, you get to write off 125% of the value as a tax loss and carry it forward, perhaps declining by 5% per quarter over the next year. The objective is to create a tax incentive to quickly yet carefully write down expected losses to obtain a more clear picture of corporate finances, and of the degree of toxicity of worthless assets. Obviously, the exact #s can be optimized with sufficient data, as long as the balance of the tradeoff achieves the objective.
- Assemble a list of sellers – presumably those who have made large writedowns (and their successors and assigns) have lots of things they’d like to be rid of. Get a list of inventory and its estimated value. If it’s entirely worthless, give them a half-penny on the dollar and move on. Allow all the bidders time to peruse the merchandise.
- Auction it. Obviously, the bid starts at $0.005 on the dollar. Then tax payers will own a lot of junk, but with high face value. We deduct the face value of our debt from the debt owed by the underlying homeowners. If we buy up the bottom $200M tranche from a $1.4B deal, everyone living in those houses gets 14% off their mortgages, instantly. The beneficiaries are the homeowners, who don’t have to be foreclosed upon.
- #5 may incent the bidders to bid $0.006 on the dollar, to avoid this will require one additional change: Make all primary residence mortgages non-recourse, at the federal level. If the lenders or shady secondary-market dealers try to game the system by selling the debt to repo men and collectors, under-water homeowners get to walk away.
- Now, if any selling financial institution would be rendered insolvent through optimal participation in the auction (i.e. their deposits to assets ratio would drop below the minimum regulatory capital), they may participate in a second auction for ownership of said institution. The precise regulatory capital shortfall having been estimated, the minimum investment is established, and bidders above (presumably foreign banks and private equity would be interested buyers) may place bids.
- Any bid will necessarily have two components A) a diagram of the institution’s capital structure, indicating the degree to which creditors (ranked by seniority) will be affected – the more of them you keep whole, the better (this would work similar to a prepackaged bankruptcy) and B) the % ownership, which would only be less than 100 if the creditors were all kept whole. If there are no bidders at any price, the FDIC will close it down and reimburse depositors from funds in the Taxpayer Holdco. Any golden parachutes are eliminated.
Possible tweaks:
- Perhaps reduce the tax on capital gains for transactions conducted at either of the two auctions, to additionally incent participation. On the one hand, we don’t want to reward people unduly for the mess they created, but on the other hand, we should recognize that some of them might be able to fix it, and that the worst will hopefully have been replaced by new people. By narrowly targeting it to the gains from participating in this national auction, we minimize the expense to taxpayers.
- Perhaps also pass into law that henceforth any compensation for any C-level executive, either in cash or in sale of stock, is presumptively a fraudulent conveyance for three years prior to any company’s bankruptcy. This means that if you drive a company bankrupt, we get to take back what you got paid and return it to the creditors.
- Perhaps also establish a federal doctrine of adverse possession, and shorten the statutory period to five years. This means if you live in your home, and nobody files suit to kick you off in five years, you get to keep it. Banks would either be forced to hire a lawyer for every property in default (not possible) or to simply give up on some properties.
The cost of this plan will be: Tax incentives to encourage compliance, some small percent of some small amount of the face value of truly toxic structured products, any capital gains tax incentives, costs to the FDIC of reimbursing depositors, and the cost of the auction process itself.
The beneficiaries of this plan will be: those who live in homes that aren’t worth what they paid, banks that are solvent but illiquid, bank employees whose banks are insolvent but worth rescuing, and depositors whose banks aren’t solvent or worth rescue. Some of the hedge funds and other entrepreneurial investors may make a good deal of profit off this, but we’re not writing them a check, we’re just providing them with the opportunity, and that’s the American way. And, the opportunity may create jobs for the tens of thousands who have recently found themselves unemployed.