Treasury’s point-man on the financial bailout, Neel Kashkari, was harshly and universally attacked in hearings on Capitol Hill today. Unfortunately, they got the wrong guy.
There are clearly people in the Administration to criticize, and I suppose it comes with the territory. But what Kashkari is working on, and by all accounts, working late into the night to do, is actually a remarkably competent and cohesive plan—particularly coming from this group of chronic underachievers.
In fact, the incoming Obama Administration would be well served to carry out, and expand, Kashkari’s efforts.
Amazing as it may be to believe, the latest ideas coming out of the Treasury deserve real consideration. As a former mortgage securities analyst, and a current progressive, I feel it’s my duty to bring you the boring details. Apologies in advance.
First, today's lambasting:
The Treasury has taken a number of steps to address illiquidity, and may be pointing the way toward a significantly improved structuring of the way the U.S. housing market is financed. These are big changes, and ones which we should understand before we attack.
First, they have taken quick actions. These are in the form of purchasing illiquid securities, and hopefully providing a pricing floor. These actions are the ones which are easiest to criticize, and surely will be going foward. But the immediate actions, taken when the market is under severe stress, are justified. What they buy and what they pay for it will surely be under great scrutiny, but there will be no "right" answer. Many of these securities are not trading at all, so there is no "fair" market price.
Second, the long-term actions, will have far-reaching effects on the U.S. housing market. The Treasury wants to establish a new form of mortgage financing in this country, borrowing an idea from European markets. They want to jump-start something called a "Covered Bond" market. By doing this, they will both stabilize the mortgage market going forward, and also find a new source of potential buyers for mortgage securities. In short, this is a good idea. A Covered Bond works much more like a Treasury security than a Mortgage-backed security. Instead of issuing a bond which will be repaid by the flow of cash from a pool of mortgages, a bank would issue a bond with a pool as collateral. The difference is that the bond would have a fixed payment schedule. Banks would be able to add new mortgages to the pool, subject to the covenants of the bond. The great advantage of this is that a new class of investors, risk-averse rate investors, would be able to buy these securities. By tapping a new source of capital, the market liquidity would improve.
More importantly, covenants contained in these bonds, such as an 80% loan-to-value requirement, geographic diversification requirements, and others, would force lenders under this program to make stronger loans and issue less risky securities.
To be sure, the Treasury’s plan is just a beginning. There is much more to do, especially on the consumer side, such as renegotiating upside down loans to prevent foreclosures. But, as Kashkari put it today, their resources are finite. The only way out of this is to take actions which have a leveraged effect—putting the weight of the Treasury behind new institutions which will, in turn, foster greater growth by getting the larger market involved. Kashkari and the Treasury team are spending a lot of time these days getting several parties in the market—buyers, sellers, rating agencies, regulators, banks—to set up a system that can work. Anyone who thinks that handouts are enough, in themselves, is ignorant of how markets work. Anyone who has a better idea should speak up, not just tear down.
For those who have the time and patience to really get a handle on the plan: