It’s time to declare martial law.
What?
The current moves by the Treasury and Fed and Congress are good. They are doing their best think outside the box. However, what they are doing amounts to re-arranging the proverbial deck chairs. Until the real problem is addressed, nothing will solve the problem. There is still the attitude that this is a liquidity crisis, yet plenty of liquidity has been provided. The underlying problem is a credit freeze due to "toxic assets" on the financial sector balance sheets, namely CDS contracts.
Most of the trillions of dollars of CDS contracts related to the mortgage markets cannot be traded. Without a mark to the market, they cannot be assessed value, and so cannot be counted on financial sector balance sheets; and since they probably represent extremely large losses, no financial institutions will risk extending credit to one another, knowing these losses are out there.
Declare marital law on a Friday evening. Give the financial sector Saturday and Sunday to identify all such contracts being held, and present a marked to the market fair value. On Monday, close trading in financial sector stocks. At the conclusion of the business week, re-open the financial sectors for equity and debt trading.
In the meantime, the federal government will take possession of all mortgage related CDS contracts and declare them null and void. This is the move which requires martial law.
A lot of steps already taken by the Treasury and Fed are probably outside their legal scope, but this would be flat out unconstitutional; hence martial law. Furthermore, it will require international cooperation, since foreign institutions also hold the CDS contracts.
During the week of martial law, the federal government would insure all finance sector deposits through the FDIC. Commercial paper would be underwritten by the Federal Reserve to jump start credit markets. Resumption of trading in all derivative markets would come under the heavily regulated oversight of the CBE, Treasury, and Federal Reserve.
If, at some future date, institutions can demonstrate fair value for the contracts, and wish to re-assume them, that would be allowed.
It’s going to take dramatic action to stop the bleeding. The G7 and other meetings accomplished nothing this weekend (so far) other than symbolic statements of unity. The EU is dancing around the idea of nationalizing banks, but no one dares. If we don’t act, and act fast, and take dramatic steps, financial meltdown is a real possibility.
At the end of the week of martial law, many institutions will have to be temporarily nationalized.
Problems? 1): declaring martial law under a Bush administration is a hair raising thought. However, a recession is already a given, and a depression is a very real threat. The Great Depression ended in world war. Is it worth cutting of our nose to spite our face, and risking the tremendous suffering which another depression would engender?
2): Will it work? The financial sector will be undercapitalized after the nullification, but of course, that merely recognizes the reality. Massive intervention would clear the decks and at least offer the chance of resurrecting the economy from the top down.
3): Is the current course better? I doubt it. Re-inflating mortgages and the real estate market from the ground up will take to long. Injecting equity into the financial sector, or assuming some debts, is a half step.
4): Suspending the constitution for an economic catastrophe is an extremely radical proposition, and sets a deeply concerning precedent.
- JP Morgan took radical action in 1907 to address a banking crisis. Do we have what it takes today to save our own bacon? Does anyone have a better idea?