Somehow the gravity of this spiraling banking situation is not getting through to the policymakers, particularly Timothy Geithner, the Treasury Secretary. So in the interests of advancing the debate we need to consider how the government could get in control of the banking system without actually taking control of the banking companies.
Right now the short-sellers, those who want the banking system to fail, are destroying the common stocks of the banks through relentless short selling. On many recent days, roughly half of the overall selling of major banks' shares has consisted of common short sales plus the short sales that spring from the ProShares UltraShort Financials (NYSE: SKF) (Cramer's Take), the weapon of choice for magnifying a small amount of capital to wreck short-side havoc on the stocks. These sales are legal, having been sanctioned by a Securities and Exchange Commission that has, unwittingly, been in league with those who need to destroy the banks in order to profit from the common stocks' demise.
The rest of the debate is being controlled by those calling for the nationalization of the banking system. Did you know that not a single person proposing the nationalization system has ever offered a reason why it would solve our problems? They keep quoting how nationalization "worked" in Sweden, but those were just a couple of small banks by U.S. standards and mean very little or are actually irrelevant to the situation.
Right now the marketplace and the doomsayers, many of whom may actually be profiting from their dire forecasts, are in charge of the situation. The U.S. government needs to regain control not of the banks, but of the system of banks, and needs to do it now.
There are programs in place and institutions and laws and regulations that the government has at its disposal to take control. These are the same ones that were used successfully by the Federal Savings and Loan Insurance Corp., the Resolution Trust Corp. and the Federal Deposit Insurance Corp. to get control of the system in another time.
What are the goals of the government? First, is to restore order and function to the banking system before the marketplace makes that impossible by starving the banks of any means to raise capital. Second, is to keep people in their homes, in order to stabilize the housing market and ultimately allow it to appreciate, taking the pressure off trillions of dollars in soon-to-be-defaulting mortgages. Third, is to increase credit in a responsible way that does not allow the banks to run afoul of the regulators. Fourth, is not to bankrupt the Treasury or the American people's future in the process, something that both nationalization and the cruel hand of the marketplace would most certainly do. Fifth, unfortunately, and ultimately, is to prevent social chaos and unrest, which might, as it did during the Great Depression, lead to social upheaval, fascism and war.
I propose a two-step plan for solving the problem over time. The first step addresses taking control of the banking system, not the banks, before it is too late and all our banks are insolvent and in danger of closing. Soon, no bank will be able to pass any stress test and will be put into receivership/nationalization.
To these ends, the Federal Reserve should issue certificates of net worth to banks giving them as much capital as they need in return for notes from the banks promising to pay for the capital when times get better. The Fed has the ability to do this under its charter. Banks will then be able to finance on their own and use the certificates to insure that they are not wiped out by the gradual disposal of bad loans over time. This system of forbearance was used successfully in 1989-1990 and can be used again. If there are institutions that cannot be considered solvent and are beyond redemption even after receiving the certificate (and given a chance over time to improve the situation), then they should be seized by the FDIC. At least that way there would be some institutions left to which deposits could be sold. Others will have the time to be created through private/public facilities.
The second step addresses the root cause of the banking system's problems: home-price depreciation and subsequent defaults on mortgages. By asserting the imperative of keeping people in their homes, while at the same time not favoring them over people who are working hard and meeting payments, the federal government should, for a period of 18 months, simply get into the mortgage business or insure mortgages that have a 4% rate and a 40-year maturity. This rate could also be given to all people seeking to refinance their homes. If you extend the low rate to everyone, you avoid the moral hazard for those who are diligently staying current and are trying to stay in their homes, and you ease the anger over the subsidies for the overstretched. These mortgages would not be for the current principal amounts, but would be for a reduced principal equal to some percentage of the current appraised values of the homes.
We have seen time and again that a simple reduction in interest rates will not succeed in keeping people in their homes. An adjusted principal amount can keep them in their homes. This in the interest of these people, the banking system -- which falters when a house is foreclosed upon -- and all who are current on their home mortgages but are seeing the value of their properties diminish because of neighborhood foreclosures.
The obvious issue is how the banks can get their money back for the original mortgages and how the regulators will be able to forbear on the banks that take the hit on the mortgages.
For that, the government should issue a Certificate of Equity, which would allow a bank to recapture the lost mortgage amounts from the original mortgages upon the sale of the house. Anything above the Certificate of Equity would accrue to the homeowner. The Certificate of Equity would be counted as equity for the purposes of a bank examination and stress test. The mortgage and the Certificate of Equity would be transferable on any sale of the house and must be assumed. Why would anyone be willing to enter into such a transaction? Because it is cheaper than renting on an after-tax basis, and in the vast majority of cases houses have more square footage than apartments. Many people have put hard-earned cash or sweat equity into their homes. Plus there would be no uprooting of their children and painful switching into other schools.
This plan would work well with the 20% of the mortgage loans that were produced between 2004 and 2007, the so-called problem whole loans, that are kept on the books at many of the largest banks. It does not solve the problem of the 80% of the mortgages that are bundled into the CDO form. In the latter, the servicer does not have the latitude of making those principal cuts. The servicer must be incentivized and indemnified to make such cuts. These cuts are ultimately in the interest of the CDO holders, because their proceeds from foreclosures are more meager. Given the nature of the national housing emergency, these servicers and the top-tiered creditors in the CDOs should not be allowed to hold us hostage.
The cessation of foreclosures that this program should bring about, coupled with a radical decline in new housing starts to a level of 400,000, should produce housing market stabilization, an integral part of what is necessary to allow the banks to be able to pay back the notes they would be given by the Federal Reserve.
To insure that banks do not run afoul of the system (besides having the close scrutiny of the FDIC), the banks' officers must agree to take a substantial portion of their salaries in restricted stock that cannot be sold until after the banks pay off their notes to insure that good faith efforts are made to return to profitability. The executives are therefore invested alongside the government. Such a plan would provide a much less expensive and more efficient solution to a nationalization scheme, which would not have such a compensation plan and would create tremendous inefficiencies, not to mention a pressure to dispose of assets immediately. A nationalization plan would further depress the value of assets that would most likely be viable if left to a time when the economy ultimately improves.
I am open to any suggestions about how to hone this two-pronged plan to make it more palatable and less expensive to the government and the taxpayers it must defend.
Jim Cramer is co-founder and chairman of TheStreet.com. He contributes daily market commentary for TheStreet.com's sites and serves as an adviser to the company's CEO. At the time of publication, Cramer had no positions in the stocks mentioned.
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Reader Comments (Page 1 of 1)
2-23-2009 @ 10:51AM
paul s said...
I don't believe you Cramer. I was upside down on my first house three years after I bought it. It declined 35%. Thats life. I kept it. Over the years turned into a rental. Sold it last year for 3 times what I bought it for. Writing a check to Uncle Sam for 60 thou next month, capital gains. That's how it works when you play fair. That is how it works when you don't cheat.
2-23-2009 @ 11:03AM
Bill said...
Jim:
I do appreciate that you are providing solutions. Whether your is better or worse than others provided, time will only tell. I just got done reading Paul Krugman's idea on Nationalization. Now, if I remember correctly, he did win a Pulitzer on Economic Theroy. Maybe, you haven't had the time yet to read his article. He does suggest how it would work in today's environment. With no respect to your economic intelligence, I feel Paul Krugman has a leg up on you. Maybe, you can make him a regular on your show, until we come out of this economic malaise which the world powers have found themselves.
2-23-2009 @ 11:05AM
Normnorton66 said...
You forgot to mention putting the "uptick rule" back into place.
2-23-2009 @ 11:26AM
pcatlow said...
Who are the servicers of the mortgages that are bundled into CDOs? Can these servicers be the helping hand in cleaning up this crisis? Is there some entity that can analyze the individual CDOs? Is this a potentially new industry that could hire the Wall Street unemployed? I ask these questions to have a better understanding of CDOs. David Faber's documentary, House of Cards, make the CDO market as a major player in this crisis. If we understand the components of a CDO, there just might be a solution in a new security that can be reconfigured from these components. Remenber high school Chemistry class in how certain atoms are bundled to make a gas and if rebundled with some other atoms it makes a liquid. Let's use the same principles with mortgages/CDOs.
2-23-2009 @ 12:24PM
Larry Spiegel said...
The trouble with the "Toxic Assets" is supposedly, they can't be priced in the present environment . Consequrntly , the government doesn't know how much to put up and the banks don't want to let go .Why not have the government take them all from the banks,in one shot,all or nothing, paying say twenty cents on the dollar or even perhaps paying nothing.Banks declare these loses at"face value"indexed over 5,7 or 10
years paying little or no taxes for some time.At such time as markets are interested in in these assets again "we" can first take what we"may" have spent and
split the "profit" 50/50 with the banks.Banks that refuse to go
along,so long...
2-23-2009 @ 12:49PM
wrabbit1 said...
I have a small business. When I make a bad decision I lose. Consequences make for good decisionmaking.
The reality is that the banks and others made bad decisions. The consequences must follow. What happens If the banks and other bad decisionmakers all go under as do stockholders who took unwise risks while the account holders and borrowers who made responsible decisions are protected?
Yes there is pain. However new businesses and decisionmakers will spring up in the ashes.
Giving money to bad decisionmakers is like Feed the pigions. All you get is more bad decisions.
2-24-2009 @ 12:50PM
Sergeant said...
The problem is that the people who are trying to fix the economic crisis are the same ones who caused it. Nothing will change until the criminals are removed from positions of power, and are replaced with objective, knowledgeable economists, scientists and sociologists who are not beholden to lobbyists, campaign contributors or other special interest groups. Faith in the system will not be restored until the powerful individuals who have been manipulating the financial markets are put on trial!
www.youtube.com/watch?v=eQ9vTJLIA8M
2-23-2009 @ 12:40PM
LLipsitz said...
The specifics of the Cramer Plan would work as well as any other plan, but the big advantage here is that, unlike most people making proposals lately, he sees that much of the problem is being caused by Short Selling vultures who are profiting by taking advantage of today's fear! And the situation is not helped by those, such as Paul Krugman, who advocate for the government nationalizing all of the bnig banks! Wipe out thye shareholders, they say, as if the owners have not already just about been wiped out (at $2.00 per share for CITI, what's the difference?). The key is do stop making proposals and just do something, finally.
2-25-2009 @ 4:39AM
zaaana said...
Why should the tax dollars be used to bailout the private sector?
Those who profited from the marketplace should also face the risks (of losses).
If an honest solution is being sought --- then the govt. can set-up its own bank, let us see 850b leveraged through the govt. bank would make available over 9 trillion in lending (liquidity).
The loans could be maked to the citizens at govt. rates (feds are at nearly 0%) of one or two percent.
The citizen taxpayer can borrow the money from the govt., and use it to payoff the loan sharks (banks), who are charging rates on consumer debt (creidt cards, etc.).
The savings in interest payments would free up consumer cash to provide stimulus spending,
And,
Lower value (or foreclosed) property can be repurchased by those who lost their homes (with affordable mortgage payments).
2-23-2009 @ 12:55PM
Steve said...
@paul s above:
You say your house declined 35% after you bought it, and yet you sold it last year (in the middle of this housing collapse) for THREE TIMES what you paid for it?
Please tell us where you live, since your real estate market is a LOT healthier than where I live.
2-23-2009 @ 3:48PM
paul s said...
By the ocean. It seems sea level attracts all kinds of schemers, dreamers, drunks, and fools.
2-23-2009 @ 4:37PM
Lee said...
Jim:
At least you have some ideas.
It could also work another way, by loaning the people the money, but paying the bank directly. Individual citizens could get relief and pay this relief back in their annual taxes over a 5 to 10 year period. Perhaps a one time front pay of the mortgage of $10,000 to $50,000, thereby leaving no monthly payments for 12 to 24 months. This would leave a capital injection to the market place where goods and services would be consumed with available cash.
I'd like to see a few more ideas, like increasing the margin call from 20% to 80% thereby limiting the power people have to decimate a company's market value with a relatively small amount of capital.
BRING BACK GLASS STEAGAL!!!!
Bunch of Pirates running everything...
-Lee
2-23-2009 @ 11:24PM
chezcachet said...
We need Glass-Steagal back and an end to the short-selling.
The market used to move on a whisper, now it moves before the whisper hits the lips.
This is not good for the companies being brought to their knees, and it's not good for the people to have NO IDEA why the market does what it does. We have perfectly good stocks like GE being beaten into the ground.
Less government and the least invasive proceedures are always best.
2-24-2009 @ 12:44AM
Ellen said...
Just saw you on Hardball. I agree that Geitner must go. The 4% plan is a good one, and the Obama administration has lost precious time and credibility with its management of the stimulus. The Republicans have been given a opportunity to create havoc and fear.
2-27-2009 @ 8:01PM
KennyG said...
You stated, "The second step addresses the root cause of the banking system's problems: home-price depreciation and subsequent defaults on mortgages." You couldn't be more "wrong", it was nothing but "GREED" for the almighty dollar. They gave everybody & their brother, mortgages, credit cars, 2nd mortgages, more credit cards, whether they could afford it or not. That's what did them in & caused all the defaults on mortgages which in turn caused the home-price depreciation. If they would have stuck with the "old" 20% down & a documented income, this would have never happened.
3-14-2009 @ 1:58PM
Tom Blackburn Rodriguez said...
You sold us out. You play the victim now. You knew the business inside and out. You will not reply to this e-mail and continue to make money, just like the CEO's you NOW say lied to you.
You lied to us make a buck.
Congratulations, Jim. Enjoy Aruba.