We got a great comment on our blog entry, Financial Bailout Bill Passes House. It was written by Michael S. Zarin, President, Wellfleet Investments LLC.
It is worth posting as its own post:
The financial rescue package contains a provision that permits troubled financial institutions to apply for insurance (federal guarantees) and could prevent an outlay of $700,000,000,000. Furthermore, it can cut interest rates substantially, keep troubled homeowners in their homes, and certainly end the credit crunch.
The purchase assets provisions of the bill, buying paper at much less than its face value, will not put the financial institutions in enough funds to mitigate the credit crunch.
In fact the guarantee provision could even go too far in that direction. Administered sensibly by the Treasury Department it could be just right – if they would do it.
If I’m a banker holding 13% sub prime mortgage paper now worth 40 on my books instead of 100, and I get a US Government full faith and credit pledge (insurance, really a guarantee) behind that debt, my lousy paper is worth way more than 100 right now. Maybe 120 or more. No one wants that. Inflation.
So, when the banker comes in to get his insurance, he should pay a fee and, most important, agree that the interest rate on his paper will drop to, say, 3.5. He has to agree, because the US government can’t change his contract unilaterally.
In that way, his paper is worth 100. He sells it. He’s back in cash and the credit crunch is over. Regulations should cut back on the permission that sunk Lehman – ability to leverage cash 30 times. Twenty times does it nicely enough.
If you want to punish him because he was a bad boy, cut the interest a little so he only gets 90 cents on the dollar instead of 100. Less than that. No good. Because he won’t be able to do enough business and end the credit crunch.
New point. The homeowner who is paying 13% or whatever on the sub prime debt, a victim or a risk take or whatever (we’re at saving the economy not punishing him, his family and us now) should have his mortgage rate reduced to 5% so that he can pay his monthly charges. A sub prime mortgagor (interest rate, say 7and 1/2% or more) who has enough household income to do that should be part of the program. See below for the others.*
The difference between what the banker gets, say, 3.5%, to bring the paper to 100, and 5% ,what the homeowner pays, should go to the federal government to pay the costs of the program and any anticipated defaults.
That’s a program that works and benefits the economy, the taxpayer who lays out no money now, the financial sector and the homeowner.
*For another program, are we, as taxpayers better off if the guy who can’t pay all of his mortgage is thrown into the street, or do we really pay more to keep him in other housing, welfare and so forth. Maybe he should be subsidized some to keep him in his home. As I say, that’s another program.
The program outlined above works. Secretary Paulson has given no assurance that his plan works.