Dear Senator Obama-
Chances are most if not all of the major commercial and investment banks are insolvent. Not one of them is opting out of the do-not-short list, and they don’t seem to have the confidence in their survival to opt out of the L3 asset swap program Secretary Paulson is proposing.
It is also very likely that acutely dangerous systemic risk already exists, not merely from direct lines of credit among the banks, but especially from credit default swaps, which if activated by more than one large bank default would probably bring down many others. Remember, though, that this systemic risk is highly concentrated in the top 25 or so banks in the world, and does not jeopardize the 6,000 other community banks in the U.S.
Third, it is also highly probable that as this recession worsens, and as housing values continue to sink, forcing more foreclosures, the large banks will be even closer to collapse.
Having worked for many years in the banking industry and been closely involved with risk management and derivatives, I can tell you that it looks like catastrophe is already here.
More after the jump.
What Sec. Paulson wants you to believe is that catastrophe is approaching, but it can be averted if only Congress acts urgently to give him the extraordinary authority he is requesting. The implication is if you don’t give him $700 billion in borrowing authority within a week, markets will collapse and it will be all your fault.
We’ve seen this drill before, with the Patriot Act and with the Iraq War authorization. The scare tactics, the urgency, the implied threat of blame for any failure – this is what the Bush administration does. Some of you in the Senate were able to stand up to this pressure, and that type of strength is desperately needed now.
If insolvency is here now for the big banks, the last thing you want to do is throw $700 billion of money that is not yours at bailing out the banks who created this disaster. You’ll need every bit of that money to protect the taxpayers and their deposits in these banks when these financial companies are thrown into the bankruptcy courts. You’ll need that money to make sure consumer deposits are protected with insurance, and you’ll need it to keep the healthy parts of these banks that deal with consumers and businesses functioning until they come out of bankruptcy.
And forget about comparing Paulson’s plan to the RTC. These L3 assets aren’t homes, condos, or commercial real estate that can be easily sold at the right price. They are bits of paper giving the bond holder the right to some small portion of thousands of mortgages, a right that is shared with all the other investors, who are required to agree on what is done with foreclosed properties in the pool. This is one of the reasons no one wants to buy this stuff, and no one will for many years until it is crystal clear what the final losses will be.
Once you give Paulson the authority he seeks, he will buy these securities at 65 cents/dollar, then quietly auction them off at a nickel each. It will be “unfortunate but necessary” to revitalize the banking industry, even though you will discover the banks won’t be lending after this is all over to any but the finest credits. You will have rewarded the banks for their calamitous decisions, stuffed the taxpayers with huge losses, squandered your remaining ability to shore up the FDIC, not prevented the big banks from collapsing anyway, done nothing to help the community banks that will constitute the new banking system in this country when these problems are solved, and in the end made the situation much worse.
If you want to do something practical, require the SEC to go into these banks, open up their L3 holdings to public scrutiny, auction off a sampling of these securities, and apply those prices to the L3 portfolios of all the banks. In this way we will know which banks are insolvent. You won’t need to go through this charade of having the Treasury take ownership of these assets, because the core of the problem is not that these assets are clogging up bank balance sheets, as Paulson says (which is tantamount to saying, by the way, that no one will buy them). The core of the problem is that there is no transparency about these portfolios and their real worth. Congress doesn’t need $700 billion of our money to create that transparency, and if it shows as I suspect that many of these banks are insolvent, that’s why we have bankruptcy courts. You can certainly protect the banks from bank runs while they are in bankruptcy.
Paulson is basically rolling you and the rest of Congress into giving him unprecedented power to protect his friends on Wall Street. This decision you are making is probably as momentous as the Iraq War resolution. Don’t fall for this bailout disguised as the only way to prevent Armageddon. Armageddon is already here – at least for the big banks – and it needs an entirely different solution. Spend our money protecting us, by ensuring the FDIC is properly funded, by throwing these too-big-to-fail banks into bankruptcy if they truly are insolvent, by preserving the healthy parts of these banks while in bankruptcy, and bringing them back out again so they function under much better safety and soundness regulations. We’ve had airlines functioning properly and safely for years while in bankruptcy, and there is no reason we can’t do the same with banks.
Please, please, do not fall for some useless compromise or bipartisan agreement that gives the administration what it wants in the end. Kill this proposal here and now, protect us from this bailout, and deal with the real problem – the insolvency of the major banks, not the paper that is supposedly blocking their lending capabilities.
Hits all the right notes if you ask me.