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The assets cannot lose more than their face value.

The liabilities, on the other hand, can grow infinitely. But, in a climate of deflation and low interest rates, liabilities grow slowly.

So the problem is that some assets are maybe worth zero. All you need to do is add free cash to the assets until the assets are worth enough. Normally this would be done with an equity injection, which would mean a share of ownership. If the share of ownership becomes more than 50%... tough for the management!

This is the way to deal with this mess: Turning Bad Bank / Good Bank on its head (Update) by BruceMcF

OK, now, suppose we do it this way. Bank examiners do "stress testing", which is to say, a real world audit instead of the fantasy audits that we have been doing in order to avoid official recognition of the depths of the problem. And banks that are in too much financial peril to be allowed to continue operating as they have been doing ... are put into receivership.

Now, the US government strips out the liabilities that we wish to protect ... the account liabilities ... and takes over the "good" assets. If that is a net plus, the government pays the original bank for the positive net assets. If that is a net minus, the government makes up the difference with the new Good Bank, and takes a compensating Senior claim in the old Bad Bank.

Then the residual of the old Bad Bank is run through ordinary Chapter 11 proceedings ... in most cases the shareholders will be zeroed out, the bondholders will become shareholders, the new shareholders are quite likely to sack the old senior executive management, and the old Bad Bank will see what they can do to recover whatever value can be had in the trash that forms their asset base.



Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Carrie (migeru at eurotrib dot com) on Fri Mar 20th, 2009 at 05:18:57 AM EST
[ Parent ]
I agree that the solution could work, but the problem is that the liabilities HAVE grown, and will ocntinue to grow massively, given that they included tons of bets that a lot of stable institutions would not fail - several already have, and more could follow them).

The asset side of the mess could be plugged by Fed injections, but the liabilities side cannot (and yet this is what is being done via AIG).

Whatthis means, though, is that lots of people (like Paulson) are making outrageously large profits from having bet on supposedly rare failure events - and this money is being created for them by the Fed.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Mar 20th, 2009 at 05:50:35 AM EST
[ Parent ]
Credit default swaps could be delared null and void in a fell swoop of the legislative pen and the effect wouldn't be too serious.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Carrie (migeru at eurotrib dot com) on Fri Mar 20th, 2009 at 06:00:17 AM EST
[ Parent ]
Then declare them illegal - maybe all short sales, too.  At least, re-institute the one-uptick rule in the U.S.

The only problem is that we're discussing things that: 1) won't happen, because the U.S. Congress is what they are; and 2) won't help, because this mess is way beyond re-regulation.  Rationalization - i.e., socialism for the monopolistic/oligopolistic elements of the economy - is the only solution that can offer progressive outcomes at this point.  And that ain't going to happen without a real fight - not Apple vs. Microsoft.

I support Chris Cook's ideas in every way, except that they won't happen either at this juncture.  We're just not evolved enough, however much some of the objective conditions call for his approach.

paul spencer

by paul spencer (paulgspencer@gmail.com) on Fri Mar 20th, 2009 at 03:22:32 PM EST
[ Parent ]
paul spencer:
I support Chris Cook's ideas in every way, except that they won't happen either at this juncture.  We're just not evolved enough, however much some of the objective conditions call for his approach.

I think it depends on how the propositions are put across. And I don't think we actually have a choice, because the system of credit is terminally fucked IMHO.

First, Peer to Peer investment though unitisation offers a mechanism that wipes the floor with secured debt. Any bank or investor that does not use such a Debt/Equity swap mechanism to exit their crap loans will be at a disadvantage to those who do.

And the more who use it, the more liquid the "Pool" of Rental Units becomes.

Second, Peer to Peer unsecured credit which is interest-free, but not cost-free. What's not to like?

The Carnegie Institute liked the ideas....

Peer-to-Peer Finance: A Flight to Simplicity

Credit and investment may be achieved without the intermediation of banks. Since bank capital will be further depleted as the credit crunch spreads into the productive economy, peer-to-peer finance offers a solution from an entirely unexpected direction.


"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Fri Mar 20th, 2009 at 04:36:43 PM EST
[ Parent ]
Don't know how it is in northern England, southern Scotland currently, but it's getting tense here.  (Old guys like me, who have stuck their minority opinions into controversial situations, have an acute sense of dangerous levels of tension.)

I'm actually still working on your/our principles.  If you can help me find $300k, we can do the land phase of workforce housing in Carson, WA with a guaranteed 5% for investors.  I'm good for $30k, and Steve N. might be interested.  LLC with builders and suppliers at-cost for labor and materials with (reasonable) profit as their buy-in on the long term.

Another (producers') co-op project involves chipper, dump truck, and track-skidder for forest-health/fuel-reduction thinning operations cum woody biomass energy-source purpose.  I'd diary that and several related topics, but I just don't have time at present.  I'm going off to Texas April 7 for a visit, then driving back over 8 days.  Should be able to elaborate then.

paul spencer

by paul spencer (paulgspencer@gmail.com) on Sat Mar 21st, 2009 at 02:27:02 AM EST
[ Parent ]
Paul,
Send me a link or links so I can educate myself. And do diary this, with time frame ASAP.

Capitalism searches out the darkest corners of human potential, and mainlines them.
by geezer in Paris (risico at wanadoo(flypoop)fr) on Sat Mar 21st, 2009 at 04:57:30 AM EST
[ Parent ]
but I really do not have time.  I barely manage to come by ET and sample the diaries.

paul spencer
by paul spencer (paulgspencer@gmail.com) on Sat Mar 21st, 2009 at 11:06:21 AM EST
[ Parent ]
Commendable - at least someone is putting some ET talk into action.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Carrie (migeru at eurotrib dot com) on Sat Mar 21st, 2009 at 05:12:04 AM EST
[ Parent ]
That is why the New Good Banks / Bad Old Banks plan pulls out protected bank depositary liabilities to be the liabilities of the "New Good Bank" and the sound assets  to form its assets, makes up the shortfall if there is one, against a Senior stake in the Bad Old Bank ...

... in the case that there are more sound assets than deposit liabilities to be protected, the surplus sound assets can be left as a part of the asset base of the Bad Old Bank. Shareholders are still likely to get wiped out, but bondholders in those institutions will get more cents on the dollar ...

Then the Bad Old Bank can be moved from receivership to bankruptcy, and the management of the Good New Bank can be taken over via an LLP/LLC with an existing bank that managed itself with enough prudence to be solvent in the middle of such a severe recession.

Geithner is protecting the wrong part of the finance sector ... which is not surprising, since he is from the Anglo Disease part of the finance sector ...

... since finance companies that survive will have trimmed their sails substantially, small and medium sized businesses are going to need a functioning banking system if they are going to be able to respond effectively to any upturn in demand that should occur and consumers are going to need a functioning banking system to be able to respond to any stabilizing of household income.

Indeed, if we are going to hope to bring as many banks OUT of receivership as we will need to do, it will have to be in the context of a recovery, and waiting to clean up the mess until the recovery happens means we are caught in a vicious circle, since the lack of confidence in the solvency of large money center banks makes recovery less likely.
 

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Sat Mar 21st, 2009 at 07:48:02 PM EST
[ Parent ]
Indeed, if we are going to hope to bring as many banks OUT of receivership as we will need to do, it will have to be in the context of a recovery, and waiting to clean up the mess until the recovery happens means we are caught in a vicious circle, since the lack of confidence in the solvency of large money center banks makes recovery less likely.
My own prediction is that, for instance, the stock markets won't hit bottom unless and until the banking sector is repaired.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Carrie (migeru at eurotrib dot com) on Sun Mar 22nd, 2009 at 04:21:42 AM EST
[ Parent ]
My own prediction for the US is that with the stock market in the toilet (whether or not it hits bottom), many medium sized companies that could raise funds in equity markets will need bank lending for working financial capital should there be a prospect of new orders.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Sun Mar 22nd, 2009 at 11:34:14 AM EST
[ Parent ]
Well, stock prices are underpinned by earnings, and for as long as earnings are perceived to be falling there won't be anything underpinning stock prices.

We're into second order effects now. If people are out of jobs then it doesn't matter much what the mortgage rate is or the market rent - they won't be able to pay.

So a second wave of defaults on apparently "prime" mortgages gathers pace.

I cannot see any conventional way of stopping the spiral we are in. The numbers are too fucking big.

Better try something unconventional, eh?

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Mar 22nd, 2009 at 11:44:36 AM EST
[ Parent ]
See this article I quoted in the other thread:


Accordingly, his funds generally eschew leverage, or making bets with borrowed money. He insists that his fruitful subprime trade, far from being stunningly clever, was a no-brainer for anyone who bothered to analyse the complex securities' underlying collateral. "It was obvious that a lot of the stuff...was practically worthless at the time of issuance," he says. He finds it "perplexing" that the banks holding the higher-rated tranches could not see this danger, and that so few others were prepared to believe that Wall Street's finest could have miscalculated so badly.

Another motivating factor for Mr Paulson was the alluring asymmetry of shorting credit. The most you can lose is the spread over some benchmark rate. Yet if the bond defaults, the gains can be mouth-watering. He targeted BBB-rated tranches, the lowest in subprime securities. With credit spreads so low because of a liquidity glut, his possible upside as a buyer of protection using credit-default swaps (CDSs) was as much as hundred times the potential downside. One $22m trade is said to have netted him $1 billion when Lehman Brothers went bust. Though the CDS market has been good to him, he believes it "blew out of control" and needs to be regulated and moved onto exchanges, with margin requirements to limit excessive speculation. He also advocates tighter oversight of hedge funds.



In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Mar 20th, 2009 at 05:53:43 AM EST
[ Parent ]

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