Random Thoughts on the Bailout Crisis

Lessons Unlearned

Which part of the last 7 years did the administration and Congress not get? They've been giving money to every size organization since the airline bailout in 2001, and none of it has stimulated any sustainable growth. Every tax cut and government rebate check have only provided a short term spike followed by continued instability on the downward spiral.

Market stability can't come from an infusion of cash any more than a broken engine mount can be fixed by stepping on the gas. Buying up the bad debt in the market won't stabilize them because the problem isn't the bad debt, but the means by which that debt came to tie up the markets. In the New Deal, the Glass-Steagall Act separated the operations of banking institutions to minimize risks by eliminating conflicts of interest and preventing the mixing of risks between these institutions.

In essence this act worked to ensure a stable economy by making sure the U.S. was sufficiently diversified, and that no common financial event could wipe out the entire economy. This would be similar to keeping your 401K diversified to an acceptable level of risk.

This act was repealed in the 80's and allowed the creation of sub-prime mortgages and the MBSs and CDOs that made them so popular. In essence the repeal of this act recreated the event which caused them to originally be written, but with a 21's century flair. Funny how that works.

Self-funded Bailout Plan

It's hard to get your money back from a bad investment because there may be nothing illegal about that investment. However, there is something quite illegal about an organization wide attempt to defraud individuals and banks. This is essentially what was occurring with many sub-prime mortgage, MBS and CDO lenders. We have heard many reports about this but haven't seen much action.

The problem is that the SEC isn't equipped to handle enforcement of something so widespread. However, the FBI is. I am not suggesting that the FBI enforce SEC policy, but they sure can enforce laws against wire fraud, 18 U.S.C. § 1343:

Whoever, having devised or intending to devise any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises, transmits or causes to be transmitted by means of wire, radio, or television communication in interstate or foreign commerce, any writings, signs, signals, pictures, or sounds for the purpose of executing such scheme or artifice, shall be fined under this title or imprisoned not more than 20 years, or both. If the violation affects a financial institution, such person shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both.

The problem is obviously the fine limit (which should be updated for the 21st century), but this is an avenue to restore some balance. Everyone involved in the wire fraud is subject to being a participant in the act. Could they net 1000, or 10,000, for this crime when you involve all of the e-mail, blogging, texting, blackberry, and cellphones of the modern age? Guaranteed.

The money that would be received from the suits should be put into a general recovery fund. The recovery fund would first be used to refund those who were mislead into believing that they were in a fixed rate loan but found themselves in an ARM. Second, the fund would be used to repair those who were mislead into investing into MBS or CDO type vehicles. Remaining funds would be used to help out faulting mortgages and in renegotiation of those mortgages to acceptable rates.

Post-Facto Anti-trust Enforcement

Over the last few months, we've heard the term "too big to fail" too often. We have anti-trust laws, but they haven't been enforced for decades. Over the last few months, firms that were "too big to fail" were falling apart and being assumed by even larger firms. Doesn't it now make these firms "much much too large to fail?"

AIG was one of these firms, and the government bought them in the blink of an eye. The plan, as it's been portrayed, is to break the firm apart into smaller, lower risk elements which would not cause so much instability in a collapse.

The rest of these monstrous economic single point failures should be identified and broken into smaller, safer chunks. Not only would this be safer, it would create jobs, induce competition and provide more options for diversified growth.