Saturday, September 27, 2008

Since I know as much about the financial crisis as McCain, Obama, or any member of Congress (which is to say nothing), I figured I could propose my own plan. The root of all the financial troubles is bad mortgages. Too many Americans bought houses they could not afford, by using "innovative" financing like adjustable rate mortgages, or even better, interest-only adjustable rate mortgages. Home buyers stretched as far as possible to finance purchases, the mortgage industry handed them more rope to hang themselves, and housing prices surged into a bubble because of the escalating availability of funds. So, to me, this just means many houses are mortgaged for more than their "real" market value, and many home owners are living with mortgages they can't afford. Everything else - mortgage back securities, mortgage insurance, credit defaults on institutions that own mortgage backs - are all financial leveraging and hocus-pocus. These instruments are evaporating and causing the financial industry to "de-leverage", which is a polite way of saying lose a huge amount of paper wealth. The game on Wall Street has been to re-package and pass around all these mortgages because Wall Street basically makes money on transactions. The more money changes hands, the better. So, besides the poor sobs who innovate on Wall Street, who cares about these paper losses? Pretty much anyone who needs to borrow money, which in America is everyone. Banks are folding at such a clip that banks are afraid to loan money to each other. To compensate, the banks charge each other more interest. To continue to make a profit, the banks charge businesses and consumers more interest. Taking loans is much less attractive, so fewer are taken, and basically the economy hits a real recession, maybe worse. So, what the hay is my plan? So far in this crisis, we've been shuffling the levered paper around. Everyone who holds the bad paper eventually suffers a credit downgrade, which means you need to post more collateral for loans and pay higher interest. That kicks off a spiral that leads quickly to insolvency. Now, I know Lehman Brothers is the proverbial fly on keester of the elephantine US Government. But we're talking about three quarters of a trillion dollars; the Federal Reserve's entire balance sheet is "just" a trillion dollars. I don't think it is a good idea for the US taxpayer to attempt to swallow all that bad debt. Instead, what if the individual property owners appeal to the US government in the event they are at risk of foreclosure. The government then buys the property from the bank holding the mortgage for tax appraisal value, and writes a new, affordable mortgage for the home owner. The difference, I think, is the US avoids absorption of the leveraged instruments. By only paying the current value of the underlying real estate the US would hold physical assets (the real estate) as well as mortgage obligations from home owners. It also focuses the expended funds to fend off foreclosures (many of the bundled mortgages are not at risk of default). Also, while this plan would stem a panic, it does not completely isolate irresponsible financial institutions and individuals from the free market.

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