"The wealthy, not only by private fraud but also by common laws, do every day pluck and snatch away from the people some part of their daily living. Therefore, when I consider and weigh in my mind these commonwealths which nowadays do flourish, I perceive nothing but a certain conspiracy of rich men in procuring their own commodities under the name and authority of the commonwealth.

They invent and devise all means and crafts, first how to keep safely without fear of losing that which they have unjustly gathered together, and next how to hire and abuse the work and labor of the people for as little money and effort as possible."

Thomas More, Utopia

Tuesday, September 30, 2008

In a nutshell...

The following comments are courtesy of a poster over at the New Republic blog and it is perhaps the clearest and most accessible synopsis yet of the Wall Street debacle and what's at stake:

(September 30, 2008 9:07 AM)

Very few people in or out of government understand what this crisis is about.  The simple  answer is that highly levered financial companies that participate in the credit/money supply have lost their equity due to the market decline in their mortgage-backed assets and related derivative contracts.  That freezes the flow of credit/money supply.  So, something needs to be done if the economy is not going to tip into sharp recession because credit/money are essential lubricants for transactions.

However, there is a correct and visceral negative reaction to the notion that the best or only way to stabilize the credit system is for the public to eat the losses generated by rapacious finance types by buying up their bad paper at above market values -- which is what the Paulson plan is about.  Dress it up how you will, it is nothing more than a giant handout to the very people who are to blame for the problem at the expense of everyone else.

It is simply unnecessary to do this in order to stabilize the system.  The right way to do it is a variation on what has occurred at AIG and WaMu, which is that the investors, both debt for money borrowed and equity, get wiped out in the course of the recapitalization of the operating assets.  It isn't even necessary to wipe out the debt and equity.  They can be left in a position to realize the full value, and more, of what they own today.  How can this be done?

It can be accomplished with a law that, by fiat, removes from the books of the operating companies their bad assets, their indebtedness for borrowed-money, and their derivative contracts (which combine both an asset and a liability) and spins them off to a parent or trust that is free to realize them as a pass-through tax entity (meaning there is no taxation at that level, only at the level of the ultimate owners).  The trade/operating liabilities (deposits, customer accounts, and such) are left undisturbed.  The owners and investors have exactly the same pool of assets and liabilities that they did before this maneuver, but now there is an unlevered operating subsidiary that is free to do business, borrow money, and raise capital without the burden of past mistakes.  In those cases where the operating entity is still under-capitalized (too many liabilities for its good assets), THEN the Treasury can be authorized to inject capital by purchasing a combination of preferred stock and warrants (the same deal Warren Buffet got at Goldman).

In this manner, the investors are left free to realize the pool of assets, liabilities, and fresh equity that they hold, but without invading the capital of the new subsidiary to do it.  They are no worse off in financial terms, other than the fact they they cannot liquidate the operating company, and are likely better off as the market as a whole returns to equilibrium.  They can hold instruments to maturity for their cash flow, sell them in the market, sell the equity of the subsidiary, whatever they want, without clogging up the flow of credit.  It reorganizes the situation so that it is the shareholders and investors who bear the losses, not the operating entity, as if, for example, the shareholders of Lehman had gone bankrupt, not Lehman itself.  Best of all, this "recapitalization on the fly" does not redistribute losses from those who produced them to anyone else.

Now, you tell me why the Bush administration prefers just to hand out money to the very people who caused the problem -- the dying gasp of the Bush kleptocracy.  People may not understand the intricacies, but their visceral negative reaction to the Bush/Paulson plan is spot on.  It is a pity that the Dems seem to have no one who can figure out what is wrong with the Bush plan and how to fix it.


Cut it, paste it and pass it along.

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