How the Government Can Fix the Credit Crisis
The government is putting its printing press into overdrive. Congress passes new legislation every week that either bails out auto companies or bails out banks; the Federal Reserve has lowered its rates to zero and opened up the borrowing window; and the Federal Deposit Insurance Corporation (FDIC) has increased the amount of insurance it allows each bank account to be insured for.
In your own life, when confronted by a budget crunch, don’t you look for some free ways to alter your lifestyle to make things better? Our government can do the same. Here are two suggestions as to how the government can make the playing field fairer, and help alleviate the credit crisis without spending a penny.
First, they need to bring back the “uptick rule” to the stock market. The uptick rule was part of the Securities and Exchange Act of 1934. It allowed traders to sell a stock without owning it, but only after a slight rise in the price of the stock. The rule stopped raids from happening on stocks for 74 years. After being repealed on July 6, 2007, shorting could and still can be done without waiting for any upward movement in the price of the stock. Just sell the stock, hope the price action goes your way, and make money buying it back. Short sellers can be merciless. If there is enough selling pressure, a frenzied run on the stock can ensue. Investors are either forced to sell because of margin calls, or sell to save any profit they have left in the stock. If there is enough selling pressure, a run on the stock can start as investors sell to cover losses or take profits. It has been alleged that hedge funds colluded to attack different bank stocks.
Our nation’s stock exchanges are a public market where capital is raised for business. Of course, you can make money there speculating and investing. However, the primary role of this marketplace is for businesses to raise equity stakes to create cash for their balance sheets and continuing operations. By framing the role of the marketplace in this manner, having rules on speculative short selling provides proper regulatory control of the marketplace. Short selling would still be allowed, but the short seller would have to assume a little extra risk by selling into a higher price. Shorting stock does provide an invisible hand, as it keeps companies and investors honest. Call options writers would have special rules with regard to shorting stock. We have to limit the way short selling can occur because its misuse has brought detriment and dislocation to the marketplace. This change in regulation costs nothing.
What’s the point of being a shareholder if it’s illegal to be paid your share in the profits? And what value does that stock then hold, if there’s no legal way to collect a dividend?
I would be holding a stock that will collect no revenue, and I can’t sell it. Until someday, when a ban is repealed.
“How do we value the assets if there is no comparable market”
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So far, guns and ammunition are fast becoming good investment commodities.
Your whole post makes too much sense and as [surely] you must know…the people ‘running’ things [into the ground] right now have about as much sense as a chic trying to crawl back into its own shell.
Our obese, bloated, gassy government has taken charge full steam ahead right off the rails…
If/When we survive this sucker punch the drinks are on me.
♥,
Delia
The author may be correct, but he is very naive. The current government is not interested in fixing the crisis. They are only interested in using it to expand their control and relieve citizens of their freedom to choose. Rahm Emmanuel slipped and spilled the beans when he said ‘We cannot let a good crisis go to waste’.
We have been warned of this sort of mischief by many wise men down though the ages. That so few recognize it is testimony to our failed public education system – a system that now produces socially conditioned sheep.
The ‘Brave New World’ has arrived.
Regulations to make the market more ‘fair’ or ‘efficient’ never work, overall. They just shift risk and capital to where it would go otherwise.
Also, unless there is some form of fraud taking place, or some other right being violated, there is no moral justification for the Feds to step in to arrange things the way some traders would prefer.
Short sellers have the same right to risk and reward as anyone else.
The author misses the fact that banks can be precluded from paying dividends to shareholders at this time if their balance sheets are precarious. De novo (new banks aged less than three years) are in this class regardless of financial strength. If the present value of bank shares is the summation of the discounted cash flows from the bank to investors over time, and those cash flows are zero should dividends be prohibited, then does that make their value zero? And if so, why would any rational investor seek to invest in banks?
No penny, no stimulus, no payoff to ACORN, no earmarks to cronies and supporters, no contributions to next campaign and life after. Ergo whatever you suggest is DBA (dead before arrival). The biggest threat to Mr. O and Mrs. Pelosi is the economy turns up before any pretty penny was spent.
How can the suspension of bank dividends be done at no cost to taxpayers? I’m a taxpayer and I own bank shares and I receive dividends, upon which I pay taxes. What is the author talking about? Moreover, the value of my shares would absolutely decline, causing me a further loss. Give me a break, come up with some more realistic solution.
I don’t see why “government” has to fix credit; They didn’t create “credit”. Every time a policy is passed that effects credit, my credit cards charge more interest and have more penalties and fine print.
The “government” has screwed up credit enough; They should stick to what they are supposed to; Protecting our borders and individual freedoms.
But, it is evident, the Democrat Party is on its crusade to enforce themselves on all citizens; Like it or not.
The whole damn Democrat Party should fail.
Obama Pelosi and Reid should be brought up on criminal charges for cruel and usual punishment against the American people for what they will do in the next two years…..
They are actively usurping our Constitution as the Supreme Court and the Republicans stand idley by and do nothing
I don’t see how the government can fix much of anything. Dabbling in the private sector by politicans, compounds problems. If politicians were so good at handling money, we wouldn’t have a deficit.
The government has run amuk with our tax dollars, trying to invest in programs not intended to be run by politicians. Most of them are not trained in anything but the law and most of them never really worked at it much but became politicians instead.
Putting the government in charge of banks is no different than having a politician do heart or brain surgery. How would you expect that to turn out?
You don’t help an addict kick the dependancy until you pull away the supports. Let the banks fail, and support the borrower (under appropriate circumstances). Regulating the ability of banks (which is necessary in part, but not…) to give dividends is not the answer…it punishes the good with the bad. The free market needs to stay free, but with punishments for those that focus on short term vs. long term gains. Housing bubble for example, proper regulations could have prevented banks and investors from crossing the solvency line. Banks wouldn’t lend to someone who had a debt to asset ratio that was out of line…take the commonly accepted standard, add a few points, and mandate/regulate it (at least for now). We have regulations to keep banks from lending more money than they actually have in the vault (well, a ratio of such), and this is no different. Don’t stiffle business and banking, but keep it within GAAP and lending standards…capitalism is fantastic, but it can overreach itself and we’ve seen it hundreds of times. Give them flex, but not to the point of becoming an AIG or Citi that can fall into the “too big to fail, but enough latitude to fail” category.
Jack
There is no such thing as hard to priced toxic assets if there is loss compensation agreement from bank which sells the toxic assets, and the bank has financial ability to make the compensation, plus government guarantee the bank has financial ability to honor the loss compensation agreement, by guaranteeing the timely interest and principal repayment if the bank defaults.
Toxic assets can also be sold at hold to maturity price, i.e. the present value of expected cash flow of the toxic assets, with the government guarantee and bank guarantee.
For example, the Public-private Investment Fund purchases toxic mortgage backed securities at cost of $500 billion with the loss compensation agreement from banks. If the investment fund finds that expected cash flow of the toxic assets worth $300 billion one year later, the banks will compensate $200 billion, plus interest, to the Investment Fund. The Fund, or taxpayers, will not lose any money in the purchase arrangement, and earns interest on the principal invested in the toxic assets. The banks sell the toxic assets at high price, but realize the actual loss based on the actual write-off rate of the mortgages, and do not suffer from selling toxic assets at distressed or unreasonable low prices. The Public-private Investment Fund injects $500 billion into the banking system and induces initial credit flow of $500 billion in the process. This is a win-win situation for the government, the purchasers of toxic debt securities, the banks, the taxpayers, and the economy.
Government can ensure taxpayers will not lose any money in offering guarantee of the banks’ financial ability to make compensation to purchasers of toxic assets, by charging insurance premium to cover the risk, reserving the right to raise premium in the future when the default risk of the toxic assets increase, requiring the bank to place collaterals of 5% of the value of sold toxic assets at central bank, by AAA rated securities, and adjusts the amount of collaterals in accordance with the risk of default in the toxic assets. Hence, government can ensure the banks selling toxic assets with government guarantee can have financial ability to make compensation by controlling the amount of toxic assets sale, risk premium, amount of collaterals required, and will not lose any taxpayers’ money in offering the guarantee. The stress test to be done by the Treasury Department and Federal Reserve can ensure that only banks with financial ability to honor the loss compensation agreement to be eligible for the sale of toxic assets.
If a bank is viable, this bank should have financial ability to make compensation to government or purchasers who purchase the toxic assets with price higher than the hold to maturity price. Any loss incurred by government in offerring guarantee or purchase of toxic assets will mean that banks are subsidized by taxpayers and are not viable.
Your comments are completely accurate and enacted in totality, might have mitigated some of the effects of the meltdown, but don’t offer much in the way of remedy for our current predicament. Preventing people from selling short stocks or writing short options isn’t going to increase the value of those stocks in the marketplace in the long run. … Read MoreThere are plenty of bottom pickers and value investors out there to pick up that slack. Lack of buyers is more closely related to lack of confidence, deserved or not. Shooing out the sellers may rally a market in the short run, but, as in the case of oil, look out below.
I agree that the mark-to-market accounting standard has put undue stress on banks and caused many to go under, I question the effect of suspending that system now. Where will that leave their balance sheets and how will they evaluate their portfolios? It doesn’t address the systemic root of their problem, falling housing values and rising loan defaults.
The government should suspend ALL divident payments. GE will save $9B next year by cutting its dividend by 75%. This would bolster all companies balance sheets, but ultimately undermine the intrinsic value of their securities. Gotta go, 2 hour Brothers and Sisters 2nite.
I agree with the uptick rule idea – it would provide a little more order in the market. With the decimal system being used, it won’t have quite the salutary effect as it would under the fractional share system; but less volatility in this environment would certainly help. Mark-to-market standards being revised at the Tier 3 level would help a bit as well – especially help the more fundamentally sound (and collaterally damaged) institutions ride the storm out. The last idea is a bit daft. Cash flow is the best arbiter of dividend-paying ability. Dividends are the last bit of “honesty” on Wall St. That being said, if a bank is receiving significant gov’t assistance, at the very least the dividends should be payable to the “US Treasury.”
This sort of thing is the proper role of government in the marketplace. Its job is to keep the playing field level.
The uptick rule is a good one. It helps keep people from gaming the system; exploiting a loophole. What idiot repealed it in the first place?
Mark-to-market was a bad reaction to the Enron mess. Fail. Repeal it.
Suspending dividends is a really BAD idea. There is an avenue for that already: bankruptcy court. If a bank misses its payment, and the market can’t respond because such a suspension rule makes the value instantly zero, you have essentially seized the stockholders’ assets. Really, really bad idea.
Suspending dividends arbutrarily is a bad idea, but based on what “dontreadonme” said I’d say that the drive to provide dividends is a short term incentive that is not always a good indicator of long term gains (i.e. it can be a lure) so I’d not want to rely on that alone. Let the lender fail, prop up the borrower where it makes sense. The borower may be dumb, but the lender needs to learn to be accountable.
Jack
Today, March 10, Barney Frank advocated bringing back the uptick rule, and changing mark to market.