Tuesday, September 23, 2008

A Way Out Of This Mess

The following is a letter that I have given to Inslee, Cantwell, and Murray. I have also put this to every member of the House Financial Services Committee and the Senate Banking Committee.

If you agree with this, please visit:


Please take this letter, put it under your name and send it to your representitives. I have been working with Inslee's staff in DC to get this into the hands of someone that can get this moving. If you would like to help, please do so. Call Inslee's office at 202-225-6311 and tell them you like the FedUpUSA.org proposal and want to see it implemented. It gives Congress a "way out" of the current mess that Paulson and Bernanke have trapped them.

If you are in Norm Dicks' district, I encourage you to press his office. He is one of the most powerful members of Congress and he can get things done.

Please leave a comment if you have any questions. Due to the serious nature of this matter, I will have to pass on my normal snarky tone. I hope you understand.


A Solution That Works

The Honorable Jay Inslee:

By now, you have been thoroughly deluged by angry phone calls and letters from your constituents. They do not wish to pay Wall Street bankers trillions of dollars of their hard earned money for putting our financial system at this level of peril. You should respect their wishes.

However, you can’t leave without doing “something,” and that “something” always seems to come with a hefty price tag and an uncomfortable level of trust given to those, who for the last 18 months, have told us not to panic and that all is well. There is a solution that costs the government nothing, eliminates “moral hazard,” and ensures we never have to do this again. Any variation of the current proposal lacks all these features.

The solution is to fix the problem, not paper it over.

For the past 13 months, every “crisis” in the banking sphere has descended from three basic flaws in the current regulatory structure:

- Over leverage. The failures of the Bear Stearns, Lehman Bros., Merrill Lynch and various hedge funds descend directly from their level of financial leverage. At the present levels of leverage, one mistake and you are dead. Back when these financial institutions were regulated to carry no more than 12:1 leverage, we didn’t have banks blowing up every 13 weeks.

- Unregulated derivatives. This is what caused the trillion dollar insurance company, AIG, to be taken under by the Treasury Department. Financial service providers made billions writing insurance policies that were unregulated and carried no regulatory oversight that ensured they would be paid in the event they were triggered. No other category of insurance policies is unregulated in this manner. Warren Buffet refers to these instruments as “financial weapons of mass destruction.” The notional value of these numbers in the tens of trillions.

- Fictional Accounting. This is the precise reason that “short sellers” have pounced on the various financial institutions. The current accounting allows banks to intentionally produce fraudulent financial statements, regarding the value of various assets they claim as part of their net worth. The short sellers understand that the value of these stocks are grossly under their current price and act accordingly. Banning short selling does not change the fact that these companies are priced well above their value. You NEVER see short sellers attempt this with healthy, truthful companies.

The solution is to pass a comprehensive regulatory reform bill that:

- Reduces leverage to safe levels. This needs to happen over the next two quarters. Company reports shall be required to show that financial leverage is within statutory limitations, or enforcement action will follow.

- Put Credit Default Swaps on a regulated exchange. This ensures the insured party can be paid and prevents the nightmare scenario of a chain-reaction of defaults across the system. The equity options markets are a good example of how this needs to be structured. No company may be allowed to write these derivatives without the capital backing necessary for performance.

- End fictitious accounting practices. Every company must mark all of their assets to current market value on their quarterly and annual statements. Each asset must have its own accounting as to its value. This way, full transparency is brought to the marketplace and investors know exactly what they are buying. This will end the practice of hiding unhealthy companies within the larger herd of structurally sound companies, as is the current practice in the US banking system. Capital will immediately flow to the healthy companies and the assets of the unhealthy companies will be taken into the market and deployed to their most efficient use. The current practice only serves to cast a pall of doubt over the entire sector until it fails en masse.

Note that these proposals end the current “crisis” within two quarters. These proposals do not cost the taxpayer one dime. They fix the problem, and most importantly, they eliminate the enormous moral hazard that is present in any derivation of the current Paulson/Bernanke proposal. They establish the framework for building a healthy, stable, and useful financial system in the United States. “Bailouts” and dark-of-night enforcement changes are obviated.

The Congress retains all of its financial oversight and regulatory powers. The Administration is consigned to its enforcement role, as the Founders had set forth.

For more information, please go to:


We are a non-partisan organization dedicated to banking transparency and regulatory reform. Our proposal is simple, effective, permanent, and cost neutral. We are not coming to you at the last minute with some hideous scenario that we denied for 18 months.

We are giving you a way out of the present mess in a manner that the taxpayers you have been hearing on your telephones will cheer.

Please do the right thing. Do not give our money to Wall Street. Force them to take their marks like the rest of America.

Very truly yours,


Jillayne Schlicke said...

I have sent this to Maria Cantwell and Jay Inslee.

I'm concerned that Paulsen and Bernanke have held back until now, and timed this so that it would seem like a massive crisis.

It seems like congress is screwed either way. If they vote for it, taxpayers will revolt. If they stall, then they'll be blamed.

This appears to be a set up, but I don't want to read too much into the timing. What do you think?

Eleua said...

I am reading the timing as horribly suspect. While my opinions in this matter are strictly conjecture, I believe the timing of the takedown of FNM/FRE and AIG were to get to Pelosi.

Look at "Roll Call." Today, the Administration admitted to having this plan for several months. If so, why didn't Congress hear of it until the last minute?

Fratto [Deputy WH Press Secretary] insisted that the plan was not slapped together and had been drawn up as a contingency over previous months and weeks by administration officials. He acknowledged lawmakers were getting only days to peruse it, but he said this should be enough.

This is from "Roll Call" 9/23/08

Yeah, these guys are scumbags. See my previous blog entry.

Anonymous said...

Your plan will lead to multiple collapse of banks and insurance companies and massive loss of savings of regular people since they don't sell anything short.

People like you are willing to sacrifice many others. I had visited a few countries where banking system collapsed and freedom is the least likely outcome of that.

Eleua said...

You think that is why I oppose this? Are you that cynical?

FYI, I am largely flat on the market with a slightly LONG bias, as I believe this bill will pass in some form. I will short it when it gets to its apex.

I am trying to defeat it for the reasons outlined in my last two blog postings. It only serves to crater the market, distort the banking system even more, bail out the wealthiest 1/200th of the country, and tax all those poor people you think will get ruined because they "don't sell anything short."

Freedom? What kind of freedom comes from debasing your currency, setting up a dictator, and taxing the middle-class to death for generations? That assumes the bond market does not implode. If it does, then you have complete economic chaos and a Congress that just went against 97% of the people.

You are a myopic fool that can't see what is plainly before your eyes. If you think this will help out all of those "regular people," please elaborate.

This is something I must hear.

Anonymous said...

You and your kind always seem to know "the truth". You know enough to be dangerous to yourself and others. Without this plan, however poor, the monetary system as is will sease to exist. If you don't understand it, you are clueless.

Eleua said...

Please explain how this plan saves the monetary system, and how it will cease to exist if we implement banking regulatory reform.

Absent any cogent explanation, I will assume you are buying the spin that this makes all our debt boo-boos go away.

3 generations of debt excess can simply vanish by giving those that caused this mess a $700B revolving money printing power to extract all their money from the system.

Please explain how this helps the average American. Use specifics.

Anonymous said...


Good job. Thank you.


Anonymous said...


The current monetary system is based on credit. Right now, industrial companies that usually access commercial paper market to fund daily operations can not do so. Many such businesses operate on Net 60 to Net 90 days with their customers. Farmers can not get loans for equipment and fertilizers. Companies like Caterpillar have to pay huge premium rates, directly impacting their daily operations. Yields on municipal paper are through the roof, cities and towns are impacted right now. Without this intervention we are going to see complete seizure of credit markets and multiple bankruptcies of industrial companies and banks.

The plan, as is, is not perfect by any measure. At best, it buys 2-3 months. It fails to address the critical issue.

Market-to-market accounting forces banks to write down to pennies perfectly decent bonds. Let’s look at some numbers.

For instance – let’s say a bank has sub-prime paper that originally yielded 8%, with $10 million par value. The actual number of mortgages in such paper is about $10.8 million actually since 8% is “equity tranche”, or protection built-in to sell such paper.

We know that one of the worst underwrites, Countrywide, has default rates of 30% on sub-prime mortgages. Let’s apply loss of 50% of VTV to those 30%, since prices in some CA and FL markets are down 50%, and another 50% from that on collections, commissions, selling costs, etc., with overall recovery rate ending at 25% of original principal. So out original par of $10 million, we are down to $7.056 million (paper had $10.8 million in mortgages, default of $3.024 million, but $756,000 (25% loss recovery) is also returned to investors). Heck, let’s apply 50% loss to the value of remaining collateral across the board (even though it is not realized and likely in large % will be repaid). Thus the extreme low value of remaining paper would be $3.528 million. Yet, Merrill Lynch had to sell this sort of paper at $.22 on $1. Or for $2.2 million, just to take it off the books. The buyers for $2.2 million got the paper yielding $560,000. Not bad, eh? Merill Lynch lost $560,000 in cash flow, AND financed the transaction.

Prime MBS may have yielded 6%. Worst default rates are 5% of such paper. Let’s apply 100% severity loss. Since prime paper usually had about 5% equity protection, this would not even impact the principal in any way. Even with 20% default rates with 50% recovery, only 5% of principal is impacted. Yet, nobody will buy this kind of paper in current market even at
$.80 on $1 of par value.

What was needed is temporary suspension of mark-to-market accounting for mortgage paper. The banks could be required to disclose loss severity, cash flow, vintage, geography, etc. It would allow market to return to normalcy and stop never-ending write-downs based on fire-sales.

Additionally, restoration of short selling is required, so market can be supported on the way down, but with re-instatement of up-tick rule, so short-sellers can not beat the stock down without any resistance. Up-tick rule served as protection to market manipulation at extreme times.

Further, without some sort of national low-rate mortgage program it’s all mute. Banks will not put the cash back into mortgage market; they will keep it in order to pay off coming due short-term loans. The Feds can use tax $$ much better by providing Fannie and Freddie with $250 billion for temporary refinancing program, with rates at 5% for for 5 years, reverting back to market rates after that, so people can refinance and new buyers can buy homes. While still a subsidy, this is better than loaning banks money through FDIC at 2%. Twenty largest banks can be offered $100 billion in capital in exchange for preferred shares at 8% coupon rate, with an option for banks to buy back this paper at $1.05 to par. Thus, the total costs to taxpayers will be $350 billion, with revenue in a form of yield on all that paper coming at $20.5 billion per year going to tax payers. Banks can keep the fees for originating this low-rate paper.

Bernanke and Cox need to be fired immediately. They lost all credibility.

There is no alternative. The simultaneous demise of Lehman, Fannie, AIG and WAMU triggered payments on many credit default swaps. Right now multiple money-market funds broke the buck. People are withdrawing money from them. Commercial paper market is frozen. Fortis, the large EU conglomerate with $1 trillion in assets, is on a brink. Its demise would severally undermine EU credit markets.

The plan has a chance to buy some time. Without it, you are looking at drop in stock market in 40%-50% range, massive loss of pensions and 401-Ks and unemployment rates of 12% to 15%. I know some people like you actually would like this to happen. But it will mean the end of current monetary system.


Theirs answers than theirs solutions.