Could Wall Street Have Bailed Itself Out of This Crisis?

Placing blame on Wall Street, Washington and the irresponsible behavior of mortgage lenders is on everyone’s mind. But stepping back, the whole subprime debacle was predicated on the fact that lenders said, "Well, this borrower is not really credit worthy and can’t afford the house, but in a few years the home value will be up 20% more."

And let’s face it, five years ago almost everyone knew someone selling mortgages. Primerica, a multi-level marketing company with 100,000 sales agents (and a Citigroup subsidiary!) is just one example. While just about anyone can sell Avon or Tupperware, home equity loans are just a bit more involved. Yikes! (see primerica.com).

The industry also believed that through geographic diversification you can diversify risk, so high risk loans would likely be absorbed into a much larger loan pool. This was part of the underlying cause for the entire breakdown, and was building for 10 years. Fannie Mae and Freddie Mac were also recklessly and incompetently run.

But, let’s go on. Wall Street executives and bankers did earn massive profits in a good business cycle, they did take investors for a ride and then got a taxpayer-funded bailout as a safety net when the miscalculations, faulty assumptions and obvious greed caught up with them!

As if the last eight years hasn’t indebted the country enough, the $700 billion bailout will have to be repaid to the tune of just under $5,000 per taxpayer… plus interest! This will surely tie the hands of the next president such that tax increases will be inevitable, and new programs will be a real challenge to implement (healthcare, education, social security, infrastructure!). But those effects are only the beginning. As the months roll by get ready for a weaker dollar, higher interest, higher commodity prices and stagflation for the next few years.

Isn’t there another way?

(The primary resource for this section is credited to Thom Hartmann). As a matter of fact, there is. Create a tax on financial trades. Not a big tax, but a miniscule ¼ of 1%. That would amount to $25 on any $10,000 stock, currency or derivatives transaction. Sounds fair enough, yes? Have a government agency dole out the bailout funds from the Treasury, but collect a tax on all stock trades, swaps, derivatives or any other type of trade, to pay back the Treasury. In the first year alone, Wall Street could collect a staggering $150 billion. Yes, that’s right. Wall Street could literally pay for its own failure. It’s Wall Street that needs saving from itself, so this seems only fair, doesn’t it? And one of the better outcomes might be a renewed faith in a new - more responsible - stock exchange.

Is this plan really so far fetched? Actually, no. Securities Turnover Excise Taxes (STETs), as they are called, have been used before, and they are still being used today around the world. These taxes are not only fair, but they work.

Let’s go back in time for a moment. In the decade leading up to the Great Depression. Rules limiting speculation were lifted, which led to a bubble in housing. The bubble spread nationwide until it burst in 1927. Falling home prices burst the bubble, and the great stock market crash followed in 1929. Sound familiar?

In the period that followed, Hoover tried to bail out the banks, which only amounted to huge bonuses for Wall Street executives. It ultimately failed to work, and only staved off the inevitable. It wasn’t until Franklin D. Roosevelt instituted new rules against speculation and doubled the STET tax that the stock market finally stabilized, grew and persisted until 1966. Several nations are using STETs today, including the UK and Taiwan.

As John Maynard Keynes pointed out in his seminal economics tome, The General Theory of Employment, Interest & Money in 1936, such a securities transaction tax would have the effect of "mitigating the predominance of speculation over enterprise."

In other words, it would tamp down toxic speculation, while encouraging healthy investment.

The reason is pretty straightforward: Without costs to the transaction, people of large means are encouraged to speculate … to, for example, buy a million shares of a particular stock over a day or two purely with the goal of driving up the stock’s price, so three days down the road they can sell their stock at a profit and get out before it collapses as the result of their sale.

Perhaps the most important benefit of immediately instituting a STET in the USA, however, isn’t that it would raise enough money to bail out the banks and billionaires (and after that crisis is covered, could help pay for a national health care system!), or that it would encourage investment and calm down markets. Those are all strong benefits, and absent the current Bush bailout proposal would stand-alone strongly.

But borrowing another $700 billion (from China and Saudi Arabia), adding it to our national debt, and repaying it with interest, drives the actual cost over the next 20 years to over $1.4 trillion!

So let me ask you? With all the brilliant economists out there feverishly soul searching for a rescue remedy, why has no one proposed this simple, tried and true Treasury reimbursement plan, and have Wall Street pay for its own lack of due diligence?

But hey, it’s not all bad news. While a STET seems highly unlikely, the government’s decision to actually invest in troubled banks has worked in the past, and could likely work again.

Bringing Back The Resolution Trust Corporation

With so much fear and lack of trust going around these days, to whom would you turn to manage the cleanup of our financial system? Is it wise to put the job in the hands of only one individual to perform voodoo on the economy, one financial institution at a time? Is it fair for a single individual to have the power to decide whether a Bear Stearns or an AIG survives?

Make no mistake; we have a serious problem. We have not seen market turmoil like this since the Great Depression. The worst part is that trickle-down economics, stuck in reverse, has not yet wreaked all its havoc on the American citizen. It will surely get worse before it gets better. Wall Street plays the central role in a global economic ecosystem. Its ripple effects are enormous, much like throwing a stone into a lake. Wealth made on Wall Street feeds concentric rings of downstream micro-economies that immediately feel the pinch when spending slows down. Wall Street spending also provides countless jobs as the money changes hands again and again to purchase goods and services. The negative impact on the global economy will be, and already is, immense.

How do we stem this problem quickly, decisively and responsibly? In order to consolidate and clear out those "toxic" mortgage assets (if that’s still the government’s plan du jour), we need to revive the old Resolution Trust Corporation.

The Resolution Trust Corporation, or RTC, as it was called, was a government asset management company created to liquidate mortgage loans which were assets of the failed savings and loan crises of the 1980’s. The RTC used equity partnerships to liquidate real estate and financial assets it inherited. Under these partnerships, a private sector partner would acquire a partial interest in a pool of assets, then manage and sell assets as the partner saw fit, and return a proportionate amount of the profits to the RTC.

The private sector involvement gave the RTC a "better deal" than just selling assets in bulk. Portfolio investors with expert knowledge and involvement in the real estate market could provide better returns than the RTC could.

A new incarnation of a nonpartisan RTC would keep people in their homes while removing the "toxic" paper. After the trouble has subsided, the RTC would be dissolved. Of course, the RTC would require a substantial amount of capital to do its job, but the upside is the potential for complete recovery of the Treasury’s "investment" in the effort.

Translation: It’s about trust. With a new RTC, American taxpayers would not have to foot the bill for the bailout, and in the end, we will have returned the financial system to a sound footing. If a new Resolution Trust Corporation were to be installed, Wall Street would likely see a major rally within hours.

A Financial Fiasco: Who’s Really To Blame For This Mess?

Who caused the housing bubble that led to the situation we find our financial markets in today?

Let’s go way back for a moment. Back before the tech bubble imploded at the turn of the millennium. What was happening back then? As I recall, Alan Greenspan was very concerned about the "irrational exuberance" in the stock market and tried to talk it down, while insisting that he was not trying to talk it down. Meanwhile, he began a series of interest rate increases designed to slow the economy. The Fed jacked interest rates up and up and up until the last straw broke the "new economy". This effort didn’t just slow the economy down; it shattered it. The tech bubble that threatened the establishment was over. Brick and mortar was saved.

Shortly thereafter, to help the reeling economy recover from the tech bubble disaster, the Fed made money freely available. The government even threw out a bone - a nice tax cut to provide the wealthiest Americans a means to "trickle down" prosperity to the rest. The Iraq war was launched, causing significant new spending and an increase in the price of oil, which shifted spending overseas - away from American goods and services.

The Fed, under Mr. Greenspan’s watch, reduced interest rates sharply and unexpectedly, going too far for too long, keeping rates at historic lows. Money quietly shifted into real estate. Free credit allowed consumers to live the American dream while piling on gobs of debt, taking home equity loans to buy SUVs and flat panel TV’s. Many even paid basic living expenses with these loans!

At the same time, Wall Street got creative, packaging up mortgage securities into baskets of financial instruments that even they didn’t fully understand. If they had understood that complicated economic models can’t predict human behavior, which in times of distress follows a herd mentality, they would have foreseen that an implosion was brewing. (Most economic models expect rational "normal curve" behavior.) As home prices kept rising, some warned of a tech-like bubble - even Greenspan. Tinkering with rates while talking down the housing bubble, and continuing to champion self-regulation, the Fed raised rates from just 1.00% mid-2003 to 5.25% mid 2006.

For two years consumers teetered under the weight of higher credit card interest rates and adjustable rate mortgage payments. George Bush again doled out some tax freebies to try to keep the spending going, but the party was almost over. As late as July 2008, the American public was being told by the Administration and notable others such as Hank Paulson and John McCain that the financial system was fundamentally sound. Perhaps this was a last ditch attempt at talking up consumer confidence. Or, perhaps they really didn’t see it coming. Either way you look at it, and to whomever you attribute blame, it’s clear that our economic stewards have been asleep at the wheel for quite some time, and the new administration needs to make some fundamental changes in financial stewardship and oversight.