Capital Commerce

Jim Cramer’s $500 Billion Bank Bailout Plan

July 16, 2008 RSS Feed Print

NBC's Today Show featured a segment this morning in which it brought in three economic experts—investment strategist Liz Ann Sonders of Charles Schwab, Steve Forbes, and CNBC's Jim Cramer—to give ideas about how to boost the economy. The threesome was set up with an easel and a big pad of paper so they could write their suggestions down. Then Matt Lauer interviewed each in turn.

1) Sonders had no real policy proposals. She said she wants to see a stronger dollar and thinks a recession would bring down inflation and purge excesses from the financial system. Overall, she urged America to be patient while saving more and spending less.

2) Forbes wants to cut taxes and break up Fannie Mae and Freddie Mac—once they were recapitalized by taxpayers—into 10 or 12 smaller private companies with no government guarantee, implicit or otherwise. He also wants to strengthen the dollar, although in attempting to explain how to boost the greenback in a way that the average American would understand, Forbes ended up being completely incomprehensible.

3) Cramer wants to kill government ethanol programs to bring down food prices. More interestingly, he also wants to replicate the Resolution Trust Corp. from the 1980s S&L crisis and have this 21st century version buy up mortgage-backed debt in order to strengthen the banking sector.

Me: I have also given my suggestions on this topic. But as for the above ideas, Cramer's RTC: The Next Generation idea might actually happen. And it would cost a lot, like maybe half a trillion buckaroos. (Add that total to a possible second economic "stimulus" package and you can throw out the window any idea of balancing the federal budget anytime soon.) Michael Mandel of Business Week blogged about this recently:

I think the next president, whether it's Obama or McCain, will be looking at a $400-$500 billion bailout of the U.S. housing sector. This will encompass not just Fannie and Freddie, but a wide buy-up of bad mortgages—just getting them off the books of the financial sector at a substantial discount.

It's worth looking at the S&L crisis of the 1980s to see how that might work. The total size of the bailout back then was $225 billion (see the GAO report, Appendix I, page 31). The Resolution Trust Corp. recovered $140 billion, so taxpayers had to put in roughly $85 billion (these numbers are very rough).

Assuming that the same ratio holds this time, a $400-$500 billion bailout would end up requiring $150-$180 billion of taxpayer money, spread out over several years.

That's a lot of money—which is why I don't think anything major can be done with the presidential election looming, though [Treasury Secretary Henry] Paulson went further than I thought he would.

Tags:: NBC,; mortgages,; banking,; government intervention

« Previous Post Next Post »

Reader Comments Read all comments (4)

Add Your Thoughts Comment Name State Email

Please enter the two words below into the text field underneath the image.

Your comment will be posted immediately, unless it is spam or contains profanity. For more information, please see our Comments FAQ.

Additionally, if some of these "failing" companies see that the deal they get from the government is not very attractive, they may miraculously figure out how to handle their own problems or find an alternative White Knight which is not as greedy as the federal government; in either case, a desirable outcome.
How Much to Appropriate?
I have heard that $700 billion was calculated by assuming 5% nonperforming mortgages and simply multiplying 5% times the total value of all US mortgages. If true, the government shouldn't need anything close to that. This would be a huge pot of money just waiting to be stolen.
$700 billion assumes 1) that all dicey mortgages are worth zero (no income and no asset value in the real estate) and 2) that the companies will go bankrupt if they don't receive the full original value for these problem loans. Both assumptions are ridiculous.
If all such loans were completely nonperforming, the mortgage holders would be losing a total of about $55 billion per year in income. How does that require an injection of $700 billion?
Of course, it's not quite that simple because nonperforming mortgages must be carried on the balance sheets at a very low value, decreasing the creditworthiness of the banks. This is only an accounting figment and does not represent reality. The real estate is still there and it has value. Nevertheless, even neglecting the value of the real estate the amount of injection required to clean up the balance sheets might be another say $45 billion, bringing the total to $100 billion.
The $700 billion request, further assumes that the companies had no margin for error. Most companies should be able to lose 5% of their income and yet take corrective action to avoid bankruptcy. Some companies may be holding well above 5% problem loans and they will need more liquidity. But then, logically, others must have less than 5% and they will need less or no help from the government.
Let's see how they spend the first hundred billion dollars and then go back to Congress if necessary.
Regulations
As Mark Cuban pointed out, in less colorful terms, any regulations developed by Congress will have their locks picked by the smart guys on Wall Street before the president's ink is dry. I think Mark Cuban and Sarah Palin, working separately, came up with a great insight, transparency through the Internet.
If all transactions are published on the Internet, the government doesn't need a huge regulation law nor a large regulation bureaucracy. The population will do it. I know that having the people know what's really going on scares the hell out of most politicians, but I hope and believe that both of the presidential candidates are different in this regard.
Objective #2, Further Explained
2. No Resolution Trust Corporation this time.
(I moved the further explanation of Objective #2 away from the beginning of this working paper because I didn't want to detract from the efficient pre

C. Sterling Portwood of HI 5:17PM September 25, 2008

Three Basic Objectives
1. To prevent a progressive collapse of the US economy, liquidity must be injected into the mortgage system.
2. No Resolution Trust Corporation this time.
I was involved with the Resolution Trust Corporation the last time and the government should avoid taking on this responsibility this time. Banks, through their mortgage and REO departments, are much better at handling negotiations with mortgagees concerning staying in the properties and paying reduced mortgage amounts, foreclosures if necessary, maintenance and upkeep of the properties after foreclosure, and resales. Objective #2 will be justified in greater detail at the end of this working paper.
3. Officers and stockholders of organizations bailed out by government should suffer severe financial consequences, to assuage moral hazard and for the perception of equity on the part of the population.
Alternative Solutions
1. Government loans to the companies, secured by the company's assets, à la AIG.
2. Government purchases of new stock offerings, which have a priority call on the assets of the company.
3. Government purchase of newly issued convertible, which have a priority call on the assets of the company.
Any of these three would be acceptable, but I would prefer number three.
The major question is how much to pay. Like AIG, leaving the stockholders with about 20%, as opposed to nothing, seems about right.
Another approach toward determining an appropriate price might be to require that new stock or convertible bonds be issued, say 30% be sold on the open market at a given price sufficient to clear the 30% offering (like a typical new stock offering), and the government guarantee to purchase the remainder at half the given price. This would set a market price for the stock, given government support, and give the government the extra benefits it deserves.
Why should the government get the benefit of a 50% discount? Because the government may be the only entity capable of saving some of these companies. Without its investment, the deal could not happen. So, in fairness, the government, i.e., the people, should benefit from that fact, as opposed to other stockholders. In this case the government is playing the role of a large investment business and should be remunerated consistent with that role.
Without government investment the companies are worth nothing. But with the government bailout, the companies should be worth a lot and just compensation for the government should be about 80% of that increase in value.
This approach to the injection of liquidity should enable the government, in the long run, to do much better than breakeven . The political benefit from such an outcome, or even the valid projection of such an outcome, at this moment, would be enormous.

C. Sterling Portwood of HI 5:15PM September 25, 2008

Why not give the money to the people who owe the loans

Dan of 10:41AM September 21, 2008

Jim Cramer’s $500 Billion Bank Bailout Plan

Related Articles

Reader Comments Read all comments (4)

Capital Commerce

Subscribe

Editor's Picks