Tuesday, March 17, 2009

Possible Solutions and a Real Economic Policy

A Better Tomorrow

February 23, 2009

Welcome to "A Better Tomorrow". This blog will provide an evolving discussion of the macro economic crisis we in America face today. We will define the crisis in general terms and we will suggest solutions as the main platform of the blog, we will also make comments on responses to the situation in the mainstream press at times and we will request reader input into this page in all areas of discussion. If at any time you wish to contact me, please feel free (my name is Jerry Baldy and my e-mail is gbaldy1@verizon.net).

Let us begin

The situation we have is an economy that produces approximately 11 Trillion dollars annually of GDP and has approximately 70 Trillion dollars in debt and growing (about 10 trillion already spent (accumulated budget deficits) and about 60 trillion promised in the form of Baby Boomer Social Security, Medicare and Medicaid obligations. There is no way the economy itself can support 70 Trillion dollars of Debt. In addition, the economy presently is in a severe contraction due to both governmental and banking mismanagement and corruption. This current set of circumstances has resulted in HUGE government bailouts (700 Billion Tarp, Paulson/Bush banking system bailout and 797 Billion Obama economic stimulus package and 500 billion for current budgetary considerations).Thus adding 2 Trillion to the 70 trillion aforementioned with more to come.


Considering the circumstances there will be some appetite for future Treasury issuances in the short run and mid term (the additional two Trillion referred to above). But the longer range appetites ( reserves for Baby Boomer obligations of Social Security, Medicaid and Medicare) for U. S. Treasuries are more questionable and undoubtedly will be more, much more, expensive with yields paid by American taxpayers much higher and revenues received by American tax payers much lower. At some point perhaps there will be a currency devaluation. I never thought I would say that.Unless we devise a plan that will satisfy world markets that Americans can successfully address this Financial Crisis and the massive inflation that could follow in a sustainable way, very unpleasant consequences will occur. We need a plan that is based in reality not the program we are engaged in now, IT WON’T WORK.

Suggested Partial Solution

Fed/Treasury Partnership &
Direct Fed/Treasury Economic Stimulation:

A successful solution will require an understanding that a significant Federal Reserve and Treasury Department partnership is mandatory (a Keysian/Friedman partnership).
This Partnership is critical because the economy is fragile and continues to weaken and cannot grow us out of this set of circumstances. Further, confidence has been essentially lost in all governmental institutions and elected representatives with the possible exception of the Fed and Treasury.
The Treasury Department ( with Tim Giethner’s leadership along with Larry Summers and Paul Volker’s experience and intellectual horsepower) teamed with the Federal Reserve (with Ben Bernenke at the helm) have the human resources and balance sheets to lead us back to the path of prosperity. The Feds balance sheet should be used in a manner that maximizes monetary policy while utilizing the Treasury department as a partner temporarily until this Crisis has been resolved and a sustainable Economic policy is in place.

An example of this would be for the Federal Reserve Bank and the Treasury Department to partner. This partnership would be represented by a model that consists of equal contributions of 30 year U.S. Treasury Bonds Principle and Interest. These contributions would be the engine of the partnership supporting troubled commercial banks loan activity. The partnership would serve as a guarantor of the new loan activity for qualified banks and would be called the Fed/Treasury Partnership. The Fed/Treasury Partnership would have two functions the first would consist of contributed Treasury bond principle for use in stabilizing troubled banks and the second would be contributed Treasury Bond interest used for other Fed/Treasury purposes (discussed later). For the first part of the Fed/Treasury Partnership to be successful the bank in question must be free of toxic assets. To accomplish this, the troubled bank would quarantine all of its toxic paper. Proceeds from toxic paper would be used as a further cash infusion and/or a set aside for additional capital requirements into the bank. The troubled mortgage/other assets themselves would be would be left unadjusted, no Mark to Market valuations. Toxic asset valuations would remain at their cost basis on the banks books and would be represented on the balance sheet as troubled assets to be worked out. Asset valuation would take place at a more tranquil time and environment and be market driven. With this treatment of toxic assets completed a clean bank emerges to work with.

With the bank now clean of toxic asset effects the Fed and Treasury representatives can determine and guarantee (thru the Principle portion of the Fed/Treasury Partnership contribution) a sufficient amount of new loan activity to obtain stability and/or profitability. This will be expensive as the Partnership is guaranteeing virtually all new loans and will do so for a sufficient amount of time for bank recovery. Management of the partnership model “Principle Portion” should be managed by Federal Reserve Bank representatives. By the end of the Fed/Treasury Partnership intervention the bank will be profitable and in a better position to dispose of toxic assets in a reasonable market driven fashion. The problem banks will survive. The toxic assets will be sold in the free market. The bank will finally be removed from the Fed/Treasury Partnership umbrella to lend again and prosper.

This process can and should be used in a Federal Reserve Bank Partnership with foreign Central Banks and /or appropriate foreign government agencies. This model can be very useful as global portal linkage in addressing the global aspects of the financial crisis.

The Interest Portion of the Fed/Treasury partnership model will be used to support strong banks (banks not suffering from toxic assets) to generate a more balanced and healthier overall banking system. Management of the interest portion of the partnership model should also be managed by Federal Reserve Bank representatives. The result of the interest portion of the Fed /Treasury partnership model would be to effectively expand strong banks product lines and profitability. This is accomplished by the Fed/Treasury partnership utilizing the model's on-going revenue stream (interest portion of the model) to underwrite new business Loan programs or Credit Card programs, asset purchase programs and other product line expansion that emerge as part of recovery. Other Product line expansion possibilities from the Fed/Treasury partnership on-going revenue stream (interest portion of the Fed/Treasury model) could be to allow mortgage warehouse lines for Jumbo’s mortgages, non-conforming mortgage loans or to purchase asset backed securities. These and many other potential partnership activities would have the beneficial effect of attracting private capital and confidence back to the markets at an efficient cost basis.
These suggestions would begin the credit thawing process and would have a calming effect on financial markets. In addition to previously mentioned benefits of using the Fed/Treasury Partnership another important use is the Fed/Treasury Partnership in supporting Bank to Bank Lending. This could be a very important contribution of the Fed/Treasury partnership.
In addition to freeing up Credit Markets, instilling Investor confidence and reinvigorating asset securitization and eliminating the need for immediate Mark to Market accounting for toxic assets and reinstituting a secondary market for non-conforming mortgage loans (Jumbo’s and other collateralizations) and supporting Bank to bank lending, the model can be modified to stimulate the lower economy directly.

Direct Fed/Treasury Economic Stimulation:
Direct Fed/Treasury Economic Stimulation Program will be similar to the Fed/Treasury Partnership (described above). Both the Fed and Treasury will contribute 50% of partnership requirements into a model. These contributions will consist of both the Treasury and Fed contributing 30 Yr. U.S. Treasury Bonds, Principle and Interest into the model. However, one difference is that this stimulus would go directly to the lower economy and augment the work of the Fed/Treasury partnership in stabilizing and balancing the banking system. Another difference is only in Interest Portion proceeds of the model are used as the program guarantee. The Principle Portion of the model is NEVER used. A further difference is this program is a for profit program for the Fed. A fee structure, payment schedule and program time line will be established as part of program architecture with the Treasury managing the program.
One example of program use would be for the Direct Fed/Treasury Economic Stimulation Program to directly guarantee loans made by thrift banks that participate in a national Jumbo and/or non-conforming mortgage program financed by the Fed/Treasury Partnership (referenced above). This guarantee would encourage thrift institutions (thru stimulus program guarantees) to provide refinance and purchase credit to individual borrowers while the Fed/Treasury partnership encourages commercial banks to provide warehouse lines to thrift institutions. This approach would have the effect of creating seamless financing available for housing purchases and mortgage refinance activity, creating greater confidence and jobs in the mortgage, Construction, Real Estate and related service industries.
Another example would be for the Direct Fed/Treasury Economic Stimulation Program to directly subsidize small and medium size commercial (FDIC) banks not involved in toxic asset activity through direct loan guarantee programs designed for specific industries. This would make credit more available to a variety of small, medium and large businesses while creating confidence and jobs. Further, this program could be expanded to direct commerce lending with the amount, nature and duration of support determined by specific troubled industries or local economies as needed. In total the Direct Fed/Treasury Stimulus would maximize the work of the Fed/Treasury partnership. The combination of these two initiatives is intended to augment current fiscal and monetary policy while lending flexibility to the crisis management plan now in place.