Let us pre-suppose that Obama grows a sack this afternoon and today after the market closes announces it.
What does it mean?
A few things happen:
- All banks are closed as of the close of business and will not re-open unless they’re certified clean and solvent. No mergers, no take-unders, you either live or die.
- ATMs, Checks and ordinary “course of business” payment streams are honored. Account transfers and anything that looks like one is refused. The point here is to prevent runs on solvent institutions, which would otherwise result. Since nobody knows at this point who’s solvent or not, you lock the system for other than ordinary course-of-business actions. The Fed does what it is supposed to do – intermediation of the payment system. There is already a contingency plan and process for this – they know how to do it, and both can and will – they just need to be ordered to do so by the Administration.
- Bank examiners swarm into the banks, starting with the big ones. The 10 largest ones are all examined over the weekend. MBS and other instruments, including HELOCs, are all marked to the market at today’s prices.
- The CDS related to these institutions are frozen. All CDS holders are brought “into the room” and ordered to net out their exposure and post cash margin against any underwater positions. Those who refuse or are unable have their CDS declared void as fraudulent in the inducement, as there was never an intent or ability to perform. Yes, this is an abrogation of contract in theory, but in fact you can’t contract to do an impossible thing (e.g. I can’t contract with you to jump over the Empire State Building, since I can’t perform.) Let the aggrieved parties litigate it out over time – for now, the beast’s fangs have been pulled, and suing a bankrupt entity (in the case of a “resolved” bank) is a waste of time anyway – there’s nothing to get.
- All banks that are insolvent are immediately resolved. For those that are large national institutions the deposit-bearing parts are broken off into one for each Federal Reserve region. The securities and other business units are left naked; if they die, they die. Bondholders are crammed down into equity as required to fill the holes in the balance sheet; the common equity is wiped out. If – and only if – that is insufficient the FDIC steps in and makes the depositors whole. Any insolvent bank has its officers and directors ejected and barred for life from any national bank-privileged institution. The forensic auditors will stay on for months, examining for control frauds and referring all they find to prosecutors.
- The solvent banks (and resolved banks) re-open over the space of the next two weeks, starting with the largest institutions.
Now what happens to everyone and their positions?
- Common stockholders in resolved institutions are wiped out. They get nothing.
- Bondholders become either stockholders or are, potentially, protected, depending on their seniority and position. JP Morgan ($812b), Citibank ($664b), Bank of America ($890b), Wells ($213b) and Goldman ($393b) have approximately $3 trillion in bondholder equity between them. To this limit within each firm there are no FDIC losses to be incurred. Goldman, as a non-retail bank, has no deposits to protect at all. It is my belief that of the “Big 5” all of them can be resolved through this process without any FDIC loss.
- The MBS holders who bought fraudulent securities are made whole. These are pension funds and other investors – literally almost every American who has some sort of retirement fund. These same institutions wind up as equity holders in the big banks if they held bank debt – so while they will take cash losses in the debt, they will offset that with par recoveries on the MBS, and they will have a stake in the resolved institutions and be the ones who have control and profit from their operations on a forward basis.
- There is no “collapse” of the banking system, the payments system, or the economy. What there is, however, is a clearing of huge amounts of derivative exposure that has never been able to be covered, all of the fraudulent MBS, and a huge amount of bogus debt that is being held on and off bank balance sheets. Wells $1+ trillion in off-balance-sheet exposure, for example, is marked to the market and the bogus part of it, whatever it is, disappears.
- The “moral hazard”, “too big to fail” and “too big to jail” rubric and BS games are over. By referring all control frauds to prosecutors, we put a stop to the games and provide ample evidence that they will remain unprofitable into the future.
- Lending costs drop dramatically and the economy clears. Right now there is a huge imputed “tax” on all transactions through the financial system that in many cases exceeds the actual interest cost! In addition dollar debasement from all the “QE” nonsense has gone into commodity price ramps and will shortly show up on the store shelves. This money is being funneled to these insolvent institutions to keep them afloat behind your back. We are talking about hundreds of billions of dollars a year that immediately becomes available in the economy in general. To put this in perspective this is likely around 2% of GDP that would show up in the economy immediately. That’s a huge increase, given the just-reported numbers – a near-doubling! This would be offset by all the newly-unemployed Wall Street Bankers who would no longer have their $500,000 salaries that they’re siphoning off from the rest of the economy, so it’s not all going to go to the bottom line. But to the extent that any of this goes into capital formation (and plenty of it would, including, I suspect, some new Wall Street institutions) the net impact would be insanely positive for the nation as a whole.
- Unemployment would initially spike higher, but as replacement institutions sprung up it would quickly be absorbed into the new, lower-cost environment. Again, while the short-term impact would look very bad, it wouldn’t stay that way for long – months at worst.
In confluence with this The Federal Government should announce an expedited consumer bankruptcy authority. Since the banks now have their assets marked to the actual value, there is no harm to be had to the banks by doing this. There is, however, the ability to transfer assets to those who can afford them (at the current market price) and free consumers to actually discretionary income again, which is necessary for true recovery. Let everyone have one bite at this apple – you can go in, you lose the assets, you also lose the debt.
We need to do this, and do it now. What we cannot afford is an economic incident of some sort that winds up creating another crisis situation that happens in an uncontrolled fashion.
It’s time to do the right thing Mr. President.