Monday, September 29, 2008

The Blinders Bailout Plan

I posted last week about the bailout package for Wall Street, and came out in favor of it. The basic thinking was that you can’t just blame the banks, because it was a combination of them making stupid loans, and consumers taking advantage by signing up for loans they could not afford, and would only pay back if house prices went up. Ultimately, there is an absolute ton of money that was loaned against assets at inflated prices. Since those assets will never see those prices anytime soon, the U.S. Financial system is about to collapse. We can sit back and watch it collapse, or we can take some kind of steps to prevent it. I was for the Paulson plan in general, because it was the only plan on the table, and it could possibly work. I realized if the we did nothing we will head into a deep recession, and I think with today’s stock market reaction to the lack of leadership from congress we are well on our way there.

I am not for bailouts in principle, as I believe in free markets. Our market may stay free if we do nothing, but it will stop functioning. With banks going under left and right, and with the stock market crashing, there are no longer any safe places to put your money. Banks, Bonds, Stocks, and Real Estate are all currently out of the question. It is time to stuff your cash into the mattress. I have already increased my cash position ten-fold. The other option out there I guess is gold. So we will have more flights to the safety of cash, and more runs on banks, stocks and bonds. Rinse, repeat, and we may be heading for a depression sooner rather than later.

Bailing out Wall Street sucks though, and the plan is fatally flawed. The biggest problem is that it does nothing to address the problems that got us here. No reforms or new regulations on lending. No reforms or regulation on the packaging of mortgage backed securities. I would hate to see the banks get bailed out, and go right back to business as usual with option payment and liar loans. The Republican balked at the proposal, because it violates their basic principles. The Democrats love the plan, as long as some sort of welfare for Main Street is included. No way the Democrats vote against a spending bill in an election cycle, unless it looks risky like this one. So the prospects are not currently looking good as nether side is fully behind the plan.

So rather than accept the Paulson plan as is, I will offer up the Blinders plan. My perfect version of the bill is closer to what what the Republicans in the house have proposed. Forget about the U.S. buying up any of the troubled securities though. Offer up low interest loans against the troubled assets. Come up with a fee for the entire banking system that will fund an insurance pool against the assets. Any company taking the loan must offer up warrants on their stock, so that if they get too good of a deal on the loan and their stock price goes up the U.S. profits. Throw in some caps on executive pay, and remove all help for foreclosures. Why would we bail out dead beats that do not pay their loans back? It is one thing that the banks got out of control, made some real bad investments, and paid a massive price. It is another thing to take out a loan, and then refuse to pay it back. I would rather the investor get some form of bailout, then the dead beat. If these dead beats are really in a position to buy a house, then let them buy one on the free market, after they lose the one they could not afford. What is great about this version of the plan, is the only way we don’t get paid back is if the company we loan money to fails, and if we get taken advantage of in the process we profit from the stock warrants. We want to make it a poor option for a company to take the bailout, so that only those who truly need it will.

In a perfect world, I would add the following provisions, but these will probably not be added due to time constraints.

1) Make it illegal to borrow money to put down on a house, or to lend money to someone for the same purpose. A massive part of the problem was the lending of money for down payments to avoid PMI (Primary Mortgage Insurance). Without 20% down on a house you have to pay mortgage insurance to cover your elevated risk of default. When you lend somebody the money to cover the down payment, no PMI is taken out, and the primary loan takes on more risk than it should. If all people who put down less than 20% had PMI we would not have this problem as the lenders would have been protected by the PMI.

2) Go after people who defaulted on liar loans for fraud and throw their asses in jail. Just because it is called a liar loan, does not mean you are allowed to lie on it. If you lied about your income to get a liar loan, and then defaulted you committed fraud and should be punished to the fullest extent of the law. If we actually throw some of these guys in jail, and make examples of them, people will be less likely to commit fraud in the future.

3) Make teaser rates on mortgages illegal. Everyone must qualify at the fully indexed payment, and must start making fully indexed payments immediately. Houses are not car stereos. Whoever came up with the idea of teaser rates on home loans should be shot.

4) Raise the minimum required down payment to qualify for a loan. Fixed rate loans require at least 5% cash down +PMI or 20% cash down no PMI. Adjustable rate loans require at least 10% down + PMI + excellent credit or 20% cash down + excellent credit. Payment option and liar loans require 20% cash down period and excellent credit.

5) Remove the regulations that require banks to lend to unqualified borrowers. This whole problem can be traced back the Democrats requiring banks to make a certain portion of their home loans to those that are not qualified. This was done as a way to expand homeownership to the lower classes, but I guarantee that most of these loans went bad, and are the ones we are paying for now. The government can’t make these types of demands on banks, and expect them to remain solvent. Shame on the banks for not fighting this more, but these types of regulations need to be removed. Freddy Mac and Fannie Maes main purpose was to get these bad loans off of the banks books, so that the banks could continue to make bad loans. Fannie and Freddy in return contributed huge amounts to the congress members who supported them.

6) Cash out refinancing should only be allowed when 20% equity is retained in the house. You actually used to be able to cash out more than all of your equity which was a joke, but is still legal to this day.

Throw in some fixes like that and we have a very workable plan, or go buy a king sized mattress to store all of your cash.

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At 7:21 PM, Blogger Buffalo66 said...

The financial markets are not trading on any rational information right now - they are trading on fear (perhaps panic).

While I'm against the bailout, some intervention has to take place to calm the markets down.

We will not return to prosperity until housing starts to appreciate again. That could be a few years down the road.

Funny how the economy was "fundamentally sound" less than 30 days ago.

At 3:27 PM, Blogger cubb said...

If some would actually check I'll bet most of these bad mortgages we just bailed out had PMI (private mortgage ins)
I pay PMI on my mortgage and my wife is a realtor and in 25yrs has never sold anyone a house that could or did put down 20% so that they didnt have to carry PMI. She also has not sold a house that the buyer could finance the down payment. Where is the PMI premiums
that were collected. Show me the money!!!


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