The 2008-2009 Crisis: Solutions

This page is one part of the Finance Repo and a supporting document for the longer essay When Magic Unravels: The 2008-2009 Crisis.

Solutions

  • Policy Approach
    • Recent proposal: it would give new regulatory powers to the Federal Reserve, create a new agency to help protect consumers of financial products, and make derivative-trading more transparent. It would give the government the power to take over large bank holding companies or troubled investment banks — powers it doesn’t have now — and would force banks to hold onto some of the mortgage-backed securities they create and sell to investors. Many experts, even at the Federal Reserve, think that the country should not allow banks to become too big to fail. Some of them suggest specific economic disincentives to prevent growing too big and requirements that would break them up before reaching that point. another way to restrict the bespoke derivatives would be to strip them of their exemption from the antigambling statutes. “regulators ought to insist that derivatives be homogeneous, standardized and transparent.”(source) (opinion)
    • Balance. “in recessions, underwriting standards tighten, and borrowers get more nervous about taking on new loans, so you see credit levels falling. We want markets to find the right balance. We don’t want them to be too loose right now. We want people to be able to get loans. But we also want them to be prudent.” (source)
    • Speed. “the TALF program itself is just another form of leverage. we’re moving leverage to the federal government’s balance sheet. We need to de-leverage, but what’s the speed at which that de-leveraging takes place, and how damaging is that de-leveraging process to our broader economy, while we reach equilibrium? programs like the TALF are trying to provide a more graceful approach to those new equilibriums. Things like the TALF are designed to be very expensive, relative to what normal market conditions provide. The cost of that leverage, as an example. So that when markets begin to heal, those programs will unwind themselves, and the private sector will return to using their other sources of leverage”. (source)
    • Taxonomy. “We segmented the world into two camps. Healthy banks, who we wanted to make even healthier so they could support lending, and systemic banks. If you have a bank that is neither healthy nor systemic, then we have something called “receivership,” where the FDIC comes in and winds down the bank and sells it. So, I think it really depends on the situation.” (source)
      • Fact: “some banks, like Washington Mutual and Lehman Brothers, were left on their own and did not receive assistance.”
      • “Treasury didn’t have the legal authorities to intervene. The Federal Reserve has very powerful authority to lend money in exigent circumstances. But the law requires the Federal Reserve to be secured with secured collateral, when they make those loans, so they’re not taking much risk. So in the case of Bear Stearns, there was a collateral pool of $30 billion of mortgages and mortgage assets that the Fed lent against, and that collateral secured the loan that they made.” (source)
  • Pledge
    • Avoiding Bad Lending Practices. including by govt. “However well-intended, government officials are not positioned to make better commercial decisions than lenders in our communities. The government must not attempt to force banks to make loans whose risks they are not comfortable with or attempt to direct lending from Washington.” (source)
    • Reducing Too Big To Fail Subsidy. “…there are some people who are proposing that we should put a tax on all of these institutions that are deemed systemically important, to effectively increase their borrowing costs, so that they no longer have a competitive advantage over institutions that are not too big to fail. You could call it a debt tax, or systemic tax.” (source)
    • Realigning Incentives.
      • Expanded Receivership Authority. Abiltity for rescuers to “pick and choose which contracts you want to honor” in global bank holding coys. (source)
    • Introduction of Supercurrency (Investopedia)
      • Mooted by Chinese PBOC governor
  • Turn
    • Reducing Defaults.
      • (effectively) Lowering Interest Rates
        • enable commercial real estate borrowers to restructure maturing debt by
      • Encourage long-term sustainable loan modifications.
        • Impact on MBS. “Some people bought homes they could never hope to afford… not going to help them…(or) investors… loan modification (is) targeted to help those homeowners who want to, and can fundamentally afford a reasonable mortgage. The analysis that we’ve done suggests that those type of loan modifications are, in fact, in the interests of the aggregate of investors.” (source) A few MBS investors disagree and would rather foreclose on them as per servicing agreements.
        • Moral Hazard. Where to draw the line? Would the borrower have walked anyway? Who really needs it?
      • Refinancing
        • Lenders already own risk. “if you happen to have a Fannie or Freddie loan — Fannie Mae or Freddie Mac loan — typically, you need to have 20% down to get a Fannie or Freddie loan. But let’s say you have a Fannie Mae loan today, and you’re now at 100 loan to value (LTV). So, you were in at 80. Your home has lost 20% of its value. You’re now at a 100 LTV. Fannie Mae already owns your risk. So, what the administration has done is said, “Look. If you’re already a Fannie Mae loan, Fannie Mae can now refinance you up to 105 LTV.” It’s not increasing the risk of the government, because they already own the loan. But it’s enabling you to achieve a lower interest rate, which actually lowers your risk.” (source)
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  • Prestige
    • Clearing Bad Debt. PPIP -  Legacy Loans Program uses FDIC-guaranteed debt along with private equity to purchase troubled loans from banks.
    • Restoring Asset Liquidity, including price discovery and taking buy-side. PPIP – Legacy Securities Program is designed to use funds from the Federal Reserve, Treasury and private investors to reignite the market for “legacy securities”.
    • Replenishing Bank Equity. Capital Purchase Program, to invest up to $250 billion in banks. “The private markets were unwilling to take risk. We had to be able to take risk. That’s what the TARP was about.” (source)
      • Preferred Stock. “It is important to remember, Treasury is buying preferred stock in these banks — not giving them money.” (source)
      • Healthy Banks. “Healthy banks are in the best position to support their communities by extending credit. A dollar invested in a healthy bank is far more likely to be used to promote lending than a dollar invested in a failing bank, which would more likely use it just to survive.” (source)
      • Explicit covenants. “One, we restricted dividend increases and share repurchases and, two, placed restrictions on executive compensation” (source)
    • Directly Reducing Cost of Borrowing (which spiked during crisis)
      • TALF: “Treasury also helped the Fed… reduce borrowing costs for consumers, including auto loans, student loans, small business loans and credit cards… (and) other asset classes, such as CMBS.” (source)
    • Restoring Confidence Through Information
      • Stress Tests/Financial Stability Plan – “Treasury and the banking regulators launched a stress test of the 19 largest banks to make sure they had enough capital and the right kind of capital to continue lending even in an economic scenario that is worse than expected.” (source)
      • “In January, Treasury began collecting (lending) data from the twenty largest recipients of capital under the CPP, representing almost 90% of CPP capital investments”. Published monthly, it shows, “bank by bank, the lending and intermediation activities of institutions by category, such as consumer, commercial and real estate loans”. (source)
    • Restoring Confidence through Government Guarantees of Institutions
      • “We regretted having to take these actions — to put so many taxpayer dollars at risk to support individual firms that had made bad decisions… the potential cost to taxpayers of inaction so much greater than the cost of intervention.” (source)
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