Modest Proposal to Jump Start The Credit Markets

Open any newspaper or put on any news program, you are bound to see the same or similar headlines:  The global credit system is in a state of paralysis.  Simply, those institutions that normally lend to businesses and consumers (such as banks and credit card companies) have decided a more prudent course of action is to limit or entirely cut off credit lines, bank loans, credit revolvers, home equity loans or mortgages, or refuse to purchase corporate or high yield bonds.  While the equity markets normally get all of the headlines, it is the credit markets that is the lifeblood of the economy.  It terms of size, the credit market dwarfs the equity markets.  That is why Bill Clinton was so concerned with how the bond market reacted to his policy proposals.  Therefore, if we are going to get out of this deep recession, we need to somehow stimulate the credit markets, and get lenders to lend more money to businesses and consumers.

“My” Solution to the Toxic Asset Fiasco–Revised

As I previewed two days ago, “my” solution to the toxic asset problem is for the government to buy these assets at the value the banks currently have for them on their balance sheets—what they have the securities marked at on their books (I use the scare quotes because I cannot remember if I came up with this idea on my own or read about elsewhere).  In return, the seller gives the Government essentially an insurance policy that they will pay for any losses the Government actually suffers, but only when those losses are suffered.  Essentially, the Government will not only be purchasing the assets, but also be purchasing a Credit Default Swap from the bank.

The Public-Private Partnership Does Not Solve the Root Problem: The Pricing of the Toxic Assets

The plan announced by Treasury Department to partner with private investment firms does not solve the root problem–the pricing of the toxic assets.  When one reads the Treasury’s plan, one would think that we simply have a liquidity problem–a lack of of capital in the private markets to buy up these assets.  But as has been reported,  there is plenty of capital sitting on the sidelines specifically waiting to buy these assets.  For example, back in July, Merrill Lynch sold toxic assets with a face amount or notional value of $30.6 bn to Lone Star Funds for 22 cents on the dollar–$6.7bn (and lent them non-recourse, except to the assets, 75%).