The bill has failed. Good. It deserved to die. There are two considerations at this point. The first is to get through the next three months. Paulson, in testimony admitted that all 700 billion wouldn’t be spent right away. So give him 150 billion and only that, to him. While I doubt he exactly "needs" it, he and Bernanke must not be given an excuse for engaging in a fit of pique now that their pet bill went down, and "proving" that disaster would occur without it. (Note: read the transcript myself and he never admitted 150 billion would be enough, updated post. For a better 3 month solution read here.)
The next step is to start working on defining what a good bill would look like for January. I am going to reference myself and Stirling Newberry on this and list what I consider essential in a good bill meant to help both Main Street and Wall Street.
The January Bill
1) Buy up mortgages at a discount and give people new fixed rate mortgages. The government shares in further house appreciation (only fair since it bailed the homeowner out). This stabilizes mortgage prices and helps people and banks both. It is essentially identical to what FDR did with the Home Owners Loan Corporation (HOLC), and we know how to do it. Initial price tag? Probably around 20 billion.
2) Use the FDIC (the folks who take over failed banks) to take over failed mutual and money market funds, make sure the investors get as much money back as possible, liquidate the funds in an orderly fashion (or keep them operating if necessary) and if they are kept alive, kick the people who screwed them up to the curb and change how they do business.
3) Declare a national emergency, with judicial review (unlike Paulson’s seizure of ultimate power) and use the authority to review all purchases of banks, to institute oil rationing if necessary (or simpler procedures like "every street now has a 55 mile an hour speed limit, if it is normally higher). Also allows release of oil from the reserve, if necessary.
4) Expand the safety net such as food stamps, employment insurance, welfare and so on. We know this is going to get worse no matter what we do, so why aren’t we taking care of ordinary people?
In addition to this, the bill must include the necessary regulatory and tax changes to ensure that this does not occur in the future. I have listed the bare necessities after the jump.
I) All income over 1 million dollars a year from any source, including bonuses and options, to be taxed at 90%. As long as executives know that in 3 years they can make enough money so they never have to work again and will still be filthy rich, they will never manage their companies or the financial sector for the long term.
II) No loan can be sold more than two steps beyond origination.
III) No security can be more complex than the underlying transaction. We need to make sure that this situation where no one can value or even understand the instruments at the heart of this problem never happens again. Mortgages are simple contracts, no derivative based on them should be more complex than they are.
IV) Forbid any credit default swaps going forward and start unwinding the ones that currently exist. It’s fairly clear that the people buying it used it to offload default risks they knew were too high for them and the people who sold them didn’t understand the risks they were buying. In particular, no default insurance for banks. You loan the money, you are responsible for it.
V) End to end leverage of no more than 12 times. No borrowing one place, then getting more leverage somewhere else, then creating a security based on that money, then using that security to borrow again, and other such idiocy.
VI) No leveraged security can be used as collateral. The ratings agencies are not allowed to give any leveraged security more than a B rating.
VII) Simple mortgages which can be understood by anyone with a grade 8 education. If it can’t, it can’t be sold, and a judge is permitted to set it aside if it was sold anyway.
VIII) Banks may only sell the portion of a mortgage which is equal to what 30% of the median value of earned income in a zip code can finance. If they want to make loans beyond that level, that portion stays on their books and cannot be offloaded on anyone else. Mortgages should be based on what people can afford, and so, ultimately, should housing prices. If we want to modify this we can allow some modification based on an individual’s income, but not full modification. After all, the question still remains whether the sort of people who live in that community will be able to buy and afford the house.
IX) Bankruptcy law fixes. ‘Nough said.
X) Insure money market funds (not everything, just money market funds and maybe mutual funds) and regulate them. Allow banks to use money market holdings to meet reserve requirements. This allows an increase in the money supply and a new source of money, which is necessary since there isn’t actually enough money in the world to pay back all these debts.
XI) Pay for all this with progressive taxation. A 10% surcharge on those with incomes in the top 1% is a good start, but I would suggest just raising income tax levels starting at about $250,000, closing loopholes and taxing capital gains income at the same level as other types of income.
None of this should be particularly controversial. This is what a good bill looks like. It helps set a floor on housing prices, which are the underlying problem for many banks, it punishes the banks that failed but makes sure that people get as much money back as possible, it forces a revaluation of securities so we actually know where we stand and it makes the necessary regulatory and tax changes so that this doesn’t all happen again. It also bills the people being bailed out (that would be the rich) for cleaning up their mess.