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The global economy has crashed: we need a comprehensive credit crisis plan

There are three things I have been wrong about and I want to fess up right here and now after the massive 777 point decline in the Dow.

First, I was wrong that we would not see a crash. 777 points down is a crash.

Second, I was wrong in thinking that a feckless Congress would roll over and pass the extremely flawed Paulson Economic Patriot Act. Whether they are brave or stupid will be decided based on how events unfold in the future.

Third, I was wrong in wanting a bill to pass at all. I certainly did not want Congress to use Paulson’s plan as a baseline, which they did. But, given the choice of passing it or doing nothing I felt passing it was better. Having had time to reflect, I believe this was wrong too.

So, I was wrong on three counts – full stop.

However, despite the fall in markets, Congress’s not having passed the Economic Patriot Act may be a blessing in disguise. The FTSE is trading up. Dow futures show a rise of 170 points. So, maybe the sell-off was a one-day event.

In any event, it does give the U.S. Congress more time to pass new legislation crafted from scratch. And the new proposal can have the things we need in it:

  • An explicit government guarantee of deposits to end the worry about the solvency of the banking system.
  • An independent agency to shut down, merge and liquidate insolvent banks. The independent RTC-like agency will make the determination for every single bank. The banks themselves will have zero say in the determination of the independent agency. The faster the liquidation process is complete, the sooner confidence will be restored.
  • Separation of good assets from bad assets, not by buying them up at inflated prices, but by sticking bad assets into separate a separate “bad bank” entity at market prices. This will bolster banks’ counter-party confidence.
  • Recapitalization of remaining solvent banks. This can happen through private monies. But, if necessary the government can get preferred shares or warrants or what have you. That way the solvent banks are re-capitalized and taxpayers get the upside.
  • Increased regulation. Obviously this is what the public wants. Unless we can show how we are going to stop this from happening again, there will be little support. The new regulation may merely need to be explicit oversight of regulators by Congress as much of the problem is not the need for new regulation but enforcement of the regulations we already have. While we need this to get the bill supported, I am skeptical about the need for more regulation.
  • Cap on pay. The independent agency will determine who needs additional capital and who doesn’t. Banks should be given a chance to raise capital in the private sector for a fixed number of days. Banks that need capital injections from the government will not have a say on pay caps as this will be mandated. Again, we have seen that people want this pay cap.
  • Defense against politicization of the process. Having Hank Paulson or his successor controlling the crisis resolution process is setting the United States up for a politicization of the process. The regulator must be an independent body free of all political influence.

So, there’s my new plan. I am cautiously optimistic we might see something more along these lines now that Paulson’s plan has initially been rejected.

Other posts addressing real systemic solutions
The U.S. financial system is effectively insolvent
The $700 billion Paulson Plan is dead on arrival
Lehman’s bankruptcy: putting the cart before the horse?
The Swedish banking crisis response – a model for the future?
Credit deflation and the Japanese problem
The Japanese Problem is now ours
De-leveraging
De-leveraging redux

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

1 Comment

  1. pej says:

    Cool, it’s very rare to see someone mention his past errors and also claiming he was wrong. That’s very cool.

    The good thing about me is that I am always right (!!! ;-) ;-) ) so when I say that’s cool, you can take it for granted.

    I still think that you are wrong about something though: 777 down on the Dow was not a crash. It was just the expiration of the Bernanke+Paulson PUT, which I have mentioned here several times. There was a whole lot of bullishness excesses in the market, and the plan not going through, the stock market had to adjust to the normal level without the bailout plan flooding money in the markets.

    The proof that the sell off was not a crash is that we are quite a nice recovery today. I think if it was a crash, the sell off would have continued.

    Also note that the sell off might have been accentuated by the fact that no short covering could happen, since the SEC and the gov have decided that prices should only go up.