Financial Crisis – What Next?

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The past month, and especially the past two weeks, has seen the worst worldwide financial debacle since the 1930s.  Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson have worked seven days a week developing, proposing and implementing a combination of textbook and innovative solutions.  The crisis has only gotten worse.  What should they do next?  Here is a summary of the next actions to take.  Subsequent posts shall discuss each point:

  1. The U.S. Treasury must immediately inject capital into those banks that are currently undercapitalized, but healthy enough and well-managed enough to succeed with government capital.  Systemically critical banks should be included at the discretion of the Secretary of the Treasury.  This must not be a giveway.  The government must take an equity stake in each bank that takes government funds, proportionate to the size of the capital infusion.  Urgent action is required.  There is no time to stall around to see who wins the presidential election in November.
  2. The federal government (Treasury, FDIC, Federal Reserve) must identify banks that do not have the resources to succeed, and move swiftly to shut them down, transferring their operations to healthier banks.  There is no time for analysis paralysis.  Some mistakes are inevitable, but if bank examiners determine that a bank is below its capital reserve requirements, and cannot or will not immediately rectify the situation, it is better to shut it down than to wait for a run on the bank.
  3. The U.S. Treasury should proceed expeditiously with plans to buy toxic assets that clog the balance sheets of financial institutions, as originally envisioned by Secretary Paulson.  Warrants or stock options should be obtained as part of the toxic asset purchases.
  4. The Treasury should buy non-performing owner-occupied home mortgages at market value (not face value) and offer to refinance the mortgages at current fixed interest rates and principal equal to 90%-95% of the current value of the home if the owner shows the financial capability and commitment to pay the refinanced mortgage.  Appreciation sharing should be considered.
  5. The Federal Reserve should offer credit lines to state and municipal governments that cannot obtain short-term funding due to the credit crisis.
  6. Congress should pass an amendment to the bankruptcy law that would allow bankruptcy judges to force mortgage holders to renegotiate mortgages as part of the bankruptcy settlement.  Congress should repeal recently passed exemptions that allowed credit card debt to survive a personal bankruptcy with preferred standing.
  7. Congress should write and pass a comprehensive regulatory reform act for the U.S. financial services industry.
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