“This takes courage to do, but if we don’t do it, history shows that
this kind of mechanism — (to) recognize the losses, get(s) at the root of it
and move (s us) on — this is how you jump-start the economy”.

So said FDIC chairperson Shelia Blair during her Washington Post interview yesterday.

Controversy lies in the cost: perhaps $700 billion which at a ratio of one to five, could possibly generate up to $3.5 Trillion of capital aimed at banks.

This I am pleased to acknowledge was a piece of the kavipsian economic plan.

In that plan we argued for immediate clarity, and the quick separation of toxic assets away from the good ones.

However we differed from Sheila Blair on her approach. And we hope this message is heard.

Instead of “buying up” toxic assets, we encouraged the “guaranteeing” of toxic assets, making them a solid investment especially during these uncertain times.

Here is the thought process underlying that.

If the Fed buys securities that have no current value, perhaps even negative value, what do they pay? Do they pay nothing, or do they pay the price that banks want? Paying the price that banks want, gives banks capital.. The more capital, the faster the money begins to flow. On the other hand, paying to much for a product, causes the taxpayers to become proud investors of thin air. Gee, WE spent $700 billion for roughly $100 dollars of computer paper…

Likewise, banks holding on to their assets, (like we all tend to), see them as someday having value again. Why should they sell at a loss? Yet keeping those toxic assets on their books, shows them at a loss right now, tomorrow, the day after, and on to infinity. They can’t lend.

We recommend that the U.S. Treasury guarantees these toxic assets for a certain amount on the dollar. That amount can be determined by the amount of fee the investor coughs up towards the Federal Reserve for that privilege.

Guaranteeing 100% would cost more than 50%…. As mentioned before, many see these assets as again having value one day. The Federal Reserve would acquire money from the fees, money it needs to remain solvent right now, and would in turn guarantee, as did AIG, to pay the difference in value, should they sell at a loss.

If a share is determined to cost $10 for example, and the Fed charges $1 dollar to insure its value, if and when the share were to sell out, say at a bad price of $5 dollars, the Fed would guarantee the payout of $4 dollars worth. Having received the $1 earlier, the net loss would be $3.

So the choice is this. Do we buy each asset at a discount, say for $6 dollars a share, and hope its value ultimately rises, so ultimately we can exit the strategy with a profit? If not, as the scenario goes above, sellout being at $5, we are only out of $1 dollar per share?

Doing so locks down a lot of money we cannot use for anything else….. A lot of money….

Or is it better to receive the fee money, which increases the stature of our treasury, and issue instead what amounts to “free” verbal guarantees… that cost us nothing today, and maybe will cost us nothing tomorrow?

We opt for the latter, primarily because it does not indefinitely tie up federal funds, and secondarily, because it gives the FDIC much greater room to maneuver, before the it reaches levels of insolvency.

The toxic mortgages, once credibly insured against losses, immediately again have value, and can be bought up and held again by investors… WE think that is the appropriate channel which to forward this debt.

Although toxic at this time, all those bad assets, still have property value underlying those mortagages. As soon as the economy picks up…. and people want to buy property again, each one of those toxic mortgages can again be sold at market value and that asset amount, can then be recovered….

There is value “out there”. Providing a guarantee should help move these assets off the bank’s books, at a cheaper cost to the Fed, and into the market place where they belong….

Just think what an announcement of this type would do to bank stocks, right now undervalued at 96%? Hmmm…That’s our take.