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Plan B? Plan C?

Providing a temporary home for the hot potatoes without coughing up $700B

I admit to not being a Wall Street guy, but I have always had a pretty good understanding of economics and a practical sense for business.

I understand that there is an incredible snowball effect resulting from the fact that there is currently no demand in the market for mortgage-based securities. None. Who wants to buy this stuff today? Only people anticipating a government bailout or those looking to take advantage of truly distressed sellers and distressed prices.

I am open to being convinced that the proposed $700B bailout is necessary. However, until alternative approaches are addressed, I am affirmatively against a last minute government authorization for tremendous power and a $700B spending authorization based on an implicit calculus that we either acquiesce or the economy goes into the toilet.

Before we all just jump on board with a plan that had it been proposed by a Clinton Admnistration would have no chance of having broad conservative support, I would suggest taking a loot at the following articles:

http://www.ftportfolios.com/Commentary/EconomicResearch/2008/9/22/heresaplantoavoidanew_rtc

http://online.wsj.com/article_email/SB122178603685354943-lMyQjAxMDI4MjIxMjcyODI2Wj.html

The current crisis is based on the convergence of two primary factors:

(1) There is little demand for mortgage based securities in the current time, resulting in bonds currently “worth” 70-80% less (see Merrill Lynch) of their par value even though only 9% of mortgages are in default and home values are only down 20-30% (i.e. mortgage-based securities are temporarily undervalued and if an individual had any in their portfolio, they would rationally ride out the storm to avoid selling in hyper-distressed conditions).

(2) The ability of financial institutions to issue debt is limited by balance sheet considerations, which means that Merrill Lynch and other financial institutions cannot do what your or I would do, which is simply ride out the storm. They can’t issue new debt without first clearing off their balance sheets. Thus, the bad paper is a hot potato they need to get off their balance sheet if the economy is to avoid a liquidity crisis.

Bottom Line: Financial institutions need to get the distressed bonds out of their debt/equity ratios in order to make loans.

There are at least a couple of alternative ways to approach this problem:(1) Have government buy the distressed paper at a valuation above the distressed price but below the true price so that tax payers get some profit in the end

(2) Temporarily relax the mark-to-market rules so that instead of centralizing the distressed paper into a centralized Bad Bank of the US, the paper can be held in a decentralized manner by their current owners.

(3) Temporarily raise the permitted debt/equity ratio so that distressed debt paper doesn’t preclude new activities

Until someone can tell me why (2) and/or (3) are deficient, I am firmly against (1).

I vote for Plan B. Until proponents of Plan A actually address other proposed solutions, I am not going to jump on the $700B bailout package that will involve more than $1T in spending before the democrats get through with it.

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