Financial collapse or Heather Locklear in distress? The choice is easy

Clearly, Justin, this is a result of the higher volume media consumption of today’s Mustached American. While we love our economic instability news, Heather Locklear remains, well, Heather Locklear. God bless Heather Locklear.

The problem with the bill that Congress attempted to pass is it did not address the real underlying problems so here is what should be done:

A Systemic Solution to a Systemic Crisis: Hints From IMF Review of Past Crisis Resolutions

Yves Smith, Nouriel Roubini: IMF study of how past banking crises were resolved shows that public acquisition of bad assets is less effective than direct recapitalization of the banking system which can be done with the help of private sector mechanisms such as stop dividend payments, debt-for-equity swap, require matching Tier 1 capital injection by current shareholders, public injection of preferred equity.

Roubini: Any solution to deal with economic overindebtedness must entail a reduction in the face value of the debt outstanding especially for households on the ropes and who have a strong incentive to just walk away which would be the worst outcome for borrowers, lenders, and investors–> Efficient HOME (Home Owners’ Mortgage Enterprise) 10 step plan includes a combination of purchasing illiquid assets at a discount with restructuring/loan modification option in exchange for preferred equity injections.

Strauss-Kahn: Systemic crisis calls for systemic solution with three elements: liquidity provision; purchase of distressed assets; and capital injections into financial institutions. There is also a deeper structural issue to be resolved regarding regulatory failure and rating agency reform.

Martin Wolf: criteria to be used in judging the intervention: First, it would deal with the systemic threat. Second, it would minimize damage to incentives. Third, it would come at minimum cost and risk to the taxpayer. Not least, it would be consistent with ideas of social justice.–> The fundamental problem with the Paulson scheme, as proposed, is then that it is neither a necessary nor an efficient solution.

cont.: to do instead: The simplest way to recapitalize institutions is by forcing them to raise equity and halt dividends. If that did not work, there could be forced conversions of debt into equity. The attraction of debt-equity swaps is that they would create losses for creditors, which are essential for the long-run health of any financial system.

Rajan: Because of collective action issues it makes sense to apply force. Consider two measures. First, all levered financial companies (including banks and investment banks – defining who these are is an important but not impossible detail) should be asked to impose a temporary moratorium on dividend payment immediately. Second, all large well-capitalised levered financial companies should make rights offerings (if the rights are offered at a large enough discount to the market price, shareholders will be forced to subscribe) to their shareholders amounting to 2 per cent of their risk-weighted assets. The value of mandating these decisions is that no individual bank sends an adverse signal to the market. And implemented collectively, they could recapitalise the system, with those getting the most upside from a healthy system paying for it.

Calomiris: Instead of buying toxic assets, the US government should buy preferred stock capital in ailing banks that could raise matching private sector equity. This would avoid the intractable problems of how the government should value the toxic assets and directly address the banks’ immediate problem – a lack of bank capital.

Zingales: it makes sense in the current contingency to mandate a partial debt forgiveness or a debt-for-equity swap in the financial sector. It has the benefit of being a well-tested strategy in the private sector and it leaves the taxpayers out of the picture.

All of these economists are telling Congress how to get it done and get it done right. These guys know how to fix the economy…it’s just that nobody is listening…instead we’re all trying figure out whether Heather is going to jail.