Economaton

The government bailout for private investment firms amounts to a blank check written by the taxpayers to cover their disastrous years-long orgy in Vegas. I came up with some points that I hope could both mitigate the present circumstances and avoid similar future situations.

I can only hope some legislators will read them and appropriate them as their own.

1. Ban OTC Derivatives. Ban them altogether. People may still trade any derivatives they like, but they must be publicly specified, exchange-listed (i.e. also available to the public at large to trade), and cleared by a well-regulated third party. This ensures transparent accounting and allows regulatory authorities to require reasonable margins. There will be no surprises in the future from masses of unmarkable derivatives hidden in banks’ books.
2. Sliding Scale Margin Requirements. Futures contracts and derivatives in general should operate on sliding scale margins. That is, the amount of margin required should increase with overall position size. (Exceptions might be made for legitimate hedgers of physical commodities.) This would allow reasonable quantities of contracts to circulate freely with minimal margin, permitting price discovery, while making it prohibitively expensive to over-lever. Combined with the ban on OTC derivatives, this will act as a brake on excessive speculation in both commodities and financial instruments.

3. Hard jail time for bailout executives and market manipulators. If a company requires a bailout and it can be demonstrated that executives believed they were “too big to fail” and took actions based upon an explicit or implicit assumption of a government bailout guarantee, then they should be sent to prison for stealing from the government (and potentially treason and many other creative charges.) Not six months in a minimum security country club jail with tennis courts, but years of hard time. This should be easy to demonstrate with full access to the failed institutions’ records; the situation could not possibly have grown so dire were the executives not relying upon some implicit assumption of a federal bailout in the event of their failure.

   Likewise for anyone found to be manipulating markets, such as organizing a concerted shorting of financial shares. As AIG and Merrill and Bear failed, every TV in America should have been broadcasting live feeds of FBI agents in body armor driving tanks through the front doors of the Greenwich hedge fund managers who organized their downfall. This will deter future manipulation much better than any new set of regulations.

4. Do not remingle commercial and investment banking. This is touted as a way to shore up the capital base of the two remaining investment banks by allowing them to accept relatively stable deposits, and a way to place them under more stringent federal regulation. More regulation is indeed good and required; but this is actually a permanent guarantee that the Feds will always be required to step in and provide capital in case they come near failure again through heretofore unknown dubious investment schemes.

5. Have the Fed deal in commercial paper to buy time. Do not merely offer them loans from the discount window, require them all to accept loans and also require them to re-lend them. They can use broker-dealers if they must, which must be forced to provide credit to the open commercial money market rather than sit on their Fed loans or only loan interbank. This will ensure that the “real” economy still has access to credit in spite of general mistrust in the financial sphere.

   Thus, they buy the time needed to dig through the banks’ books — all banks’ books — and determine exactly who is exposed to what. (A good deal of it must cancel out.) Once exposure is known and there are no more surprises, the credit market will unfreeze naturally and further government dealing will not be required. Announce that any efforts to hide things from regulators will be met with criminal charges and hard prison time, and furthermore that any hidden assets will not be eligible for any future bailout.

6. After that, nationalize firms that cannot carry their debt. There should be no blank check written by the taxpayers to any private institution. At the same time, it is true that certain institutions cannot be allowed to fail without triggering a depression. Therefore, they must be nationalized. Rather than assuming only their debts, the government should also seize their assets. The share- and bondholders of these companies should get absolutely nothing if they require a bailout of any kind. Some of their executives and employees should be jailed as per above.

If you think this is reasonable, please circulate it. It must filter upwards fast before they finalize the “blank check plan”.