“The root problem is that debts that were incurred to finance assets at high price levels remain in place at their original amounts even though the assets that they financed are now worth far less. Debt that was incurred to finance extrapolated high incomes remains in place at its original amount even though incomes are now much lower. And, debts that were incurred to finance loans remain in place at their original values even though the loans that were made cannot be repaid. Until the debts are brought in line with the assets and the income, there is no moving forward no matter how much liquidity is provided or how eloquent the speech. And, until this happens, the self-reinforcing nature of the debt squeeze will only reduce incomes and asset values further.”

“There is no easy way out of a debt restructuring. Someone will have to bear the cost of prior bad decisions. The people who should bear the cost are those who made the bad decisions to make the loans or those who financed the people who made the loans. They intended to profit and would have profited if they were right. But they were wrong, so they should lose. The government needs to allow the losers to lose and focus their actions on minimizing the knock-on effects of their failure on people who didn’t do anything wrong (to minimize systemic risk). They should then take action to minimize the future exposure of the innocent to the future dumb decisions of the small minority, because no amount of regulation will ever eliminate dumb decisions, so you have to plan for them (through much lower bank leverage limits to cushion losses, bank size limits and non-bank entities playing bank-like roles to improve diversification, safety nets to prevent losers from poisoning the whole system, etc.).”

I could have not said it any better.

Anant Goel

I admire your efforts to articulate “The Money Morning Plan” as a proposal to solve our global credit crisis that we are facing currently. Sadly, your plan is not the answer to the present credit crisis. It may, however, preclude the future credit crisis… but that is in the future. And the future may be tens years down the road and a lot different [financially] than what it looks like to-day. So, let me address each and every item of your comments, statements, ideas, facts and proposals. Here we go…

STATEMENT:
“Dear Hank: Here’s How to End the Credit crisis at No Cost to Tax Payers”.

OBSERVATION & COMMENTS:
I totally disagree with you on the above statement. It has the sound bites and is certainly catchy, but it is not true. Some body is going to pay for this financial mess. And no matter whom it is, in all probability that entity is going to be a “Tax Payer”. As the saying goes: “there are no free lunches”! Somebody will pay… sooner or later. It may be the Investment Banks, Commercial Banks, Insurance Companies, Hedge Funds, Pension Funds, sovereign governments or wealthy investors… here in the US or abroad. Thanks to the American innovation and aggressive marketing, everyone, from individual investors to governments all over the world, fed on these toxic financial derivatives without fully understanding the risk to their capital. It may have different name and may come in different shapes or forms, but the erosion of asset value and the capital base is the core issue at hand.

The cesspool of “structured financial products” and “credit default swaps” were created through the process of financial engineering where the economic function of these derivatives is to transfer risk, for a fee, from those who do not want to bear it to those who are willing to bear risk. These structured financial products were created, packaged and marketed by the issuers [like Lehman and Merrill Lynch] for the sole purpose of “transferring risk” in exchange for future enhanced cash returns. These risk based financial derivatives were sold to all types of investors all over the world as investments with enhanced returns. The insurers like AIG insured these risks based financial derivatives and got on the hook for the capital value of such financial derivatives.

Buying and selling assets, whole or in part, is investing. Whereas buying and selling these financially engineered derivatives are nothing but speculation. Speculation is like two edged sword… it cuts both ways. And in a free market society like ours, if you live by the sword… then you must die [financially] by the sword as well.

Now, with almost all of asset class under water [in value] the risk taker is on the hook to make whole the lost value [in trillions of dollars] of the underlying asset. In the free market society like ours, the issuer [or the insurer] of such financial derivates will be on the hook to make whole the principal value of the asset. The issuers of such financial derivatives [like Lehman and Merrill Lynch] and the insurers [like AIG] are financially choking on this massive risk they assumed in return for hefty fees. The issuers and insurers took on massive amounts of risk and multiplied this risk many folds [like 30 times] by un-controlled leveraging. In good time this meant huge profits for the issuers, insurers and their fat cat executives. However, in bad times like the present, it could be the death knell for many of our financial institutions.

Buying and selling assets, whole or in part, is investing. Whereas these financially engineered derivatives are nothing but speculation. The sole purpose of these derivatives is to transfer risk, from those who do not want to bear it to those who are willing to bear risk. Speculation is like two edged sword… it cuts both ways. And in a free market society like ours, if you live [and profit] by the sword… then you must sleep [or die financially] by the sword as well. In the free market society, with no government intervention, we should let these fat, greedy and short sighted pigs [the speculators] play in the cesspool of their own creation and die [financially] in it. This applies to all speculators… the issuers… the insurers… and the investors all over the globe who came to feed on these speculative financial derivatives without fully understanding the risk to their capital.

The lean, mean, prudent, strong [financially] and men of long term vision for the future of their company [and this country] will emerge as survivors. The treasury secretary should then take these survivors by the hand and feed them the TARP money to lend out to businesses and consumers. That’s my way to solve our current credit crises, and I’m sure millions of other US taxpayers will agree with me. But that’s not going to happen, because there is too much pressure on the FED, from interest groups [like issuers and insurers]; big institutional investors; sovereign governments; and large businesses, to do something.

The politicians will trip over each other to demand that the President and the Treasury Secretary do something… like throwing trillions of dollars in TARP money at the financially insolvent issuers, insurers and fat cat institutional and private investors. Since that won’t be enough, they will also demand trillions of dollars in risk transfer from issuers [and insurers] to the tax payer. So, that’s where we are.

From the government and the tax payer’s point of view, there are four ways to solve our current credit crises:
1. Do nothing and let the free market work it-self out.
2. Do something to free-up our credit markets
3. Reform, transfer risk to tax payer, and flood market with free [at 0%] money.
4. The Money Morning Plan

Since I am responding to your “open letter”, I’ll focus only on “The Money Morning Plan” proposed by you. In a nut-shell, your proposal goes like this, more or less: “look in the rear view mirror and chart the course for the future”. Now that doesn’t solve our immediate dilemma of current credit crises.

I can take each and every one of your proposals [item by item] and point out the facts, flaws, fallacies and fiction. There are some good “islands of ideas” and are certainly of value and worth considering. However, collectively these islands of ideas do not propose a comprehensive solution because there are no connecting bridges [or links] of thought proposed or articulated… for going from here to there.

If you like, I can communicate my views, opinions, and comments in this public forum or privately via e-mail.

Anant Goel