With the implosion of Citigroup and the depth of losses across the banking sector, including today’s announcement that Bank of America is seeking additional bailout funding, the time has come to create and empower the Stabilization Oversight Council (SOC). The Treasury, positioned as the only game in town with respect to policy-making to deal with the financial crisis, has come up way, way short. While they need to have a seat at the table, other voices need to be heard as well. And not in a one-off, haphazard way, as has been done since the beginning of the crisis, e.g., the Treasury administers TARP, the FDIC drives the mortgage-restructuring strategy, the White House intervenes on behalf of the automakers, the Fed wrings their hands in public but to little effect, etc.. The SOC will take a holistic approach to the problem, working to develop solutions that fit together, are sequenced properly, and are both clearly communicated and transparent in their elements and their monitoring. A clean slate is needed, and I’d recommend that it be created before the next $350 billion is pushed out the door. Because if this $350 billion is used in a manner similar to the previous $350 billion, the taxpayer rip-off and policy failures will place an unacceptable and unnecessary burden on subsequent generations.
While it is seductive to spend stimulus dollars on infrastructure, the auto industry, and every other constituency that has come out of the woodwork with their hands out, priority number one has to be a plan for fixing the financial services sector.This extends well beyond fixing balance sheets, thought this certainly needs to happen (via takeover and Good Bank/Bad Bank restructuring of failing institutions), and includes items such as:
- Simplified and clarified accounting standards: Mark-to-market accounting treatment on all trading portfolios not supported by term financing. Tightening of consolidation rules to prevent the shunting of risk into off-balance sheet vehicles with opaque disclosures. Key themes: transparency and full disclosure.
- Revised regulatory standards: Revised capital requirements that are detached from Value at Risk (VaR) and calibrated to the business cycle, e.g. higher capital/larger reserves in good times, lower capital/smaller reserves in bad times. Key themes: capital requirements that take into account asymmetrical risk distributions, built-in shock absorbers to force capital accumulation while it is plentiful to prepare for inevitable turns in the business cycle.
- Restructuring of the ratings industry: Eliminate the inherent conflicts in issuer-funded ratings. Create an independent and impartial body to issue and maintain ratings, partially funded by the deal. Key themes: independence, transparency, free from bias, paid for as an implicit due diligence expense by investors.
This is not about bailing out undeserving bankers; they will be fired, their stock wiped out. This isn’t about creating another real estate bubble; it will take years for existing inventory to be worked through, partially-built homes to be finished and sold and current sellers to find buyers at anything other than distressed prices. This is about getting the US to face into its problems, to swallow an expensive, bitter pill and to move on. But we can’t move on with a financial system in shambles. We can’t restructure the auto industry, make necessary investments in technology infrastructure and enact effective tax policy in the absence of healthy, functioning credit markets.
Another key element of the plan is creating a culture of transparency, honesty and responsibility, three items sorely lacking as evidenced by reasons for and magnitude of the credit crisis. While cynics may scoff, I don’t see the presence of these things as being anathema to making money or supporting the free markets. To the contrary, I believe they can usher in a healthier, more sustainable investment climate, one where investors and individuals alike will have more realistic expectations of returns and reduced volatility due to fewer unpleasant surprises.
The time has come for a change. TARP hasn’t worked. The banking crisis has only deepened. We need the best minds from relevant disciplines to build a comprehensive plan for stabilizing the financial system. Perhaps President Elect Obama can use his energy and fresh perspective to taken an unconventional approach to solving our problems. He can be the catalyst; he is not the answer. The SOC is the answer.