Needed: Another Fat Bank Subsidy

Dolors & Sense

by Sanford Rose 

KISSIMMEE Florida—(Weekly Hubris)—9/19/11—You’re kidding.

That’s the last thing we need, most people would argue.

After all, the banks have already received a massive subsidy, TARP money, and another in the form of zero short-term interest rates—a policy objective mandated by the Federal Reserve (that’s the Government) and affirmed until at least 2013.

Zero short-term rates enable the banks to borrow at no cost from the public. They then can take the money and buy longer-term bonds.

Normally, that would be a somewhat risky strategy because it would create a maturity mismatch. That is, bank liabilities would mature before the bonds they finance. And if interest rates were rising, those bonds might have to be re-financed with much more expensive liabilities.

But if the Fed promises to keep interest rates at or close to zero, the risk is obviously far lower, or non-existent.

Some banks insist that they match-fund—that is, seek liabilities with yield maturities equal to those of the assets.

This proposition is ludicrous, since the same banks usually argue that one of the services they offer the public is “maturity transformation” —i.e., bearing the risk of aligning the penchant of savers to stay short and borrowers to go long.

No matter. Let’s assume all banks match-fund. Let’s assume that they just leave their money on deposit with the central bank. Banks have so many excess reserves that they earn $4 billion a year by just doing nothing and collecting the interest the central bank currently pays them.

Your and my deposit may earn nothing, but the Fed pays the banks 25 basis points on every dollar.

But this is a piddling subsidy.

The banks need much more. And we must ensure that they get much more.

I’m not crazy. I’m not trying to write a Swiftian “modest proposal.”

The economy is mired in a swamp of swollen mortgage debt. There can be no recovery until that swamp is cleared by the write-down of this debt and the resultant re-mortgaging, at realistic market values, of literally millions of individual mortgages.

Once people get relief from inflated mortgages, they will feel rich enough to start spending again. And once they start spending again, companies will start hiring again. And, yes, banks will start lending again, drawing down those excess reserves.

Obviously, however, banks that write down mortgages to realistic amounts will wipe out their capital. This is just another way of saying that they currently don’t have any capital, although they claim to have oodles of the stuff.

So, since we need banks with capital to cushion the effect of future losses, and we’re not about to nationalize lending services, we must recreate the capital that will be lost in the process of re-floating the economy.

Once again, and nearly four painful years after the plan was first suggested, it is time to do the following:

1. Government borrows another trillion dollars from a global market literally panting to give it the money at a trifling cost.

2. Government buys mortgages from banks at book values and re-mortgages properties at market values.

3. Banks agree to pay Government back the difference between book and market values, plus interest, on an installment basis, but only starting five years hence.

4. Individual mortgagors agree to pay back half of any increase in the value of the property over the amount of the reduced mortgage, either on sale or in installments based on appraisals, but again only starting the same five years hence.

Result: The biggest, fattest bank subsidy imaginable.

But the economy recovers, as do government revenues (remember that every 1 percent increase in growth adds $2.5 trillion to Governmental coffers).

Some subsidies pay off.