Wednesday, October 1, 2008

A Proposal Regarding Nationalization of the US Financial Sector

This is the forth straight day I've posted something about the US Financial Sector Meltdown. Don't worry, unless something significant happens it'll be the last one for a while.

Now, with that said, I do have some thoughts on the so-called bailout.

In a previous post, commenter Ilya took me to task for complaining about the financial sector meltdown, without proposing a solution. That got me thinking. I was trained as a US Navy Chief Warrant Officer, and if there's one thing about Warrants it's this: they never bring a problem to the chain of command without a proposed solution. And Warrant Officer solutions tend to be a bit, uh, different from the usual proposals (usually they involve violence, but not in this case). As such, I've given this some serious thought.

Here's what I think we ought to do:

In the last three posts I've mentioned that while I am ideologically opposed to bailing out the arrogant greedy bastards who dug this hole, I fully understand and appreciate why we have to do it.

But I've got to tell you, this whole thing hits me about the same as coming home after busting your butt on the third shift and finding that your roommate has thrown a blowout end-of-the-world party. The house is trashed, empty beer cans are everywhere, cigarette burns on the carpet, all the plates are dirty, the garbage can is overflowing onto the kitchen floor, there's vomit in the bathroom tub and used condoms on your pillow, and some drunk, half naked chick is passed out in the bushes. Your folks are coming by in a couple of hours, your roommate went home with the waitress the way he always does - and you get stuck cleaning up the mess.

Everybody else had a great time, the party was legendary, they'll talk about it for years.

You? Too bad you missed it. But, you get all the work as a consolation prize. You're a sport, you are.

No matter what the final version of the bailout bill ultimately looks like, the US Government is going to end up acquiring a rather large number of foreclosed properties (well over two million, and maybe significantly more depending on which figures you reference) and nationalize a significant fraction of the US Financial Sector.

I think nationalizing private property and a good sized chunk of the Financial Sector is a bad, bad idea and I think it is fundamentally opposed to the principles America was founded on. However, there appears to be no other solution at the moment. Those foreclosures are an albatross around Wall Street's neck, and it will be nearly impossible for the market to recover until that drag is removed - well, it could recover without the buyout, but it will take a long, long time. Ideally, those foreclosures should be bought out by the mortgage and S&L industry - and some small fraction certainly are being bought out - but the industry lacks the capital to relieve Wall Street of more than a small fraction of those properties and the average citizen isn't in a position to buy a new home at the moment.

And that leaves the Fed - and that's exactly where a lot of that $700 billion bailout package will go, in phases over a couple of years.

In order for this to work, those properties will have to be sold and that $700 Billion recouped over time, plus interest, in order to pay back the people and entities we borrowed it from in the first place - and ultimately ourselves, the taxpayers.

As I said, we have to do this. We've been given no good alternatives. But, here's what galls me more than anything else - once the Fed acquires those foreclosed properties and direct interest in Wall Street, we assume the risk. If those properties don't sell, both quickly and for high enough return, they'll end up being an albatross around our necks. Every day those properties sit empty in the Fed's hands, we're paying for them - not just the basic amount the Fed spent to acquire them, but the daily, compounding cost necessary to maintain them until they can be off-loaded on the home-buyer market, which is, as I mentioned, in the toilet.

Think about it for a minute, how many foreclosed properties are there in your neck of the woods? Regular commenter Beastly is currently working in foreclosure recovery in Arizona. He told me on the phone the other day that in the Phoenix area alone there are 50 - 77 thousand available properties on the books. 50 - 77 thousand, about a third of which are foreclosures. Some of those houses were significantly damaged by the previous owners, to the point where they cannot be occupied or pass a basic pre-loan inspection. They have to be repaired before they can be sold. Nationwide, we're looking at roughly 2.2 million foreclosed properties, and even if those homes are in salable condition, all of those properties have to be maintained. Heat, water, electricity. Somebody has to cut the grass, and clean the pool. Somebody has to keep the crack-heads and looters from pillaging the place. In neighborhoods where there are large numbers of empty house, those properties are dragging down the value of the homes around them. All of these things cost money, every day, and once the Fed becomes the landlord, we get to pay for it. Notice that little item isn't mentioned in the Bailout Bill (though technically, while not spelled out, I suspect that Sec 5(b) probably covers maintenance and upkeep and Sec 2(b)(1) covers hiring people to manage and execute the process (And once those people are hired, see if we can get rid of them anytime in the foreseeable future - we will in essence be creating a new branch of the Fed, sort of like a Mortgage Industry TSA).

Every single day that we, as taxpayers, own those properties, we're bleeding money - just exactly as the Mortgage Industry is right now. What? You didn't think those properties are magically going to be worth something just because the Fed purchased them, did you? If they were actually worth something on the current market, there would be no need for a bailout, now would there?

That's right, a whole bunch of people threw themselves a party, and we get to pay for the carpet cleaning.

Now, here's the thing, most of us didn't make this mess, we had it thrust upon us. But, if we have to assume the risk, and a significant risk at that, then we should get to enjoy some of the profit - should there be any.


Now, here's what I propose: Create a National Permanent Investment Fund.

Let's start with some background:

Since Alaska has been forefront in the news lately, a large number of folks - both in the news media and in private blogs and forums - have noted that Alaskans get money annually from from the oil industry.

That's not exactly true.

We get money each year from the State, via dividend from the Alaskan Permanent Fund, the APF.

In essence, the APF is a constitutionally established fund, managed by a semi-independent corporation, established by Alaska in 1976. The Permanent Fund was created by an amendment to the constitution of Alaska to be an investment for at least 25% of proceeds from some minerals (such as oil and gas) sale or royalties. The Alaska Permanent Fund sets aside a certain share of oil revenues to continue benefiting current and all future generations of Alaskans.

The Alaska Permanent Fund Corporation manages the assets of both the Permanent Fund and other state investments, but spending fund income is up to the Legislature. By law, the Corporation is to manage for maximum prudent return. The Fund grew from an initial investment of $734,000 in 1977 to the sum of approximately forty billion dollars as of July 13, 2007. Some growth was due to good management, some to inflationary re-investment, and some via legislative decisions to deposit extra income during boom years. Each year, the fund's realized earnings are split between inflation-proofing, operating expenses, and the annual Permanent Fund Dividend.

The Permanent Fund Dividend is a program benefiting Alaskans without a felony conviction who have resided in the state for at least one calendar year preceding the date applied for a dividend and intend to remain an Alaska resident indefinitely at the time applied for a dividend. The amount of each payment is based upon a five-year average of the Permanent Fund's performance and varies widely depending on the stock market and many other factors.

* Note, I took this description directly from the Alaska Permanent Fund Wikipedia entry, further details can be found there or on the Alaska State Website, Permanent Fund Dividend Division.

With the Alaska Permanent Fund as a model, what I propose is this:

1) Use the $700 billion bailout to acquire the foreclosed properties, as currently indicated by the draft provisions of the bill.

2) Create a national permanent fund in the Alaskan model, and put the money recovered from each property into it. Based on an estimated average of real recoverable value, say $250,000 per property, times 2 million properties we get approximately $500 billion give or take over time as a starting principal.

* Note, a number of those properties will sell well below the $250K average, and a number are valued at much higher worth but will not sell anywhere near their current estimated value. $250K is a lowball best guess based on the current mortgage foreclosure offload price, as best I can determine. The numbers are extremely fluid and vary significantly depending on source. Because of this, initial fund principal could be anywhere between $300 billion and $1 trillion, I used $500 billion as an average best guess.

The initial principal investment does not have to occur lump sum, but will build up as each Fed controlled property is sold back into the market.

3) By law, make the principal untouchable, except by 90% congressional consensus with concurrent presidential approval and Judicial Branch review. Make this a US Constitutional amendment if necessary. The principal must be protected from the politicians, who will always find a compelling reason to plunder it if given half a chance, always - which is precisely why the Alaska Permanent Fund was created and protected by State constitutional amendment.

4) Invest the principal in long-term, stable financial instruments, with the goal of maximum prudent return, managed by a purpose-created, semi-independent corporation under oversight of the Fed. This separation is a critical buffer between the money managers and Government oversight, and is absolutely necessary if the government is to maintain it's proper Constitutional role in our society. If the government manages the fund, there is no oversight responsible to the taxpayer, this is unacceptable.

This investment alone will immediately provide a massive and continuing infusion into the market and long-term stability. Because this will be a permanent investment, it will also provide a continuing cushion against future free market fluctuations - while at the same time not restricting the free will of both independent and corporate investment.

As a side effect, properly distributed this massive investment will almost immediately save retirement investment plans and individual long-term savings plans.

5) Unlike the initial half million dollar APF investment principal, the National Permanent Fund should immediately return a large dividend if properly invested in the market. Distribute the dividend return as follows:

(a) designate a percentage, say 10%, to reinvestment in the principal. Unlike the APF which depends for principal growth primarily on oil revenue input, the National Permanent fund will not have outside input once all the federally owned foreclosed properties are sold.

(b) use what percentage necessary to pay off the $700,000,000 bailout package per quarter. Note: this percentage, while high at first will decrease as the principal increases in size and value.

(c) Divide the remainder up as follows: (1) 50% to back to the national treasury to be spent as determined by Congress, see below. (2) for the first five years, reinvest the remaining 50% back into the fund in order to rapidly increase the principal. After five years distribute the remaining 50% equally to every US federal taxpayer. Note that the word 'taxpayer' is emphasized. See below.

- Taxpayers will assume the risk of this bailout, this will be their reward. If you don't pay federal taxes, you've assumed no risk and you deserve nothing in return. Yes, taxpayers will have to wait five years for their first dividend. We're talking a long term, permanent fix here, and that means long term rewards.

- Instead of a check, each taxpayer's dividend will be deducted from his or her federal income tax as a standard deduction. The initial amount will be small, perhaps unnoticeably small at first, just as it was with the Alaskan PFD, however over time and with prudent management the amount will increase significantly, dramatically, and exponentially. Done correctly, over a long enough time, Federal Income Tax may be reduced to a few dollars for the average American, or eliminated altogether. At which point, the excess will be distributed to each tax payer as an economic stimulus check. Note: this may not occur during our lifetime, but it can be done if given enough time.

- For the percentage returned to Congress (1): Require a portion be used to create a federally backed mortgage loan agency in the model of the Veteran's Administration Loan Division. In this case, qualifying taxpayers could get low-interest, fixed-rate, long term home loans backed by the fund - which would go a long, long way towards getting the average citizen within reach of the American dream without the chicanery of the interest-only, balloon-payment, sub-prime nonsense that got us into this mess in the first place. Additionally, precisely as in the VA Loan process, each home purchase would require a detailed inspection and value assessment prior to loan approval, providing the purchaser and the taxpayer a degree of insurance against over-valued or inflated-value properties which were a contributing factor in the mortgage sector meltdown. The VA Loan process provides an excellent and workable model that could be transferred whole cloth to a Federally backed National Mortgage Agency, and in fact that new agency could simply absorb the VA Loan operations as part and parcel of it's responsibilities, efficiently consolidating all federal mortgage loans under one roof.

- For the percentage returned to Congress (2): Initially require the remainder to be used to fund both short-term and long-term energy research and directly fund reconfiguration of the national energy infrastructure on the order of the Eisenhower Administration's commitment to the Interstate highway system. Soaring energy costs outside of our national control were a direct contributor to the mortgage crisis; using of a portion of the dividend to prevent that in the future and gain energy independence would be in the nation's best interest.

- For the percentage returned to Congress (3): as the energy infrastructure begins to become self supporting, the funds may be spent as determined by Congress via the normal process currently in place - my personal recommendation would be to allot a significant amount towards fully funding the plundered Social Security fund.

Additional thoughts:

- Create a federal and/or state home lottery system. Sell lottery tickets for certain federally owned foreclosures. This may be an excellent way to recoup far higher than market value for damaged properties, sold "as is." Local and State governments could determine which communities are optimal for such lotteries, and a percentage of the lottery income would be returned to them in order to fund the process. However, the majority of the lottery income would be input directly back into the Permanent Fund principal. Lotteries could be divided up into Individual and Corporate categories. Corporations could compete for blocks of properties. Note: while many Americans currently do not have the wherewithal to purchase a home in the current loan market, most could afford a $100 dollar lottery ticket for a chance to win a home. Now the home they win will have certain equity, even if damaged and unlivable. Because they didn't need a loan in order to acquire the property, they could get a home improvement loan against the property's equity even if that is far below what the property would be worth in good condition. If those loans are acquired through the aforementioned Federal Mortgage agency, the loan could be mandated for use in home improvement only. In fact this could be made an automatic part of the lottery process itself, waived if not desired by the winner. This way, people could acquire properties for no initial outlay other than the price of a lottery ticket, the Fed gets its money for the property (and probably a hell of a lot more, depending on the number of tickets purchased), the bank can loan money to the new home owner based on real assessed value at a rate that the new owner can afford even if he works at Pizza Hut, and the value of the property is restored to full market value. With a little luck and some common sense, a family with a combined income of $60K could end up owning a $300K house free and clear in a couple of years. And that, my friends, is just plain as good as it gets for everybody.

- Create an auction process for certain properties, similar in process to the eBay on-line model. Properly administered, this process could serve cities and townships as a tool for urban restructuring and development. I.e. municipalities could purchase blocks of home for low-cost subsidized housing, or for removal and rezoning, or as an investment of their own. Note: provisions would have to be put in place to ensure compliance with Federal non-discrimination laws and etc. Additionally, a block auction process would allow solvent mortgage agencies to compete for the available properties, which in turn would allow the market to drive the overall value of the properties vice a federally determined base value. However, just as in the eBay model, a minimum starting bid and a "purchase now" value could be set - either way the Fed, i.e. us, gets its money and gets rid of the property.

- States, townships, and cities could pay the Fed, and again with the resulting monies funneled directly into the Fund principal, to advertise on the lottery and auction sites - i.e. states use the funds they have currently set aside for attracting business and residents (For example, the "Say Yes To Michigan" campaign) to make the advertised homes more attractive.

Both the lottery and auction models would make properties available to buyers nation-wide or even world-wide, rather than depending solely on the pool of local home buyers, drastically increasing the likelihood of a sale. Indeed, the lottery process would guarantee liquidation of the property in question, returning higher than market value to the Fund and removing the risk to the taxpayer.


Obviously, this would be a radical departure from the current thinking, and just as obviously there would be many details to work out. There are a number of pitfalls I can think of, and a number significant advantages that I've only hinted at.

An additional item to note: implementation of this proposal would not hold up the current bailout bill before Congress, which needs to be implemented sooner rather than later. Rather, details and implementation could be worked out piece by piece over the next year and adjusted as necessary.

But the bottom line is this, we assumed the risk - go on, tell me why we shouldn't share in the reward. The phrase goes something along the lines of: When life hands you lemons, make lemonade. Done right, this lemonade stand could be paying dividends far, far into the future.


  1. I vote for Jim to head such agency - and to have full authority to keelhaul anyone who tries to engage in the type of chicanery that got us hear in the first place.

  2. I'm more of an idea man, I'll leave management to the Chiefs.

    And just a technical note: I think this post surpassed the highest ever recorded number of typos in a blog post, ever, in the history of the internet. I think I've fixed most of them, but frankly I'm tired of rereading this thing.

    If you note a typo, keep it to yourself. I'll fix it sooner or later. Probably later.

  3. Since I commented "got us hear in the first place," I'm in position to throw stones.

  4. Eh, I didn't even notice that - must be something in the air today

  5. I like when you explain stuff. It makes sense even to me. ;) Are you going to mail it to Congress?

  6. Well, I could mail it to my senior Senator, I suppose, except he's busy being indicted.

    I could mail it to my junior Senator, but I'm not sure she's actually still alive since I've heard exactly nothing from her in the last year.

    I could mail it to my governor, but she's busy, uh, debating Joe Biden and making pit bull jokes.

    I could mail to my representative, but it's probably best that we just not mention him, ever. Besides he's way too busy naming shit after himself.

    So, who does that leave?

  7. A grass-roots movement, maybe?

    Jim, there is absolutely nothing in this plan that I do not love! Starting with the realization that the government has no choice but to buy toxic mortgages, and then proceeding with figuring out ways to make it equitable for an average taxpayer - I think your ideas are brilliant! I wish I could claim partial credit here :)

    Just one note: I'm afraid #3 in your program will never be adopted, leaving the door wide open for politicians to loot the principal for whatever causes. Not the reason to discard the entire plan, of course, but a bit of a reality check.

    One other thought: Much of success of this plan relies on positive investment returns. As we have seen in the last year, even the most stable long-term instruments take a nosedive with the rest of the market. We are in need of a massive investment to stabilize the market, which will ensure positive returns even in intermediate-term. Which gets us back to the fact that the federal cash infusion - heretofore derogatorily known as a "bailout" - is absolutely central to any successful recovery.

    Despite outward pretenses, I lack formal economics training to further comment on the feasibility of each of your points and the program in its entirety. My financial-industry experience does not trigger any red flags with your proposal. As a taxpayer and an investor, I'd vote for it with a great hope.

    Thank you!

  8. Ilya. Agreed.

    As I said in the post, while there are a number of significant advantages, there are a number of pitfalls to this idea.

    The biggest being the principal, which is the key to the whole thing. It would take a Constitutional amendment to make it untouchable - and that simply won't happen, it'll never get out of Congress, let alone get to the states for a vote. Never happen.

    The politicians simply will not give up a pile of money that big. Ever. Oh, they'd all say why everybody else should leave it alone, but at the same want to reserve the right to plunder it for their own, very important, projects.

    It only worked here in Alaska because our state government is small and more directly answerable to the people than elsewhere. And, nobody thought that pile of money would grow to $40 billion plus. Now that it has, it makes the politicians in Juneau nearly insane with lust - every year somebody in the state house floats an idea for getting their hands on it. Problem is that it can't be touched without a referendum by the people, and the people aren't willing to give it to the politicians. Stalemate. And that's a good thing for us.

    But frankly, on the large federal scale I just don't see the politicians making the same decision.

    I think this is a viable way to turn this disaster to our advantage, but I'm absolutely convinced that even if everybody in D.C. was onboard with it, it still wouldn't happen.

    But I also think that the bailout as currently envisioned won't work either. It's a patch at best, not a true fix, or a long-term solution. And it sets a large number of very bad precedents. Borrowing money got Wall Street into this, borrowing more money to fix it simply moves the problem to the Fed. Those toxic mortgages aren't going to be any less toxic just because the Fed took them over. I see no real detox in the bailout, no real recovery for the people who need it most (i.e. the average home buyer who defaulted on his loan and now has shit for credit and will for the foreseeable future). How will the Fed unload those houses? How will we recover the $700B (and probably more like $1.5T when it's done)? And in addition to the properties the Fed picks up, there are a least another million homes either under construction or available that can't be sold either, and those were never foreclosed on, they've always been empty, and unlike the repossessed properties they have to go for full market value, else the construction companies will go bankrupt.

    I can understand the need to do something now, i.e. bailout. But what comes after that?

  9. Jim,

    Do send it too Sarah "Barracuda". After listening to her tonight, I suspect she would be open. Especially since the VP debate went so well.


  10. I think number 3 is the biggie. Wasn't Social Security something like that until it was decided that all the money that was carefully set aside to pay for future generations of retirees needed to be raided..err, I mean joined into the general fund?

  11. Yeah, protection of the fund would be a critical factor. Without constitutional protection, it would be pillaged in short order - if it was actually funded at all in the first place.

    Politicians cannot keep their hands off the money. That's a fundamental law of the universe.

  12. Mr. Wright,
    I think I need a couple of clarifications, before I say, "Hell yeah!" First, if we are to bail out the banking system, where these toxic assets are concerned, have you considered that a typical 30 year mortgage yields a profit of approximately three times the original selling price? This means the problem is three times as big as most think it is and will take a logarithmically longer time to even break even with the initial expenditure of federal funds. I am only going to mention that, during this time of hoping to break even, we are paying on the interest and principle of the loan from the Chinese that makes this even remotely possible. All of this is based on the assumption of another, steady, long-term increase in housing values, as well as having to combat massive inflation at home and a massive devaluing of our currency worldwide.
    Sorry man; I have a long history of chewing up and spitting out "idea men". Way too many years in a quality control job....


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