TARP Alternative By Lt. Daniel Kaffee (Guest Author)

A refreshingly unique perspective by Lt. Daniel Kaffee. Daniel Kaffee, a life-long friend,  has an extensive background in finance and will be guest-authoring at the Raw Deal from time to time. I am honored to share his practical insights with you, my loyal reader.

◆ Key Facts & Assumptions

◆ The TARP has been an unabashed disaster, and must be subject to a redirection and reallocation of resources in order to more effectively stabilize our economy in the long run, not just a focus on ‘tomorrow’.

◆ The high level solution is decentralization of the financial system, like the tech industry, which will lower systemic risk, foster competition and yield better ideas, services and companies. In order to alleviate the current financial market problems, it is important to understand and address the root causes – not just the symptoms and peripheral issues. Topics such as executive pay, bonus schemes, mortgage application fraud, regulatory fraud, credit derivatives and investment mis-selling all need addressing in time, however the primary concern for now must be to stabilize the global financial system and have it reopen for business.

◆ TARP does not insure that those banks and brokers that receive bailout aid will increase lending. There has been no discernible nor measurable uptick in consumer or B2B lending since the advent of the TARP program. The reality is the market is hoarding liquidity and these banks are doing the same. More importantly consumer lending has been a small, often insignificant part of their business. They made money by trading and through securitization of debt. We are talking about a seismic shift in the business model of multi-national institutions, and this will not happen over night. Banks must be viewed on the same plane as utility companies – not mega-centers for corporate profit. They have generally become massive trading houses and hedge funds with a small consumer-deposits component allowing them ready access to a cheap source of capital.

◆ The Wall Street model of securitization and extreme leverage is obsolete. Big banks and brokers made most of their earnings over the past several years in trading, not consumer lending. And now their derivatives are THE problem. Derivative devaluation does not directly affect the general public except for reducing the bank’s capital position to the point that they’re unable to lend. We must segregate the derivative write-downs from the portion of the bank subject to regulatory capital requirements.

◆ There is a fundamental lack of liquidity in financial markets as too many assets (bonds) are looking for long term homes. There is no single solution to this problem however a number of different processes can aid in freeing up markets. A central mandate of any government action must be to encourage private sector price discovery, without the crutch of a Federal Reserve or Treasury backstop or guarantee. There is a price at which buyers and sellers will conduct business. We must expedite the discovery of that price, not hinder it.

◆ Many home owners paid too much for their houses. Time, inflation and economic growth will eventually solve this problem as long as markets are stabilized and we prevent massive forced foreclosures and liquidations. Efforts to ‘prop up’ home prices are misguided, and we must return to historical levels of wage-to-price ratios, and price-to-rent ratios. Robert Schiller has published ample material about where housing prices should be and will likely stabilize – the question is simply how much money will we burn trying to prevent the inevitable from occurring?