A Humble Idea To Save The Banks And The System

It's time to face up to both the systemic and economic reality that is plaguing banks, housing and international trade. As matters stand at present, they can neither co-exist nor thrive in their current state. They are like Siamese triplets who cannot work out their joint living arrangements. They must either reconcile or die.

The first step is to acknowledge that banks are really mortgage investment companies. They do not hold any serious amounts of cash beyond a small percentage to meet daily demands. Moreover, the banking system relies on all funds that are withdrawn eventually making their way back in to the bank from other depositors.

So the expression," cash is king", holds true only if you can actually access your cash and someone else is willing to accept it as payment. In the case of a bank run, you would therefore want to be at the front of the queue rather than at the back.

The second step is to acknowledge that banks presently are holding too many mortgages that are underwater or have become the owners of properties where the owners have walked out and returned their keys. This situation has not only killed profits but has also eaten deeply into the capital of the banks. In fact if it was not for a combination of not putting foreclosed properties on the market and delaying the recognition of losses, the banking system would be seen for what it is and would have blown up. Those wretched little termites in government, accounting firms and other high places are holding hands to stop the structure from crumbling.

The third step is to recognise that money in the banking system is being severely destroyed and devalued by rates of interest that are more insult than payment. And all this is being done to keep rates at a level that do not cause homeowners and commercial property owners to keel over and cause a cataclysm.

The fourth step is to recognise that much of the cheap money found its way into the system due to the incredible trade surpluses that China and other nations made available to their customer nations.

My suggestion therefore, is as follows:

• Calculate the true level of write-offs that should be taken on foreclosed mortgages.
• Charge each depositor holding more than $2000 (or some other amount) a pro-rata amount that will equal these losses.
• Issue Type B bank shares to all depositors whose accounts have been culled with the same face value as the amount taken from their accounts.
• As banks begin to earn profits these shares can be redeemed and cash will flow back to the depositors ahead of existing shareholders.
• The whole process could be augmented by the central banks of all nations uniformly revaluing their gold holdings by a substantial amount and taking up Type B shares in these banks in exchange for gold whilst still holding possession of the gold separately in a central repository.

Whilst I cringe at the thought of taking money from people's accounts, I also feel that the circuitous route of pumping money into the FDIC and in turn loading that debt onto the nation's debt is nothing more than a slow and deceptive bleed that is not providing a quicker and more sustainable resolution.

This solution should of course be applied even to the GSE's which in turn would mean the Chinese and other holders of such securities taking a haircut/shave.

Many will see this as a retrograde step and one which will paint the USA as another Argentina, but can anyone tell me for how long and in how many ways the current rotten facade can be maintained?

There is no doubt that housing became a fixation of people everywhere and in particular the Western World where cheap interest rates and non-existent standards created an illusion that everything is possible and that homes could become the source of untold riches. Well they did, but only for some. In Australia unfortunately, the illusion still persists.

The fourth step is for the USA to wean itself off the fixation on housing and return to saving and investing. Tax deductibility on mortgages for investment homes should possibly be stopped to the extent that interest exceeds income. This should separate the real investors from the speculators and tax minimisers.

Above all the USA must recognise that the system must return to real jobs in manufacturing, reduced waste in resource consumption, upgrading of productivity enhancing infrastructure and an education system geared towards engineering and science rather than law and finance. These are the things that form the basis of longer term prosperity rather than the illusions and delusions being peddled at present.

Without real jobs all the accounting, spending and political solutions (as well as my own humble idea) count for nil and this should be apparent from the results to date.

The people in the USA may well end up consuming less if they were to manufacture and grow, most of their own output, but the reality is that on the current trajectory they will end up consuming precious little if they cling to the lure of cheap overseas products. In other words the current status is not sustainable and if the politicians in Washington have delusions or are spreading delusions that this is possible, then the end is a foregone conclusion.

This world's resources are finite but man's and government's proclivity to be wasteful and destructive reached new heights in recent years with the opportunity of cheap interest rates. If free trade is to succeed is cannot not be on the basis of gargantuan trade surpluses or horrifying deficits.

A growing GDP is not necessarily a sign of real growth if that GDP is increasingly composed of military expenditure, building houses that remain empty, building malls that cannot be filled and feeding and housing the biggest prison population in the world both by number and percentage. The list could go on both at a national as well as a personal level but I think you get my drift. All nations to some extent suffer from these problems.

Moreover, any short term advantage China may have gained will also count for nothing, if it continues to rely on unsustainable levels of US consumption. The greater the imbalances, the greater the final reckoning that awaits us.

That's right folks, we have had too much of everything.....too much consumption, too much debt, too much war, too many losses. Everything in excess is damaging. Despite this the real things such as gold and silver have quietly risen above the frenzy precisely because of that reason......they cannot be produced out of thin air like derivatives nor can their supply be ramped up with the flick of a printing press switch. Moreover, they do not have the problems of storage or 'use by dates' that other essential commodities like wheat and foodstuffs have.

I am sure that there are some problems with what I am proposing and I imagine that other writers have made proposals along similar lines, but I have yet to see or hear of any real solutions from the countless thousands of people who work for the Federal Reserve, the IMF, BIS and all the other governments and central banks of the world. They produce loads of statistics, loads of debt, mythical borrowing facilities and little else. They massage expectations but cannot perform real surgery. They have erected expensive props and scaffolding but have done little to repair the structure.

What I am not sure of is what hidden angels of death lurk in the system that cannot be flushed out without tearing the system apart. Perhaps it is those derivatives or perhaps the losses are so frightening that our political masters prefer Greek style accounting to maintain the peace.

Yes, there are solutions but personal and national self-interests only have short term profit horizons and very little long term gain. And this is where the problem lies. The world cannot change unless we change ourselves. Personal values underpin financial and economic values and not the other way round. In the meantime we continue to exceed the devil's expectations even though we have Lloyd Blankfein on our side doing God's work. Thank you Lloyd.

Perhaps Warren Buffet and Bill Gates could kick off the process following their recent pledges to give away half their personal wealth. By the way, "which half?" Who knows? Anything is possible.

In the meantime any investment portfolio without precious metals fails to understand both history and reality.

Do you understand or are you caught in the headlights of the approaching train?

Sydney Australia

P.S. I hope readers will forgive me for not responding to their recent emails as I am just recovering from a bad cold that I caught from getting caught by the rain whilst on a long walk. If I survive you will hear from me.