HAMBERGER CRISIS: Economist: Create `Bank USA'

A veteran Wall Street strategist has a plan to save the financial system by creating ''Bank USA,'' which would acquire good assets and help recapitalize financial groups.

For months, Wall Street and Main Street have blamed subprime borrowers and risky mortgages for the financial meltdown that has erased trillions of dollars of savings and sent the world's financial system teetering.

But Robert S. Gay, a hedge fund strategist and a former Federal Reserve economist, said the problem is the overwhelming indebtedness of the U.S. financial system, which is now greater than the country's $14 trillion gross domestic product.

The subprime crisis? ''It was just the trigger,'' said Gay, chief strategist for the Miami-based BullTick Capital Markets.

Gay -- who spoke at the Hedge.Funds World LatAm 2008 conference, which took place at the Four Seasons Hotel in Miami on Tuesday and Wednesday -- has a four-point plan he says the government should undertake to halt the unraveling of the financial system:

• Guarantee or ''backstop'' all short-term commercial paper and three-month swaps, a move taken by the Federal Reserve Tuesday. Commercial paper is the short-term debt issued by corporations.

• Recapitalize financial institutions by buying up ''good'' assets, not the ''bad'' assets that will be purchased under the current $700 billion bailout plan.

• Scrap the new financial accounting mark-to-market rule so banks do not have to take losses on their balance sheets right now.

• Increase the assets of the Federal Deposit Insurance Corp. to give depositors confidence.

''Governments are the only entities that have the wherewithal to manage this,'' said Gay, adding that this formula must also be sold to Europeans who face a crisis of confidence in financial markets and banking companies in as bad a shape or worse than those in the United States.

''Create a good bank with assets that the taxpayer owns -- Bank USA,'' Gay said. ``Think of this as the Treasury is going to invest in America.''

''Bank USA'' could either sell its good assets, perhaps making a profit for taxpayers, or simply hold them to maturity. Again, he said, that would eliminate financial losses.

The financial institutions would receive funds in exchange for the assets, allowing them to recapitalize and return to doing normal business. Those financial groups that still had too many bad assets on their balance sheets would not survive. But most would still be standing.

''Buying good assets is cheap, but it kills the shareholders,'' Gay said. ``Buying bad assets is expensive.''

Institutional Risk Analytics co-founder Christopher Whalen, who has issued his own four-point plan, said he basically agreed with the Gay plan. ''I would just give the banks capital rather than going through the exercise of buying the paper from them,'' he said.

WHAT WENT WRONG

Gay and other analysts pointed out that it was crucial to understand what went wrong in order to restore normalcy to the dysfunctional markets. Financial authorities erred by considering this a crisis of liquidity rather than a systemic risk, they said.

What happened was that financial companies, from the big insurance firms to banking groups, went global and tried to ''game the system'' by creating debt out of ''thin air,'' Gay said.

This meant creating instruments such as collateralized debt obligations, where $1,000 of debt could be collateralized by a few dollars of real capital.

These debt instruments were parked offshore in pools of investment assets called Structured Investment Vehicles, or SIVS, which went unregulated by the Securities and Exchange Commission -- the regulator of big financial firms until the current crisis. Much of the debt was sold to European banks, spreading the problems.

Because the system was so highly leveraged, financial institutions could end up holding worthless paper that was backed by almost nonexistent collateral in a heartbeat. That is what happened. Soon institutions could not put a value on their debt instruments because no other institution would buy them.

INDEBTEDNESS SOARED

The numbers explain the problem. In 1980, the gross indebtedness of the U.S. financial system was 20 percent of the country's gross domestic product. Last year, this had ballooned to 116 percent, Gay said.

The problem is similar in Europe. Barclays PLC, Britain's third-largest bank, has a gross indebtedness level that is larger than Britain's GDP; Deutsche Bank's indebtedness is about 80 percent of Germany's economy.

In contrast, American consumers, who have been blamed for taking on too much debt or risky subprime mortgages, increased their debt at a much slower pace, from 50 percent of the U.S. gross domestic product in 1980 to 100 percent today. Household wealth shot up, rising from $20 trillion in 1990 to $54 trillion last year, Gay said.

BY JANE BUSSEY
Ref.: http://www.miamiherald.com/business/story/718867.html

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HAMBERGER CRISIS

10/09/2008

Economist: Create `Bank USA'

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