A proposal…

In yesterday's London Times, Gerard Baker, their US editor, commented “In the 1930s, the US Congress did more than its fair share in helping to turn a financial crisis into a global depression. Yesterday it looked as though it was auditioning to assume that role again.”

An interesting view. Granted, in the 1920’s Congress passed many near-sighted and, in retrospect, clumsy and often stupid self-serving laws that when looked at in their entirety set up the “Great Depression.” I don’t believe that the non-passage of the administration’s bail-out proposal equates.

However, likely everyone agrees that the markets’ responses to the vote’s failure were not good. But I feel that it was an overreaction, as many of the responses to the ongoing market turmoil have been. The reality is that there are no guarantees for investors. The risk factor is what ROI and interest rates are based on. To take away risk lowers the return. That’s why mattresses don’t pay interest. Part of the problem that lead to the current debacle is that lenders and investors tried too hard to shield themselves from risk. By “insuring” against risk, they avoided proper due diligence and basically increased it.

So, what do we do now? Maybe a bail-out isn’t the right solution. It's really just a Band-Aid on a far larger problem.

The Citigroup takeover of Wachovia’s retail banking operations might be a good prototype for what should be done to solve the situation. Instead of buying the “toxic” loans and bonds, perhaps the Treasury should put a cap on losses through a guarantee program and take preferred equity stakes in institutions that come to its window. Granted, we might end up having a semi-nationalization of the banking industry, but it at least gives John Q. Public a better potential security on taxpayer funds than a straight payout.

As I said yesterday, “mark to market” has become a disaster. A reconsideration of accounting rules for financial institutions should be part of the package.