Banks Do What Banks Do Best

Look back to my entries from November 14th and 18th. Also, I have tried to make the point that managers in the banks and investment banks do not have a clue as to what these securities really are nor do they really understand how they ended up owning them in the first place. This is really why the banks are desperately trying to get the "government" to take them out of the whole mess by buying the defaulted securities. I don't have the time to write about this right now. Keep in mind, that 1. the ABA is the strongest lobby in the US, 2. banks will never admit that they are as incompetent as they are, 3. the problem is credit default swaps and the fact that underlying assets all got downgraded and 4. people at the fed and the treasury have been lied to and they do NOT have a clue either.

All right ... because nothing substantive has been done, I must conclude that the people who are groping for a solution really do not know how to proceed. Throwing $350 billion at the banks may have kept them afloat, but it has done nothing to solve the underlying problem - no liquidity complicated by a lack of confidence.

Liquidity is necessary for the efficient functioning of the capital market. It exists in the macro, system wide, and micro, security specific or market sector sense of the word. The lack of liquidity in the MBS sector led to the liquidity crisis in the entire capital market. The idea behind TARP was to add liquidity to the banking system and the banking system would add liquidity to the market. All it did was reward incompetence.

I touched on a solution like this in past posts but never really formed the idea. So ... the problem started because "mortgage related securities" held by Bear Stearns, Merrill, Lehman, AIG and everyone else, could not be financed by their holders. The notional value of the MBS exceeded the capital of the firms that owned them - the MBS could not be sold - the firms lost all of their ability to carry other positions (because they were insolvent) - and the credit market ceased to function. I don't think that it's too late to fix the problem by providing cash flow to the securities that defaulted owing to the foreclosure of their underlying collateral.

Keep in mind:
1. Credit default swaps, referenced by or tied to MBS, created the mess when they were downgraded.
2. Very few people, especially those at the credit rating agencies and the GSE's and the management of ANY firm involved in this mess, understood the risk associated with the subject CDS's.
3. When liquidity dried up, managers did what managers do best, they panicked, and all parties involved tried to get out at the same time compounding the problem and leading to the current crisis.
4. When the managers met with the fed, all they cared about was getting out of the MBS, not trying to fix the cash flow - remember, they don't know anything about the mortgage market. If they did, no prudent person would have let this mess happen in the first place - right?
5. Everyone involved in this mess, from mortgage originators to the investors who bought this crap, have a responsibility to fix it.
6. The MBS market is extremely efficient, it would have to be to finance the trillions that it has. The players involved know the collateral and know exactly what it would take - as it relates to interest and principal payments - to get the defaulted securities back on a cash flow basis.
7. If the $350 billion that went to the banks under TARP were used to provide cash flow to the securities underlying the defaulted CDS's, we would not be in this mess.
8. Is it too late then, to put the cash into propping up the MBS and therefore, the CDS? That is, can the market be rebuilt? If it can, all of the parties that got us into this mess are made to stay in the game and to pay in some way for their incompetence.

I'm not sure that what I suggest will work. I'm pretty sure though, that it's a lot better than throwing good money after bad by giving it to the banks and letting them do whatever they please with it.

What do you think?