Niall Ferguson's Proposed Solution

[Glenn Black]

http://www.niallferguson.com/site/FE...spx?pageid=204

Niall Ferguson, MA, D.Phil., is Laurence A. Tisch Professor of History at Harvard University and William Ziegler Professor of Business Administration at Harvard Business School. He is also a Senior Research Fellow at Jesus College, Oxford University, and a Senior Fellow at the Hoover Institution, Stanford University.

First, banks that are de facto insolvent need to be restructured
...
The second step we need to take is a generalised conversion of American mortgages to lower interest rates and longer maturities.

[Master Shake]

Niall Ferguson: A Great Repression

http://www.theaustralian.news.com.au...69-643,00.html

Money shot.

The solution to the debt crisis is not more debt but less debt. Two things must happen. First, banks that are de facto insolvent need to be restructured, a word that is preferable to the old-fashioned nationalisation. Existing shareholders will have to face that they have lost their money. Too bad; they should have kept a more vigilant eye on the people running their banks. Government will take control in return for a substantial recapitalisation after losses have meaningfully been written down. Bondholders may have to accept either a debt-for-equity swap or a 20 per cent "haircut" - a disappointment, no doubt, but nothing compared with the losses suffered when Lehman Brothers went under.

There are precedents for such drastic action, notably the response to the Swedish banking crisis of the early 1990s. The critical point is to avoid the nightmare of a state-dominated financial sector. The last thing the US needs is to have all its banks run like the Amtrak national passenger train network or, worse, the US Internal Revenue Service. State life-support for moribund dinosaur banks is an expedient designed to avert the disaster of a generalised banking extinction, not a belated victory for socialism in North America. It should not and must not impede the formation of new banks by the private sector. Financial history is, after all, an evolutionary process. When old banks die, new banks swiftly take their place. It is therefore vital that state control does not give the old banks an unfair advantage. So recapitalisation must be a once-only event, with no enduring government guarantees or subsidies. And there should be a clear timetable for re-privatisation within, say, 10 years.

The second step we need to take is a generalised conversion of American mortgages to lower interest rates and longer maturities. About 2.3 million US households face foreclosure and that number is certain to rise. For example, $US97 billion of $US200 billion of option adjustable-rate mortgages will reset in the next two years. The average monthly payment will increase by more than 60 per cent. As a result, up to eight million households could be driven into foreclosure, driving down home prices even further. Few of those affected have any realistic prospect of refinancing at more affordable rates. So, once again, what is needed is state intervention.

The idea of modifying mortgages appalls legal purists as a violation of the sanctity of contract. But, as with the principle of eminent domain, there are times when the public interest requires us to honour the rule of law in the breach. Repeatedly in the course of the 19th century, governments changed the terms of bonds that they issued through a process known as conversion. A bond with a 5 per cent coupon would simply be exchanged for one with a 3 per cent coupon, to take account of falling market rates and prices. Such procedures were seldom stigmatised as default. Today, in the same way, we need an orderly conversion of adjustable rate mortgages to take account of the fundamentally altered financial environment.

Another objection to such a procedure is that it would reward the imprudent. But moral hazard only really matters if bad behaviour is likely to be repeated. I do not foresee anyone asking for, or being given, an option adjustable-rate mortgage for many, many years. The issue, then, is simply one of fairness.

One solution would be for the US government-controlled mortgage lenders and guarantors, Fannie Mae and Freddie Mac, to offer all borrowers, including those on fixed rates, the same deal. Permanently lower monthly payments for a majority of US households would almost certainly do more to stimulate consumer confidence than all the provisions of the stimulus package, including the tax cuts.

Ever since the New Deal, American politicians have proclaimed their faith in the "property-owning democracy" and the "American dream of home ownership". For years they have actively encouraged the expansion of the sub-prime market. But the result has been an American nightmare. With housing prices still falling precipitously - the Case-Shiller index of US home-prices indices puts the annual rate of decline at minus18per cent - there is an urgent need for action.

No doubt those who lose by such measures will not suffer in silence. But the benefits of macro-economic stabilisation will surely outweigh the costs to bank shareholders, bank bondholders and the owners of mortgage-backed securities.

Americans, Churchill once remarked, will always do the right thing - after they have exhausted all the other alternatives. But if we are still waiting for Keynes to save us when Davos comes around next year, it may well be too late. Only a Great Restructuring can end the Great Repression. It needs to happen soon.

[Rajiv]

Re: Niall Ferguson: A Great Repression

Marvenger had posted this earlier (but with no abstracted quotes as you have done) here -- calls for debt forgiveness growing

[c1ue]

Re: Niall Ferguson's Proposed Solution

Sounds like a Chicago school of economics talking head to me.

[D-Mack]

Re: Niall Ferguson's Proposed Solution

Sounds like a Chicago school of economics talking head to me.

I watched the whole Ascent of Money and when he talked about Pinochet, I had the same impression.

http://itulip.com/forums/showthread.php?t=7349


He was also talking about non-recourse loans as a problem in his movies, I'm surprised he didn't advocate to change them.

[Chris Coles]

Re: Niall Ferguson's Proposed Solution

What took him so long to speak out?

I have been writing about the required rules for a free market for years, now the good professor wakes up? Unbelieveable!

If you change the terms of a deal, any deal, even to sell a mortgage and change the terms downstream of the signature on the piece of paper it is written on it is NOT FREE MARKET.

An Open Letter to Congress: http://www.itulip.com/forums/showthread.php?t=5560

[Glenn Black]

Re: Niall Ferguson's Proposed Solution

The enforceability of all contracts is subject to legality, specific terms, and acceptability to public policy. All the government has to do is pass legislation stating that this clause or that term is against public policy.

Presto! That term or clause is no longer enforceable by the courts, it ceases to exist. Problem solved.

For example, all (or a certain class of) CDS' are made null and void. Bingo! AIG is no longer insolvent, AIG is no longer burning through billions of $ in a quarter.

[Chris Coles]

Re: Niall Ferguson's Proposed Solution

The enforceability of all contracts is subject to legality, specific terms, and acceptability to public policy. All the government has to do is pass legislation stating that this clause or that term is against public policy.

Presto! That term or clause is no longer enforceable by the courts, it ceases to exist. Problem solved.

For example, all (or a certain class of) CDS' are made null and void. Bingo! AIG is no longer insolvent, AIG is no longer burning through billions of $ in a quarter.

Glenn,

Yes, in one sense you are absolutely correct. If the government set out clear rules for a free market as I suggest, then all contracts would have by law to submit to the basic premise of the rules. However, I am not so sure if we try to change the rules retrospectively.

We have the same debate going on here in the UK with regard to a contract for a pension fund for the failed Royal Bank of Scotland's' Chief Exec Sir Fred Goodwin:

"The Government is furious that the former chief executive of RBS almost certainly has a rock-solid contractual right to the money."

http://www.timesonline.co.uk/tol/com...cle5834787.ece

The debate being that if we are a nation that agrees to abide by the laws of property, (as set out today), then a contract is solid under law. We might very well dislike the terms, but under Caveat Emptor rules, the contract must stand.

So this has to be a long term debate that changes the rules for the future and we have to live with the consequences of today.