One of the ways that the $700 Billion Wall Street bailout is being shoved down the public’s throat this week is with the threat that if the government doesn’t spend $700 Billion on illiquid mortgage assets, the hedge funds and banks and whoever that own all this bad mortgage paper will stop making home loans, and everything will get worse. Another premise that people are defending is that Paulson’s dumb idea is the best idea that we could come up with.
I really doubt that this is the best idea we could come up with. I know because I have an idea that’s hugely dumb, and yet it’s better than Paulson’s dumb idea. I’m sure if you took about twenty bank presidents and stuck them in a room with coffee and Danish for about four hours you could even get a better plan than mine, but meantime, let’s look at my plan.
First, let’s set out our assumptions and goals:
- The government’s going to give us $700 Billion to play with. They’ll sell treasuries or raise taxes or whatever they need to do.
- We’ll need 10% of the total sum to administer the program.
- Our goals are:
- Support home lending as much as possible — i.e., prevent a “freeze up” of credit.
- Minimize risk to the taxpayer.
- Reward people and institutions who made good choices, and not reward people who didn’t.
Johnnie’s First National Bank
Here we go, ready?
Take $700 Billion Dollars, and deposit it in a Federally run bank. You don’t have to call it Johnnie’s First National Bank, but that’s what I’ll call it for the sake of simplicity (and narcissism).
In fact, we already have a Federal Reserve, and they have a whole bunch of districts and banks all ready to go. This is going to be easy!
We’re going to make some home loans. To make sure we have enough money to pay our $700 billion depositor (the American people) back, we’re going to have a reasonable reserve requirement of five to one — five dollars loaned for every one dollar of deposits. Since we wanted to have 10% to administer the program, we can loan up to $630 Billion times five, or $3.15 Trillion in home loans. (To leverage our $630 Billion, we will sell government guaranteed Certificates of Deposit at 3%).
Most of these loans are not going to default, even though we’re going to have high loan to value. (We need the high loan to value because nobody has any money because the government shipped all our jobs overseas — I’ll have to solve that problem later). Meantime, borrowers who choose to participate in the program agree that if they default, they have to pay back 20% of the loan amount as a tax lien. We have the IRS to enforce that. Also the government will foreclose like any bank would to recover some of its investment.
To further reduce the risk on these loans, we’re going to limit participation in the program to people who have a credit score of 700 or above. That means about 58% of Americans will be eligible to participate, and it will be the 58% who have the best credit. I don’t know the exact historical default rate for this group, but I estimate it should be about 3% or so over the life of the loan. We’re loaning at, oh, I don’t know, 6% per year, and let’s say conservatively we have a .5% yearly default rate, half of which we can recover through tax liens and home sales.
How Many Loans Did We Make?
The average home in America currently sells for about $245,000. Assuming we made all our loans in one year, we helped almost 13 million people buy homes. (More precisely, the number comes out to 12,857,143 home loans). So roughly speaking, we’re able to finance about 20% of all home sales in the United States in a year this way. Moreover — hooray for us — we picked the top 58% of all borrowers! (Compare the Paulson plan, which by definition targets the crappy mortgage backed securities that banks don’t want).
How Did We As Taxpayers Do In Our New Socialized Lending Business?
The math gets a bit tricky, and I’m not a banker, but let’s see if we can get a rough idea:
To turn our $700 billion in treasuries into $3.15 trillion in loans, we sold CDs at 3%. On the lending side, we made 6%, so that works out to 3% net. However, .5% of the loans defaulted, and we only got half that money back, so our real earnings were 3% minus .25%, or 2.75%. At 2.75%, our $3.15 trillion made us about $86.6 Billion per year, meaning we can pay the taxpayers back their initial outlay of $700 billion in just a little bit over eight years.
After that it’s all profit. See, banking’s not a bad business if you do it right.
Did We Meet Our Goals?
We made about 13 million loans. Not bad. That ought to keep things going and make up for the banks that folded. We rewarded people who made the good choices (those who that kept their credit good enough to participate). If you don’t have a good credit rating, you’ll need to clean that up, but once you do you can participate in the program. If you’re a bank and you fold, oh well, it sucks to be you, but other banks who were smart enough to make reasonable choices and are now competing with us are doing OK. The newly formed Johnnie’s First National Bank is turning a handy profit. I think once the American people learn they’re making $86.6 Billion per year on their investment, chances are pretty good they’ll vote to extend the program.