I worry about the bailout plans led by newly famous Gordon Brown (Prime Minister UK), and which every other world leader is falling over themselves to adopt.  Such an approach is natural for Brown and his political leanings, but to see it occurring around the world to the extent it is happening is worrisome. 

That worry is exacerbated now that we see proposals to help out the auto manufacturers.  This is protectionism by another name, and will result in worse companies with worse products.  The same can be said of Banks.  How can a bank with a financial tap opened from the government be motivated by anything but keeping that tap open.  This is dysfunctional to making the service better and more attractive for customers.

So it was refreshing to encounter this thinking and the paper that makes the proposal, however its still worth digging deeper to understand if this will be better or just another way of creating dysfunctional government backed enterprises.

Forget the bailout, start over: the New American Bank Initiative | O’Reilly Radar

The bailout of the US financial system isn’t working. The government’s rescue plan has fundamental flaws, including incentives that favor the failed firms, not the country as a whole. New ideas are needed. In "New American Bank Initiative:

In this paper, we argue for a New American Bank Initiative: use the $700  billion in government funds to capitalize new banks and distribute the shares of the new entities to the American People.

These new banks would then acquire the operational and human capital  assets of failed banks in FDIC receivership

The paper goes on to outline the backdrop to their proposal.

The core issue with the current crisis is that the financial system is no longer properly functioning as a conduit of capital from savers to investment projects that generate real economic growth. The focus of every major proposal to date has been to inject liquidity and capital into current institutions in the hope that it will build confidence and start lending again to real projects (i.e., unclog the conduit).

First the scale of the US initiative is noted.

$700 billion is a huge amount of money–more than the equity book values of Goldman Sachs, Morgan Stanley, JP Morgan, Citigroup, Washington Mutual, Bank of America and Wachovia combined.

The basis of the NABI solution is to construct 20 new banks across the country, and eliminate government interference in those organisations, but transferring ownership to the US people.

To avoid a concentration of risk, the capital should be distributed amongst at least 20 new institutions. To avoid the hazards of government ownership or sponsorship, the shares of these institutions should be  distributed to the American people (each bank can have 300m shares; one for every American man, woman, or child).

Relevance to Bankwatch:

While I applaud the notion from the perspective of creativity and innovation, its not clear to me how the business strategy would be defined for the 20 new banks, other than by the US Treasury, and that might be worse than the Paulson plan.  At least the Paulson plan retains the business and strategy drive from the existing bank leadership to counter the government bias.

Having said that there is something there in the idea of finding a way to bring the leverage of the $700 bn that will retain innovation, yet retain a credible banking system. 

A fresh proposal:

Split the $700 in two.

1. $350 towards a US Government owned credit union.  Provide the mandate to offer basic banking, account, loans and mortgages.
2. Use the tax system, or other methods available to government that support startups that keeps the innovation in the financial services startups.  Aggressively review the regulation of financial services, and fast track changes to accommodate internet. 

Rationale:

The problem with banks is confidence.  The reality of banks going under is irrelevant to most other than stockholders, but they understood the risk of investment. 

Point 1. above offers customers a safe structure to restore confidence.  Customers who are afraid of banks disappearing and taking their money with it could shift to the US Government bank.  The rates would be terrible, the service basic, but its safe. 

This frees the existing banks to sort out their problems write off their bad debts, including telling the truth about their bad debts, instead of the current exaggerations.  Incidentally most estimates place mortgage defaults at no more than 10% overall.  That means 90% are current.  So why does a bank need a bailout if their mortgages are still relatively current?  The headlines scream that sub-prime mortgage loans have lost all their value but that’s simply not true, or at least not the whole story.  The banks need to evaluate their portfolios, loan by loan, and define the write offs – deal with that, and move on.  Its simply ridiculous to see companies like AMEX proposing to become a bank – just so they can get money.

Point 2. will offer support and space to accommodate creativity and alternatives that will further pressure the banks to stop whining and move on. 

Thoughts welcome – how should the US Government use the $700 Bn if at all.