Bailout alternative offered by House Dems

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By Frank James

You know the failed but still alive $700 billion bailout proposal has scrambled politics in the nation's capital when a fairly liberal member of Congress offers a solution to the financial-markets crisis that looks like something a Reagan Administration official created.

Actually that's exactly who created it. Rep. Peter DeFazio, an Oregon Democrat, took the ideas of William Isaac, who served as Federal Deposit Insurance Corp. chairman during the Reagan Administration and created legislation meant to help the capsizing financial markets right themselves.

DeFazio, a vociferous opponent of the Bush Administration's $700 billion Wall Street bailout, calls his legislation the "No BAILOUTS Act" and he talked about it today at a Capitol Hill press conference. He was joined by several other House Democrats:

And the underlying concern we all share is, we question the Paulson premise.

That is that giving him 700, borrowing or printing $700 billion, giving it to him and having him buy bad assets, on Wall Street,somehow will solve the interbank loan problem and even less likely the underlying problems of the economy.

And the interesting thing is 400 economists last week questioned that premise. That was brushed off. But if you read today's New York Times, at the point in which the world market thought we were going to adopt the Paulson plan and roll over, it says here, "Other analysts noted that credit markets around the world were almost entirely dysfunctional on Monday morning when political leaders and investors alike assumed Congress had reached a firm deal and would easily approve the bailout." It goes on from there with some detail.

The point is the premise is faulty. And as much as the Democratic leadership has tried to improve it, it still is likely to fail. So we have an alternative. And we would like to talk a little bit about that today and then we're going to have further discussion from other members.

If there's a no-cost or low-cost alternative available for the taxpayers, we should take it. And we have a working paper -- it's not done yet. I'm going to be talking to Darrell Issa on the Republican side and John Shadegg later today. This is a common set of points we have so far, but it's a work in progress. We've tentatively called it the "No BAILOUTS Act" which would be bringing accounting, increased liquidity, oversight and upholding taxpayer security. You have to start with a spiffy name around here. We'll work out the details later. (Laughter.)

But the point is, folks would like to come together on something that doesn't put the taxpayers at risk. That's a common theme among members both who voted for the bill and who voted against the bill. Don't put the taxpayers at risk. The protections in that bill yesterday were nonexistent, in terms of the taxpayers.

So we're saying here, let's try a different approach....


The part of the legislation pretty much anyone would understand immediately is an increase in the size of bank deposits that are federally insured, from $250,000 from $100,000.

The bill would also mandate a new program meant to buttress eligible banks by allowing them to receive "net worth certificates" from the FDIC. Those certificates wuld count towards the banks' capital requirements, a form of borrowing that would increase their liquidity, the money they'd have on hand. The idea was used during the 1980s to recapitalize lending institutions to great effect.

There'd be other technical changes. The bill would change how banks and other financial companies account for their mortgage-backed securities, permitting them to value them not at what they could fetch in the market, which right now is nothing, but at a higher amount based on the "economic value" they could later receive.

It would also make changes to the practice of selling stocks short, that is borrowing a stock whose price you think is going to drop, selling it, then buying it back at the lower price to give back to the owner, while pocketing the profits.

The practice of selling the stock without first borrowing it is already illegal. But somehow DeFazio's legislation would make it more illegal. Not sure how that's going to work.

And it would end the uptick rule which require short sellers to sell stock on the "uptick" which, oversimplified, means the short seller would have to sell when the stock price ticked up, a rule meant to protect stocks from being driven into the ground by short sellers.

The beauty of it from DeFazio's perspective is that his bill wouldn't require taxpayer money to implement.

Here's the summary DeFazio provided reporters:

No BAILOUTS Act

Bringing Accounting, Increased Liquidity, Oversight and Upholding Taxpayer Security

1) Require the Securities and Exchange Commission (SEC) to require an economic value standard to measure the capital of financial institutions.

This bill will require SEC to implement a rule to suspend the application of fair value accounting standards to financial institutions, which marks assets to the market value, no matter the conditions of the market. When no meaningful market exists, as is the current market for mortgage backed securities, this standard requires institutions to value assets at fire-sale prices. This creates a capital shortfall on paper. Using the economic value standard as bank examines have traditionally done will immediately correct the capital shortfalls experienced by many institutions.

2) Require the Securities and Exchange Commission to restricting naked short sells permanently

This bill will require SEC to implement a rule that blocks naked selling, selling a stock short without first borrowing the shares or ensuring the shares can be borrowed. Such practices many times harm the companies represented in the sales and hurt their efforts to raise capital. There is no economic value produced by naked short sales, but significant negative effects.

3) Require the Securities and Exchange Commission to restore the up-tick rule permanently.

This bill will require SEC to implement a rule that blocks short sales without an up-tick in the market. On September 19, 2008, the SEC approved a temporary pause of short selling in financial companies "to protect the integrity and quality of the securities market and strengthen investor confidence." This rule prevents market crashes brought on by irrational short term market behavior.

3) Require the Securities and Exchange Commission to restore the up-tick rule permanently.

This bill will require SEC to implement a rule that blocks short sales without an up-tick in the market. On September 19, 2008, the SEC approved a temporary pause of short selling in financial companies "to protect the integrity and quality of the securities market and strengthen investor confidence." This rule prevents market crashes brought on by irrational short term market behavior.

4) "Net Worth Certificate Program"

This bill will require FDIC to implement a net worth certificate program. The FDIC would determine banks with short-term capital needs and the ability to financially recover in the foreseeable future. For those entities that qualify, the FDIC should purchase net worth certificates in these institutions. In exchange, these institutions issue promissory notes to repay the FDIC, counting the amount "borrowed" as capital on their balance sheets. This exchange provides short term capital, with not cash outlay. Interest rates on the certificates and the FDIC notes should be identical so no subsidy is necessary.

Participating banks must be subject to strict oversight by the FDIC including oversight of top executive compensation and if necessary the removal of poor management. Financial records and business plans should be subject to scrutiny while participating in the program.

In 1982, Congress approved a program, known as the Net Worth Certificate Program, that allowed banks and thrifts to apply for immediate capital assistance. From 1982 to 1993, banks with total assets of $40 billion participated in the program. The majority of these banks, 75%, required no further assistance beyond the certificate program.

5) Increase the FDIC Insurance limit from $100,000 to $250,000.

The bill will require the FDIC raise its limit to provide depositors confidence that their money is safe and help eliminate runs on banks which are destabilizing to the industry.