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Friday, September 26, 2008

Mark Kleiman Proposes a Plan C to save the financial system.

To me it mostly sounds similar to, but much more radical than, my "If Warren Beffet can do that why can't we ?" plan (non-expert minds think alike ?).

Kleiman is much much tougher on the banks and bankers but, in exchange, offers a sweetener, which he also considers a good idea.

3. In return, the bank gets "deposit insurance" on its new interbank borrowings up to some limit, set as a multiple of the equity investment. That makes that bank's overnight paper (up to its limit) as good as T-bills. We also take the $100,000 limit off federal deposit insurance.

4. The bank pays the Treasury an insurance fee of (to make up a number) 100 basis points on those borrowings.

5. The law makes the new, insured debt senior to all other debt. (Of course, depositors and CD holders are already insured.)

First I had trouble understanding point 4. I think the problem is I didn't understand what Kleiman means by "gets 'deposit insurance'". I would say that I have deposit insurance (I have a US checking account) and my bank doesn't. He would say that my bank gets "deposit insurance" from the FDIC.

Anyway the point is that the treasury gaurantees the banks "new interbank debt" up to some limit for a fee.

Now my problem is that if this fee is too low, then banks can just retire old debt and issue new debt. That is, I don't see a way to make sure that debt is really new. Obviously the normal rule is that seniority has something to do with being old not young. I loan and say this debt has to be senior to all debt incurred in the future. The bank can't cheat me without backdating loan contracts with other parties. Repaying an old loan and making a new one is legal unlike backdating a contract. A doomed bank can transfer a whole lot of cash to another bank by borrowing at a very high interest rate, then defaulting and making the Treasury pay. Officers of doomed banks have very good reason to do nice things for officers of non-doomed banks.

I do note that Kleimans point 2 prevents point 3 from creating new over-insurance and really highly profitable financial arson opportunities as no private credit default insurance can be issued on these new loans (even if they are really old wine in new bottles). Still I'd stay out of bank to bank insurance.


Mark Kleiman said...

Sorry. Failed to make myself clear.

Yes, your bank deposits are insured. But you're not a bank.

If JP Morgan lends to Chase, and Chase goes under, JP Morgan is at risk. That's what's driving the interbank overnight lending rates up; they're scared to lend to one another.

I'm proposing that the feds guarantee interbank loans (for participating institutions, and up to some limit for each institution). That would (I think) unfreeze the interbank lending market.

So when I wrote "gets deposit insurance on interbank loans" I meant "gets to the right to borrow money from other banks with a government guarantee behind it."

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