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Sheila Bair’s Modest Proposal

With the recent implosion of Facebook’s equity launch which is being pinned on one of the best IPO underwriters of them all, Morgan Stanley, it makes you wonder what kind of a game you are really playing when participating in financial markets.  Many retail investors were clamoring for initial shares of Facebook at a bargain $38, only to be jammed with 18.6% losses in a few days.  The unluckier few who were unable to get IPO shares but bought at the open of trading, after questionable Nasdaq activities, bought at $40-$45 and suffered even larger losses of 20-30%.  Maybe after every little retail investor is squeezed out with their tails between their legs, the stock will head to $100.

Facebook is just a small example of a lopsided game.  The real behemoth in the room is the zero interest rate policy, ZIRP, set by the Fed.  The Federal reserve has made funding incredibly cheap to banks, financial institutions, and even foreign governments and banks.  The idea is that the pain of debt deleveraging is worse than printing money and handing it to the elite.  You might think that your 4% mortgage is cheap money (which it is), but that is nothing compared to the cost of originating that money which is near zero for the bank.  You might have also noticed that interest rates on treasuries continue to fall but the mortgage rates being quoted by the banks seem to stay where they are…but what incentive does the bank have in lowering your interest rate when it can charge a higher interest rate and earn a larger spread on your business?

Now think about investment incentives for the big boys…what do you do when you can borrow short term near zero percent?  First you start looking at some short term treasuries.  Borrow at .15% and invest at .75%.  60 bps of free money.  But we need to keep earnings growing so maybe we should look elsewhere.  Borrow at .15% and invest in 10  year IG corporates at 3.5%.  What about high yield debt at 7% or Spanish sovereign debt at 6%?

This brings us back to Sheila Bair’s point last month in writing her editorial titled Fix income inequality with $10 million loans for everyone! in the Washington Post.  As former chairman of the FDIC, I can assure you that she fully understands how the banking system works and this is probably why she resigned or was pushed out:

Are you concerned about growing income inequality in America? Are you resentful of all that wealth concentrated in the 1 percent? I’ve got the perfect solution, a modest proposal that involves just a small adjustment in the Federal Reserve’s easy monetary policy. Best of all, it will mean that none of us have to work for a living anymore.

For several years now, the Fed has been making money available to the financial sector at near-zero interest rates. Big banks and hedge funds, among others, have taken this cheap money and invested it in securities with high yields. This type of profit-making, called the “carry trade,” has been enormously profitable for them.

So why not let everyone participate?

Under my plan, each American household could borrow $10 million from the Fed at zero interest. The more conservative among us can take that money and buy 10-year Treasury bonds. At the current 2 percent annual interest rate, we can pocket a nice $200,000 a year to live on. The more adventuresome can buy 10-year Greek debt at 21 percent, for an annual income of $2.1 million. Or if Greece is a little too risky for you, go with Portugal, at about 12 percent, or $1.2 million dollars a year. (No sense in getting greedy.)

Think of what we can do with all that money. We can pay off our underwater mortgages and replenish our retirement accounts without spending one day schlepping into the office. With a few quick keystrokes, we’ll be golden for the next 10 years.

Of course, we will have to persuade Congress to pass a law authorizing all this Fed lending, but that shouldn’t be hard. Congress is really good at spending money, so long as lawmakers don’t have to come up with a way to pay for it. Just look at the way the Democrats agreed to extend the Bush tax cuts if the Republicans agreed to cut Social Security taxes and extend unemployment benefits. Who says bipartisanship is dead?

And while that deal blew bigger holes in the deficit, my proposal won’t cost taxpayers anything because the Fed is just going to print the money. All we need is about $1,200 trillion, or $10 million for 120 million households. We will all cross our hearts and promise to pay the money back in full after 10 years so the Fed won’t lose any dough. It can hold our Portuguese debt as collateral just to make sure.

Because we will be making money in basically the same way as hedge fund managers, we should have to pay only 15 percent in taxes, just like they do. And since we will be earning money through investments, not work, we won’t have to pay Social Security taxes or Medicare premiums. That means no more money will go into these programs, but so what? No one will need them anymore, with all the cash we’ll be raking in thanks to our cheap loans from the Fed.

I just wonder how long it will take for them to stop Sheila Bair from speaking her mind in public forums….

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