Monday, October 13, 2008

Toxic Assets: Neutralising the Poison

I have today sent the letter pasted below to the Chancellor.

Please feel free to copy, amend (if wished) and post it to him also, and to spread it among your friends' lists. Only if they get multiple mailings will it penetrate through the rings of defence to reach the Chancellor himself. A copy to your MP will help.

There is something we can do about this crisis. We are not just passive spectators. The economics community is paralysed, and solutions are hard to find.

Right to Rent and Green New Deal are further measures we can press on the Treasury as the recession deepens.


Rt. Hon Alistair Darling MP

Chancellor of the Exchequer

Correspondence & Enquiry Unit

2/W1 HM Treasury

1 Horse Guards Road

London SW1A 2HQ

Dear Mr Darling

We congratulate you on the adoption of the UK approach to the financial crisis by the G7 and IMF. We welcome the Treasury’s support for banks with £50 billion of part-nationalisation, which gains for the State a much needed influence on the banking sector. We support further bank partial nationalisation, but find it regrettable that the shares purchased were non-voting. We welcome the decision to regulate CEO bonuses, and point to the opportunity to reform and regulate many other dysfunctional banking practices at this time. We welcome the further £200 billion of short term investment to try to ensure liquidity, noting that it may bring in an income from interest.

In purchasing shares in banks, HMG is gaining influence. We would advise that as part of that in influence that the Government would reserve the right to levy a small charge on current accounts. This may prove to be a useful instrument in case it is needed to increase the velocity of circulation of money in the coming months or years.

On the other hand, we are opposed to any attempt directly to buy the “toxic assets” that are poisoning the banking system, as in the Paulson plan. This is a high-risk strategy that will probably result in a futile waste of taxpayers’ money.

We oppose purchase of Toxic Assets for the following reasons:

1. It is opposed to natural justice, in that money is flowing from the taxpayer to may for the mistakes of the rich elite.

2. It carries a moral hazard in that in insulates financiers from accepting responsibility for, and learning from their mistakes

3. There are opportunity costs, in that money would better be spent in the real economy, applying a Right to Rent policy for homeowners who cannot afford their mortgages, and the Green New Deal, which is needed to address the triple threats of recession, peak oil and climate change.

4. There is a probability of corrupt and/or sophisticated diversion of the monies away from their original purpose. We learn that the agents who will administer Paulson’s bailout stand to gain $7 billion for their work.

5. There is no certainty of the efficacy of trying to purchase the toxins out of the system. There is no sign yet of the Paulson Bailout having stabilised Wall St, and though it may work through, our judgment is that it will postpone, not prevent, the full collapse of the stock markets.

6. The magnitude of these toxic assets is beyond the capacity of any agency, even the World Bank , to buy off. We see from the BIS that the total value of OTC derivatives outstanding derivatives reached $596 trillion in December 2007, and I sprobably greater now. The derivatives market has created a debt greater than the total foreign debt owed by all nations. Clearly it is impossible for any government or even the World Bank to purchase these derivatives out of the banking system. Yet if they remain in the system, they will continue to poison confidence between banks.

This is an extraordinary threat caused by an extraordinary problem, and it therefore requires extraordinary remedies.

Point 5 of the G7 plan is to “Take action, where appropriate, to restart the secondary markets for mortgages and other securitized assets. Accurate valuation and transparent disclosure of assets and consistent implementation of high quality accounting standards are necessary”.

In order to achieve this aim, the World Bank (or other appropriate international body) should authorise the creation of a repository for these toxic “assets”, which Prof. Willem Buiter has suggested should be termed a Toxic Asset Dump (TAD). Buiter suggests purchase of these “assets”, but we consider that viewed as a whole, they have no real value, and indeed have a negative value in their effect on confidence in the system.

Any bank holding such assets will be permitted, encouraged and in some cases required, to file them with the TAD repository, paying only an administration fee.

The concept is to have an amnesty for these assets. They will be sidelined, taken out of circulation. Once thus stabilised, they can be studied by accountants and academic economists. If it emerges that there is real value in some of them, the banks that handed them in may receive some repayment, though some will be go back to the taxpayer in payment for the expense that they have borne as a result of the errors and misjudgments of the banking system.

Initially, the concept is a free, voluntary submission of unwanted TAs held by banks. It may be that a more complex system will be evolved, depending on the rating of each asset. Clearly there is an enormous amount of detail to be added to this concept before it can be rolled out, but we hope that the concept itself will be adopted by the British Government.

The principle underlying this plan is the doctrine of Odious Debt. It can also be justified in the Abrahamic religions in terms of Jubilee.

We believe that this concept offers a way to draw the toxic assets out of the financial system.

We hope that the minds of your advisers will be open to build on this concept.

Yours sincerely

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