Too Big to Fail [53]
Kashkari looked over at Bernanke, who, having been intently studying the text, had immediately zeroed in on the key of the plan: “Treasury purchases $500 billion from financial institutions via an auction mechanism. Determining what prices to pay for heterogeneous securities would be a key challenge. Treasury would compensate bidder with newly issued Treasury securities, rather than cash. Such an asset-swap would eliminate the need for sterilization by the Fed. Treasury would hire private asset managers to manage the portfolios to maximize value for taxpayers and unwind the positions over time (potentially up to 10 years).”
Bernanke, weighing his words carefully, asked how they had come up with the $500 billion figure.
“We are talking a ballpark estimate of, what, say, $1 trillion in toxic assets?” explained Kashkari. “But we wouldn’t have to buy all of the bad stuff to make a meaningful dent. So, let’s say half. But maybe it’s more like $600 billion.”
As Bernanke continued to study their paper, Kashkari and Swagel took a second to savor the moment: They were briefing the keeper of The Temple—as the Federal Reserve is often called—on what might be a historic bailout of the banking system. Government intervention on this scale hadn’t been contemplated in at least fifty years; the savings and loan rescue of the late 1980s was a minor blip by comparison.
If the “Break the Glass” plan did get past Congress—a problem they’d concern themselves with later—they had already detailed how Treasury would designate the New York Fed to run the auctions of Wall Street’s toxic assets. Together they would solicit qualified investors in the private sector to manage the assets purchased by the government. The New York Fed would then hold the first of ten weekly auctions, buying $50 billion worth of mortgage-related assets. The auctions would, it was hoped, fetch the best possible price for the government. Ten selected asset managers would each manage $50 billion for up to ten years.
Kashkari knew the proposal was very complicated but argued it was worth the risk, as the way things were heading, there was little chance of a “soft landing.” Drastic action was required. “The bill would need to give Treasury temporary authorization to buy the securities, as well as the funding,” he said, “and it would need to raise the debt ceiling, because we only have room for about $400 billion under the current ceiling.
“But because we would be tapping the private sector so heavily, the program would require little in the way of government overhead: no significant hiring by Treasury, for example,” he continued. “But also we need to be mindful of the optics. Only public financial institutions would be eligible. No hedge funds or foreign banks.”
Then Kashkari summarized what he and his colleagues at Treasury viewed as the pros and cons of their proposal. The first and most important point was that if the government acted, banks would continue lending—but not, it was hoped, in the irresponsible way that gave rise to the crisis in the first place. The primary argument against the proposal was that, to the extent that the plan worked, it would create “moral hazard.” In other words, the people who made the reckless bets that initially caused the problems would be spared any financial pain.
The two Treasury officials next presented the alternative approaches, of which they had identified four:
The government sells insurance to banks to protect them from any further drop in the value of their toxic assets.
The Federal Reserve issues non-recourse loans to banks, as it did in the JP Morgan takeover of Bear Stearns.
The Federal Housing Authority refinances loans individually.
Treasury directly invests in the banks.
As he listened, Bernanke stroked his beard and occasionally offered a knowing smile. The meeting ended with no resolution except to take the plan and put it on the shelf until—or unless—it was needed, but Kashkari was gratified that the chairman took it so well—much better, in fact, than his own boss,