This column is addressed to Blue Dog Democrats and responsible Republicans. Once we understand exactly what our financial problem is, we solve it. Many banks have been dishonest in failing to disclose their full liabilities. As a consequence, they have hoarded money given to them in trust by taxpayers, while the Treasury and the Fed have hoarded information about why.
The world is facing a global margin call. In a margin call, traders must put up a percentage of cash, which is leveraged against the value of assets they trade. When asset value declines, they are forced to put up more cash to meet margin requirements. These margin calls create a downward spiral in markets. Selling begets selling; asset values decline further. More forced selling follows. The spiral cascades.
When banks buy, sell and trade often-indecipherable financial instruments, often using heavily leveraged borrowed money, and the value of those assets decline, the banks essentially face margin calls.
Treasury Secretary Henry Paulson, who has acted like an agent for the banks, should be drawn and quartered for not demanding full disclosure of liabilities and not demanding assurances that the money would be used as intended.
Now Paulson wants to use taxpayer money to subsidize Bank of America, whose management originally claimed it did not need federal money, to buy Merrill Lynch, whose management has been lavishly compensated based on the falsehood that they had managed their business well.
Perhaps this is necessary. Perhaps not. The point is that both Bank of America and Merrill Lynch have greater problems than have been disclosed. Taxpayer money has been been used far less effectively than has been promised. Future taxpayer support will be greater than has been discussed.
Let’s be honest. The banks are not alone. Consumer debt, corporate debt, budget deficits have all skyrocketed. Even today, banks, investment houses, traders, hedge funds and speculators play markets with heavily margined accounts, using borrowed money with assets of declining value, forcing this global margin call to cascade.
While banks foreclose homeowners, markets threaten foreclosure of banks.
We must urgently build firewalls against these cascading calls of debt. As I have argued in this column since 2007, we must freeze foreclosures now, which is one action that can be effectuated promptly to limit the cascade and restore confidence.
We must impose aggressive limits on all forms of margin trading and investing. We must end the era of speculation financed by huge debt, which is a central cause of this global wave of margin calls. We must return to a first principle of finance where real assets are bought with real money. We must return to a first principle of management where CEOs understand the assets they are buying and leaders understand the actions they are taking.
We must demand full, honest accounting of the exact condition of banks so we don’t keep wasting money on what are essentially short-term margin calls that help neither taxpayers nor banks solve the real problem.
We must understand that the problem is a global margin call. Once we do, we can build the proper firewalls, halt the slide and set the stage for the great recovery that will begin once we realize the nature of the crisis and end it.
Budowsky was an aide to former Sen. Lloyd Bentsen and Bill Alexander, then chief deputy majority whip of the House. He holds an LL.M. degree in international financial law from the London School of Economics. He can be reached at email@example.com and read on The Hill Pundits Blog.