Functions of Taxpayer Bank and the Market

April 11, 2009
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On the Nature & Philosophy of Financial Instability and Application to the Current Financial Crisis Part II

By Julian Sanchez, PhD

Read: Circuit Systems & our Financial Crisis – Part I

Part II. General Approach to Solution

Figure 2.1 illustrates a simplistic view of a given market. The taxpayer bank is a government formed entity that purchases the assets from weak financial institutions and manages them for the benefit of the taxpayer and for stabilizing the local market. Since the taxpayer bank will earn a profit (G-1) for every dollar invested1, it can use these funds to stimulate the economy.

First it can send the taxpayer a check as a return on investment thereby creating its own stimulus package. Second the taxpayer bank can work with the states to fund infrastructure projects, which are desperately needed and can increase jobs in the area.

Next the taxpayer bank can also guarantee a larger amount of Small Business Loans, focusing on those companies that will generate the largest amount of job growth and benefit the economy the most. Once banks are re-capitalized they can start to lend to both the public and businesses. This will stop the slide in job losses and improve the credit markets. The taxpayer bank also has to carefully manage assets so as not to accentuate a further slide in asset prices. We will now discuss the taxpayer bank in more detail.

Taxpayer Bank

The taxpayer bank can be viewed as the buyer of last resort. In essence this bank will purchase loans at the originated face value for the discounted assets and the difference received in equity. The equations governing the returns for both the government and the shareholders are defined in “Analysis and Solution to the Current Financial Crisis” 1. The taxpayer bank acts in a certain sense as a counterweight to the financial system.

In a systemic failure, banks start experiencing large losses causing their stock prices to collapse. As their stock price collapses other banks stop lending to them and each other. Capital becomes constrained. Asset values decline since there are fewer buyers. Banks stop lending to each other and to their customers reducing the opportunity for new earnings, which depresses the stock price even more.

As asset values decline further, bank stock prices fall even more restricting their ability to raise capital in an effort to slow down or reverse this trend. As the stock price of more banks collapse, more assets are dumped onto the market causing a further spiraling downward of asset prices, leading to other bank failures.

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Reference:

“Analysis and Solution to the Current Financial Crisis” Public Domain Oct 3, 2008.

Part III

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