Hard Asset vs. Soft Asset Manager
November 24, 2009
On the Nature & Philosophy of Financial Instability and Application to the Current Financial Crisis Part V
Hard Asset vs Soft Asset Manager
By Julian Sanchez, PhD
The Hard Asset Manager:
What approach will be taken by the Hard Asset Manager will vary from market to market according to the needs of the local market. In any case the deflationary spiral must be stopped; otherwise no matter how much capital is put into the bank, banks will continue having capital deficiencies requiring more investment from the government. A deflationary spiral inhibits lending and mortgage insurance, since it would be foolish for banks to lend with asset prices continuing downward. It is critical the government stop the deflationary spiral anyway it can, including pulling the supply of homes off the market. Once the market is stabilized, its inventory of homes can be put back into the market, in a controlled manner, for a profit.
Soft Assets Manager:
A. MBS, CMO, SIV, CDO, ABS, CDX – The Taxpayer Bank should consider marking these assets to zero if they are not performing, since they are very difficult to unwind. The Taxpayer Bank should purchase these assets (and any other NPA) from a given financial institution, providing capital for the original value of the asset and receiving all equity in return (asset marked down to zero). This will fix the financial institutions earnings, raise its PE ratio and increase its stock value.
The Soft Asset Manager has several choices with soft assets:
1. Sell them cheaply to the public, thus earning a profit.
2. Hold on to them, waiting for the third party servicer to unwind the asset and obtain the hard asset underneath.
3. Assemble all the bonds associated with a given financial instrument and unwind them. The asset can then be turned over to the Hard Asset Manager for sale. Since the financial institution has been repaired at the time the government purchased these assets, the government has time to unwind these instruments.
4. Trade the government owned mortgages (written down to aid the homeowner and perform) with non-performing mortgages for a given security pool. Since the government’s mortgages are at lower interest rates, they will have to be overcollaterized to ensure the security pool’s bonds perform. Most securitized mortgage pools allow modifications to the portfolio when a loan is in or near default, if it’s in the best interest of those who hold the security. This allows the government to get access to non-performing or near default loans and turn them over to the Hard Asset Manager.
The option used depends on circumstances, availability of mortgages, interests of the taxpayer, and the economic stability desired.
B. Credit Card Debt – Since no collateral was given for this debt and the government received all equity (assets written-down to zero), the Soft Assets Manager should write these loans to zero and clean up the credit scores for stressed credit card holders, provided they take several financial classes and demonstrate an understanding of the basic concepts of personal finance. Most credit card holders have had no financial training and most credit card companies were aggressive in approaching these customers. Their current strained experience and the knowledge received from financial planning classes may incline many such debt holders to be more cautious when it comes to credit card debt. With such debt removed, this portion of the public can then start contributing to the economy.
C. Other Debt – can be structured in the same manner, provided the firm which owns the debt can issue equity and has a depressed stock price with respect to historical measures.
D. CDX, CDS, and Derivatives – Since a number of variables affect how they should be treated, these instruments are more difficult to evaluate. Considerations on pricing should not only include the original pricing of the contract but also the liability associated with the insurance aspect of the instrument. Many of these contracts did not capture the risk involved and are under-priced; therefore, the capital to equity exchange may need to be altered. One also needs to assess the viability of these contracts with respect to the probability for future failure. One needs to use probabilistic estimations of risk, which include counter-party risk, financial risk, systemic risk etc., as well as disposition methodologies for handling these products. The discussion of this class of financial instruments is complex and will not be covered in this paper.