Kill the global financial crisis.
To figure out how to do it, let’s start with mortgages in the United States. The plan is simple: Cut the mortgage debt of all property owners to 80% of today’s value.
I estimate it’s a cool $5 trillion to pull this off. The chart below suggests this is what we have to do (See the chart titled “Rotten Mortgage Debt Adds Up”).
One problem: If $5 trillion of mortgage debt goes away, then $5 trillion of bank equity and bank bonds go away.
The bad mortgages and the loss of bank equity and the write-off of bank bonds, and then the disappearance of deposits, can all be destroyed only if we will commit to one difficult step: Bankruptcy on a grand scale.
Or, if we pretend there is no bankruptcy when there is, then the too-big-to-fail defense is used. The regulators dump money in. We pray the credit bubble will fade and die.
That’s the place we are now. The danger of this strategy: That we will end up like Japan.
And what’s so bad about Japan? It’s economy isn’t growing. It’s public debt is beyond immense. So the too-big-to-fail bailouts Japan started 20 years ago may lead to the most fantastic sovereign bankruptcy in the history of the world. If they don’t have a catastrophic failure, how long will it take to pay off government debt at 250% of GDP? Does that take 50 years or 100 years? That’s a serious question not a joke.
What was a terrible failure for Japan in 1990, by pretending that it didn’t happen, by saving failures and by blindly pursuing Keynesian stimulus, Japan may lead itself and the world to an end-game disaster.
When I first started thinking about the chart above, in November 2008, and that the mortgage bubble had left us with a $5 trillion failure, I began to explore an hypothesis that a credit crisis can only be managed correctly if the manager acts as a bankruptcy judge who is quick to write off debts. I nicknamed the hypothesis Plan Orange.
It started with the idea of cutting all mortgage debt for all property owners to 80% of the current value of a home; just the scenario I explained above. The idea led to a bigger plan: That we must destroy all excess bubble debt issued in a credit bubble. How much is excess? That is difficult to know. Should we write off the excess? Yes, we should. That is the theme to follow in managing a financial crisis caused by a credit bubble.
The goal of a housing plan is to make mortgage debt affordable and to require the owners of mortgages to recognize their losses.
The broader general plan then further suggests that other major debt categories will have to follow the same process as mortgage debtors and creditors.
The plan creates equity by destroying debt. It works for homeowners and their bankers and governments and their bankers and corporations and their bankers and banks and their creditors.
The part of the plan I understand best is in mortgages and houses. For homeowners, the plan is an overnight bankruptcy filing on high-debt properties with the obvious goal of reviving a consumer-driven economy. This leads to a massive day of reckoning for mortgage investors. Get those two things done and the financial crisis is gone in the United States. Or a lot of it will be gone.
If we take on this debt destruction ambitiously in mortgages, it would eliminate fire sales, forced sales, short sales, foreclosure sales. It would eliminate almost all delinquent mortgages. Get rid of all distressed sales, without artificially stimulating prices, and supply will fall drastically. Prices will be much more stable.
Any home owner would qualify. They should probably be required to file bankruptcy so that it isn’t a pain-free transaction. All ordinary means for qualifying for a mortgage would be eliminated including the need for income, good credit, occupancy of the property, and savings. Is the price tag reasonable? No. Do the persons who will benefit deserve the assistance? No.
Then why do it? A gargantuan debt destroyer must be deployed to blow up gargantuan twin bubbles in mortgages and property. Otherwise the aftermath may last a decade or more.
The smart way to manage a financial crisis is the fast way. Take serious and painful and massive hits and get on with life. Otherwise we may go Japanese for a decade or two or thirty years or fifty years. And the disaster we have in ten years or 20 years or 30 years will likely be much worse than our current disaster.
Better to get back to business now. Better to be honest. Kill the debt. Let’s go back to work.
Plan Orange is defined in five stories and four charts — all but two written between November 2008 and April 2009. “Liquidate Bubble Debt”, from November 2010, is a summation and a criticism of consensus remedies to a financial crisis. See also “Plan Orange for Fifth Graders” (June 2012).
- CHART: Plan Orange for Fifth Graders
- Crisis Solved: Introducing Plan Orange for Mortgages
- Killing Catastrophe: The Argument For Plan Orange for Mortgages
- Bankrupting Leverage: Plan Orange & Money-Center Banks
- Bill Gross Accepts Jesus: Plan Orange & Systemic Debt-to-Equity Conversion
- A Modest Proposal: Liquidate Bubble Debt
- CHART: Plan Orange for Mortgages
- CHART: Plan Orange for Money-Center Banks
- CHART: Plan Orange and Systemic Debt-For-Equity Conversion