It’s Called "Precedent" (Bair)

By Karl Denninger, The Market Ticker

When GM and Chrysler were bailed out, I wrote on the foolishness of setting forth precedent allowing secured creditors to get screwed so the UAW could "get theirs."

Apparently people didn’t bother to listen, because now Bair of the FDIC has endorsed an amendment to the Regulatory Overhaul Bill that would require "secured" creditors to take a haircut if a "systemically significant" firm fails – at the discretion of the government.

At first this sounds reasonable – demand that people investigate risk, basically, by demanding that they eat the cost if they don’t.

There’s a problem with this approach, however: the issue that arises with secured collateralized lending on a short-term basis shouldn’t exist.

Why not?

Because if collateral is posted on a transaction it should be removed from the firm’s list of assets, since it is no longer available to that firm until the loan is paid back.

As such only excess assets (beyond liabilities) should be eligible for this sort of thing.  And if so, why should that be subject to a haircut?

Further, shouldn’t all of the creditors junior to those get wiped out – 100% – first? 

Yes – but they didn’t in the case of GM and Chrysler, did they?

The real problem is the accounting games that are played by these institutions.  How can you tell what sort of exposure you’ve got lending to any of these companies?  As I’ve repeatedly said, I can’t buy anything in the financial space as an investment today – not even "big conglomerates" like GE – because it is impossible for me to evaluate their balance sheet and believe what I am reading.

The solution is, as I’ve said: One dollar of capital for each dollar of unsecured lending outstanding.

That’s the right answer.

It removes all the accounting games.

It forces banks to hold capital for unsecured lending – dollar for dollar – irrespective of what form the so-called "lending" takes.

It stops the BS games with derivatives.

It removes systemic risk – all of it.

And it protects depositors and taxpayers - all of them, all the time, absolutely and without exception.

Quit playing with the Vampire Squid Sheila. 

The correct response to the appearance of one or more Vampire Squid is not to appease, but rather to lock and load a magazine full of goldmoney.com?gmrefcode=bearmarket43″target=”_blank”rel=”external”title=”silver” >silver bullets, then provide them with lots of ventilation. 

There is no solution to these problems that involves tinkering or appeasement.  There is only sound banking or what we have now: kleptocracy.

Sound banking must return to The United States Ms. Bair.

Either you stand for sound banking or you stand with the kleptocrats.

There is no middle ground.

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