THE PLUMB PLAN
One Taxpayer’s Idea
The time has come for us to make our voices heard!
We are in the midst of the biggest and most chilling crisis of at least a generation. Like many Americans, I’m disgusted about so many aspects of this financial meltdown that I don’t even know where to begin. But, we are where we are. The thing that really frustrates me now is the lack of leadership we are seeing as this crisis unfolds. Many ordinary Americans saw all of this coming for years. Why, then, are the “experts” who run our financial system so surprised by it that they didn’t seem to even give the possibility any thought, planning, preparation or attempts at prevention?
Instead, everyone seems to be running around like cranially challenged chickens, wanting to do something—ANYTHING—just so they can get back to their districts and campaign for re-election. The proposed Paulson Plan is terrible and Americans overwhelmingly know it. It rewards people for having made bad decisions, it’s convoluted in the way it proposes that it might someday trickle-down to help people on Main Street and it has the taxpayers overpaying for “assets” that no one else will touch.
The same leaders, who repeatedly assured us that the financial problems were contained, now want us to take it on faith that the Paulson Plan is the answer. Excuse our skepticism. The plan’s GOAL is to have us pay to free up the balances sheets of lenders who made bad loans so that they can go boldly forward and make more loans to us. Even more troubling, with The Paulson Plan, the worse the lenders were at lending money, the more taxpayer money they receive to try it again. Americans’ disapproval of The Paulson Plan is not “a marketing problem”—it’s common sense.
The latest monstrosity to come out of Washington has a price tag of $700,000,000,000
and no one has even been able to give us a hope of how it might be effective. The markets certainly don’t seem to be buying into it. I’m sure it’s as clear to you as it is to me that, for the good of every taxpayer, the plan required essential earmarks for Puerto Rican rum (Section 308), wool research (Section 325), auto racing tracks (Section 317) and wooden arrows designed for children (Section 503). Having addressed these gaping oversights in the original bill, it sailed through on Friday as a do-over.
They are going to spend $700,000,000,000 of our money. That has been settled. My goal with The Plumb Plan is to give up lamenting this massive appropriation and try to focus on spending it more effectively than The Paulson Plan proposes to do.
It’s time for our leaders to pause and give this whole idea some thought to come up with something that might actually work. This weekend, I started work on an alternative way to use $700,000,000,000. I think The Plumb Plan has many advantages. Please take the time to read it and let’s see if we, the people, can actually get something for our money. It is essential that we (not them) come up with a viable alternative and make it known to as many people as possible. Our voices will be louder and more effective if we can propose something we are for instead of complaining about what we are against. It’s time for us to begin the debate about possible alternatives that will work for us. That’s my goal with:
THE PLUMB PLAN
(Not, The Paulson Plan)
The basic idea of The Plumb Plan involves setting up a Refinancing Fund that Main Street Americans can access to cope with their debt problems. Specifically:
• The Plumb Plan offers every American who needs it, a 10-year interest-free loan to refinance their existing debt.
• They will receive as much money as they need, up to the total value of their existing debt balances. The catch is, in exchange for this attractive loan, they cannot build up any more debt until they pay off, in full, their loan from the Refinancing Fund. They would not be able to use credit cards, mortgage a new home, finance a car, tap their home equity, or borrow for anything until the interest-free loan is paid-in-full.
• The government would not give the money to the borrowers; the money would go from the Refinancing Fund directly to pay off debt (as directed by the borrowers). In this sense, it would basically be like a 0% balance transfer (rather than a cash advance).
• All existing debt that is repaid by the Refinancing Fund would be repaid at a significant discount from face value. For simplicity, this discount should be fixed and not vary from debt to debt. The appropriate discount should be set at a level such that most good lenders feel pain (but, survive) and most bad lenders get their just reward.
• The discounted value of the refinanced debt becomes the borrower’s new principal amount. This, combined with the 0% interest rate, should make it more manageable for them to pay it back.
• If the borrower wants to transfer a debt balance to the Refinancing Fund, the lender must comply. It is essential that the lenders don’t get to pick and choose which debts get refinanced at the set discount and which don’t. They do not have the option here. They got us into this mess. They don’t get to decide whether they opt into the program or not. Plus, if the borrower is in the financial condition where they are willing to give-up all access to the credit markets in exchange for easing the terms on their existing debt, their debt is probably not currently worth face value. On balance, lenders would be receiving fair recompense for the toxic debt with which they’ve polluted their balance sheets.
• Like with any refinancing or balance transfer, any collateral or future claims would transfer from the original lender to the Refinancing Fund. Put simply, any American that so desires would have the option to refinance their existing debt at very attractive terms. In exchange for the attractive terms of this refinancing, the borrower gives up their right to take on any additional debt until they have repaid the Refinancing Fund in full.
Advantages Over the Paulson Plan
The Plumb Plan is very different from The Paulson Plan, yet it achieves the same objectives of The Paulson Plan (and much more) using the same price tag (or less). Here are just some of the advantages of The Plumb Plan relative to The Paulson Plan:
• The Plumb Plan directly benefits Main Street, bypassing Wall St. This should make it much more palatable to Americans and politicians, but Wall St. may not be overly enamored with it.
• This plan is structured to minimize the moral hazard of the bailouts that have been commonplace so far. People who got into trouble have to give up something to get out of trouble.
• It helps those who are really in need. Importantly, THEY decide if they’re in need. And, they have to make a significant sacrifice to participate. The beauty of this is that the people who borrowed the money are actually in the best position to know how toxic their own loan is. If it’s extremely toxic, they will opt for bankruptcy; if it’s workable, then they receive a very attractive workout (if they agree to the “no new debt” requirement); and, if they are not having trouble with their current debt level, they won’t opt to participate in the program at all.
• The Plumb Plan will restrict some people’s access to credit for a period of time. But, people who opt into this plan are probably people who don’t want to be going deeper into debt anyway. Those who are bankrupt would be shut out of the credit market no matter what. Those who are still able to borrow will be from the most creditworthy segment of the population. Those in the middle (who opt into and are successful with the program) would be able to re-enter the credit markets in much better financial shape and as much better credit risks. Therefore, not as many loans will go bad in the future.
• The Plumb Plan quickly takes some of the worst loans off of the balance sheets of troubled lenders. This is supposedly the main goal of The Paulson Plan. The Plumb Plan, however, would do it more quickly. As all of our leaders keep telling us, we need a plan that can rapidly make a difference.
• The banks, and everyone else, will know what they have on their books soon after the program is implemented. This is part of the big problem today. Lenders don’t know the value of their own assets, let alone anyone else’s. Thus, they won’t even lend to each other, let alone the general public. The financial system is paralyzed. Right now, loans on each lender’s books fall into three categories (although, it’s currently difficult to identify which debts fall into which category):
o Loans that will never be repaid. These borrowers are effectively bankrupt. These loans are probably worth next-to-nothing, but they are carried at some value on the lenders’ books. These people probably wouldn’t opt into the plan because they are better off just reneging on the debt. These loans should be written off.
o Loans that are in jeopardy of going unpaid. Most of the participants that opt into The Plumb Plan would fall into this group. The value of these loans is a big mystery to everyone. Many of these loans would be removed from the frozen credit system. The loans that aren’t removed would probably be the more valuable loans because they belong to people who would rather try to pay them
off at current terms than give up their access to credit in exchange for the more attractive terms offered through the Refinancing Fund.
o Loans that are sound credits. If someone with a decent credit score doesn’t opt into The Plumb Plan, they are probably confident in their ability to service their current debt and the banks should value these loans close to face value.
• Once The Plumb Plan is implemented, everyone will have a better idea of what the remaining loans are worth and this should help get the credit system moving again. This is another goal of The Paulson Plan, but it will happen more quickly with this plan. Clarifying the murky middle loans will demarcate the good loans from the bad ones. This will make it possible to more accurately value all of the loans.
• Some people will only opt to borrow from the Refinancing Fund to pay off their high-interest loans. This will still reduce their debt-servicing costs, leaving them with more disposable income to devote to their other debt. This will make it more likely that their remaining debt will be repaid.
• This is a plan that people can understand. They can see how it would work. No reverse auctions are necessary. Securitization is not part of the program. No one needs to decipher an alphabet soup of CDOs, MBSs, CMOs, or CYAs. One doesn’t need to know the difference between commercial paper and toilet paper (a distinction that is becoming blurrier by the day). This plan avoids the need to price each of these unique, complex bundles of toxic debt. No one has to walk the fine line of trying to balance paying too little (and not providing the relief the financial system requires) or paying too much (and costing the taxpayers more). Complexity has been part of the problem; simplicity can be part of the solution.
Some More Specifics of the Plan
• People can pay off the interest-free loan as quickly as they want (but they need to pay a minimum of 1/120 of the initial principal amount every month). They will have an incentive to do this so that they can once again use credit cards, finance cars and homes, take out loans, etc. By paying off the interest-free loan, they will have a demonstrated record of responsible borrowing. This should make them better risks for the lenders in the future than are people who opted for bankruptcy instead. Successful participation in the program should improve a person’s credit score.
• The number of borrowers that opt into the program, and the amount of debt involved, can be altered if necessary. To influence the program participation rate, the government could simply use a different interest rate than 0% to increase or reduce the number of people that will choose to opt into the program. No one is denied, but they may choose not to participate.
• The government could also optimize the program by adjusting the 10-year timeframe
suggested here.
• Once the Refinancing Fund pays off the borrower’s debt to the lender, that debt disappears from the conventional credit market. Unlike The Paulson Plan, The Plumb Plan does not have the government holding onto a myriad of mortgages, credit card debt, consumer loans, student loans, etc. That would be a mess even by government standards. Each loan would have different terms, conditions, maturities, interest rates, and prepayment arrangements. The list goes on. Government would be trying to package some of these loans for sale and collect on others. It would be a nightmare and it is certainly not something for which the government is set up or at
which they have expertise. The Paulson Plan would not be distinguished by its efficiency.
• In The Plumb Plan, each loan received from the Refinancing Fund would be simple and the same—ten years, no interest, equal monthly payments and no prepayment penalty.
Big Picture Benefits
There are a number of major issues threatening America’s long-term economic health. The Plumb Plan would provide ancillary benefits in many areas.
Too Much Debt: Consumers currently have way too much debt. The Plumb Plan addresses this problem very directly. People who can’t afford to borrow more than they currently have will no longer be able to do so. Most importantly, THIS IS THEIR CHOICE. This will not only reduce the level of consumer debt, but the consumer debt that remains will be in the hands of borrowers who are more able to service it. As the borrowers pay down their interest-free loans, the amount of consumer debt in the country will automatically be reduced, because these people will not be taking on any more debt until their loan from the Refinancing Fund is paid-in-full.
Nonexistent National Savings Rate: This will clearly reduce consumption in the U.S. We will no longer be able to consume things we can’t afford. In my mind, this is a good thing. It will automatically increase the consumer savings rate.
Dependence on Foreign Lenders: Much of this debt is borrowed from foreign sources.
To the extent we can reduce our borrowing rate and increase our savings rate, we can reverse this trend.
Declining Home Prices: Much of this debt is mortgage-debt. With this plan, more people will be able to meet their mortgage payments. It will convert a lot of ARMs into 0% fixed rate loans. This will keep more people in their homes, slow the rate of foreclosures and stem the freefall in the housing market, which is at the heart of the crisis.
Dollar Deterioration: Each day that this crisis worsens does more damage to the dollar’s status as the world’s reserve currency. At a time when we can least afford it, this erosion threatens a further deterioration of the dollar’s global purchasing power. An effective response by the United States to this financial crisis could stem this deterioration.
Imprudent Lending: This plan won’t save all lenders. For the ones that have been most imprudent, this won’t be enough to rescue them. This, too, is a good thing. It places punishment where it is most deserved. Make no mistake; the lenders need to feel some pain in order to limit the “bailout” flavor of any proposal. Moral hazard was a big part of what got us into this crisis. It should be minimized in the solution.
Since consumer demand for borrowing will be significantly reduced under The Plumb Plan, we frankly won’t need as many lenders. The ones that survive to continue lending will be the most deserving. They will also be lending to a more creditworthy customer base. People who are still able to borrow will have already been “screened” as good credits and they will be even more prudent borrowers after having lived through this mess. This will make our whole financial system stronger. In the last decade, we haven’t done anyone any favors by loaning people money that they couldn’t repay.
Poor Regulation and Oversight: This plan doesn’t require hastily generating and overseeing a bunch of complex new regulations for our financial system. In the panic that is being exhibited today to “do something,” these knee-jerk efforts to legislate human nature can have very bad unintended consequences. This plan aligns the incentives with the goals for the parties involved. People will comply with the plan mainly because it’s in their own best interest to do so. This makes it is easier to regulate and oversee.
Too Much Uncertainty: The Plumb Plan would take a great deal of uncertainty out of the marketplace. Its costs would be much more transparent and known quickly. Lenders would know the value of what they have remaining on their books. This uncertainty has been one of the main things plaguing the markets and The Paulson Plan only increases it.
How Much Can Be Done For $700,000,000,000?
Obviously, one of the main questions is the cost of this plan. It’s going to be very expensive. But, we are already authorizing $700,000,000,000 for The Paulson Plan. This doesn’t count all the bailout money for the likes of the Fannies, Freddies, AIGs, and Bear Stearns still lurking out there. Plus, significant funds are going to be needed to prop up the FDIC and money markets. Also, have no illusions; The Paulson Plan won’t be the last request for taxpayer money. I don’t think even the most staunch proponents of the plan would suggest that it will be. The Paulson Plan is a knee-jerk stopgap measure of enormous proportions so politicians can at least point to something before they go back to the campaign trail for the next month.
Against this backdrop, let’s analyze The Plumb Plan. By far, the largest cost of The Plumb Plan is the interest that the Federal Government will pay to finance the plan over the 10-year period. Currently, Americans have about $10.5 trillion of mortgage debt outstanding
1
. This is by far their largest debt obligation. If the government borrowed a total of $4 trillion to set up a Refinancing Fund for this plan, how much would it cost taxpayers over 10 years?
• To set up the Refinancing Fund, the government would borrow $4 trillion at varying maturities corresponding to the 10-year principal repayment schedule of the program.
• The borrowers’ payments would repay the principal each year and the government (through we taxpayers) would pay the interest.
1
Latest figure from the Federal Reserve Flow of Funds Accounts released September 18, 2008.
• A simplified repayment schedule for the debt incurred to establish the Refinancing
Fund would look like this (using today’s yield curve):
I believe that for a cost of less than $700 billion, by paying the troubled lenders a discount relative to the face value of the debt, this program could take significantly more than $4 trillion in face value of suspect debt off of lenders’ balance sheets. The cost to the taxpayers could well be less if borrowers pay off their interest-free loans early in order to restore their ability to access the credit markets. Remember, to put this in perspective, all of the mortgage debt in the entire U.S. is about $10.5 trillion.
Other Cost Savings Relative to The Paulson Plan
• The Plumb Plan will be much less costly because it will be quicker to implement and easier to administer than The Paulson Plan. Everyone that chooses to do so qualifies. The refinancing loans should be straightforward and consumer-friendly. It should be as simple as paying off a mortgage or transferring a credit card balance. • The program would require very little involvement from Wall St., the mortgage industry, or other teams of outside “experts.” Regardless, of what you think about the effectiveness of these experts, they are expensive.
• For the reasons stated above, I believe The Plumb Plan would do a better job of reducing market uncertainty and restoring confidence. Many of the variables of the plan would be known with certainty almost immediately. This would be better for the overall economy. If the economy does better, then tax revenues would be higher
2
The crisis has increased demand for the “safety” of Treasuries. These low yields will be advantageous in financing the program.
3
The “Treasury Blended Yield” is the weighted-average yield paid each year on the remaining Treasury bonds outstanding.
under this plan than the tax revenues that would be generated by an economy struggling to right itself under The Paulson Plan.
• Some participants may default, but probably significantly fewer than would default under The Paulson Plan. Remember, participants cannot re-enter the credit markets until their loan is re-paid in full to the Refinancing Fund. Also, the government has a wide range of tools available to discourage people from defaulting on their loan. It is important that borrowers understand UP FRONT the consequences of defaulting.
• This plan should be more popular on Main Street and among politicians. As such, I don’t think earmarks for Puerto Rican rum, wool research, auto racing tracks and wooden arrows designed for children will be required to persuade politicians to do what’s best for the country. This would be another cost savings over the current proposal.
• Once the Refinancing Fund is established, investors may want to invest in the Fund. In this way, the Refinancing Fund could eventually be financed with investors’ money rather than government borrowing.
Conclusion
The Plumb Plan will be a much better use of $700,000,000,000 than The Paulson Plan.
• It’s fairer.
• It’s easier to understand.
• It’s faster to implement.
• It deals more directly with the needs of Main Street.
• It will have a quicker impact.
• It gives people a choice as to whether they want to participate.
• It forces the lenders to share the pain.
• It minimizes moral hazard.
• It reduces consumer debt levels.
• It reduces future borrowing.
• It increases our national savings rate.
• It reduces our dependence on foreign lenders.
• It stems the deterioration of the dollar.
• It stabilizes the housing market.
• It improves future lending.
• It is simpler to regulate and oversee.
All of this should benefit our economy and restore global confidence. And, it ultimately removes a lot of bad loans from the books of lenders, which is what The Paulson Plan is trying to do in the first place. It does all of this at the same cost, or less.
Let’s Make Our Feelings Known
If this makes sense to you, time is of the essence. I’m just one guy banging this idea out on my computer over the course of a weekend. I’m sure there are flaws in The Plumb Plan. That, however, is not really the point. The point is that there are alternatives and they can work much better than The Paulson Plan. This may be the blueprint that spurs our leaders to think more creatively and to directly address the needs of the voters.
If you agree, then we need to make this a rapid grassroots effort. This is the biggest problem our nation has faced in at least a generation. We need to make it known, in the loudest possible way, that there are better solutions and they need to be considered. We need to immediately make this clear to our leaders. They stampeded through The Paulson Plan because they were very anxious to do something—ANYTHING—so that they could rush back and convince you to vote for them. The economy will far and away be the most important issue in next month’s elections. This crisis threatens to be so overwhelming that, without a satisfactory solution, all other issues will become rounding errors. Make your candidate earn your vote!
Please forward this to everyone you know, especially people who might be able to draw some attention to it where it matters. Send it to your representatives. Use the Internet, the mail, discussion boards, the media and anything else you can imagine.
The time has come for our nation to make a U-turn and begin a process that will put us on a sustainable path to prosperity. It’s abundantly clear from recent events that we cannot sit back and rely on our leaders to show us the way. We need to lead the way. We need
to:
• Live within our means,
• Reduce our debt levels,
• Increase our savings,
• Reduce our dependence on foreign lenders,
• And, quit passing the bill for our economic profligacy onto the next generation. This U-turn will not be without near-term pain and sacrifice, but The Plumb Plan allocates this pain and sacrifice in the fairest way that I have been able to come up with so far. The Great Depression taught several generations the value of sacrificing to pay- off their mortgages and the discipline of saving up for everything else before they bought it. We’re about to get a refresher course.
Remember, the question I am asking you to consider here is not: “Do you think the government should spend $700,000,000,000 of our money?” They have already answered that one for us. The question I want you to ask yourself is:
“Which do you prefer—The Paulson Plan or The Plumb Plan?”
This can work if WE act quickly enough with enough voices speaking out in favor of a better concrete alternative. It’s time for US to act!
—Charles W. “Chip” Plumb, CFA —
October 7, 2008
Permission is granted to reproduce and distribute this document with attribution to the author.
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