Banking Bailout: A Modest Alternative

As a former bank analyst, I don't think a $700 billion bailout is enough to make up for the fallacy of mark-to-market accounting for one-of-a-kind securities for which there can never be a standardized market. No amount is large enough.

Banks and other financial-services firms can create new, complex securities to sell to one another faster than the U.S. government can legislate, appropriate and borrow money to buy them. In addition, Treasury Secretary Henry Paulson does not want to limit the bailout to mortgage-related investments, seeking the authority to buy a variety of so-called "toxic" securities including credit derivatives.

Part of the problem ...

Partly because of these securities, we have seen just this month the government rescue of Fannie Mae (FNM Quote - Cramer on FNM - Stock Picks) and Freddie Mac (FRE Quote - Cramer on FRE - Stock Picks), the bailout of AIG (AIG Quote - Cramer on AIG - Stock Picks), the bankruptcy of Lehman Brothers, the purchase of Merrill Lynch (MER Quote - Cramer on MER - Stock Picks) by Bank of America (BAC Quote - Cramer on BAC - Stock Picks) and the decision by Goldman Sachs (GS Quote - Cramer on GS - Stock Picks) and Morgan Stanley (MS Quote - Cramer on MS - Stock Picks) to become bank holding companies.

Mark-to-market accounting rules force banks to value mortgage-backed and other securities at less than they would expect to receive if they waited a few years until the investments matured. Since they're booking losses based on low values, some banks may appear not to have enough capital to safely remain in business. Hence, we have a crisis in confidence that banks won't be able to pay back their current debts, let alone borrow new money.

Do We Even Need a Rescue Plan?

With credit decisions, confidence is everything. If a deadbeat bank is bailed out by the government, I will have more confidence in the government's ability to borrow and spend money. However, this will not increase confidence in the management of the deadbeat bank or on the valuations placed on that bank's other securities.

One possible solution ...

For one-of-a-kind securities that may never be actively traded in a standardized market, I propose the use of a valuation methodology called "valued & insured-to-maturity."

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