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In Fed Plan, Everything Old Is New Again

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Taking a cue from past bailouts.

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The government stepped up the plate - and Wall Street roared. It's fascinating that the stock market made a 500-point intra-day reversal just as everyone agreed it would get worse before it got better.

Of course, anxiety is still the order of the day, but everyone feels much better. The game plan is still on the drawing board, and there's a chance that things could get bogged down, since there are 2 proposals, each based on past bailouts:

Reconstruction Finance Corp (1932): New Deal.

Minyanville's Why Wall Street Will Never Be the SameAfter initial optimism, this program was rife with cronyism and the banking crisis grew worse. Once FDR took office and reformed it, the program went on to make billions of dollars in loans available. It is believed the majority of these loans were paid back.

Took assets of failed financial institutions on state and local levels, eventually in all fifty states. The goal was to sell assets and make loans to failing financial institutions.

Solution: Government provides capital in exchange for stake (preferred shares) in order to shore up capital base.


Resolution Trust Corp (1989): S&L bailout.

The savior of savings-and-loans which had gotten in over their heads with the passage of the Depository Intuitions Act in 1982 , which allowed them to diversify their mortgage portfolios. Of course, most historians agree the rescue eventually costs taxpayers $130 billion.

The goal was to dispose of branches and assets of insolvent savings and loans. The trust sold bad loans, which was easier for tangible (real estate) assets than non-performing assets.

Solution: Take bad loans off the books in order to allow financial institutions to get back to basics.

From Wall Street's point of view, the news is great. (Just think of Yucca Mountain for toxic investments.) Both plans have pros and cons. Do taxpayers want to get more deeply embroiled with Wall Street via its least attractive assets? Or would they feel better taking these assets and waiting for a better day?

You can be sure that Bernanke and Paulson will want a say in many of the plan's details, and it feels a little like the plot of the movie Magnificent Seven:

The local villagers, having given up their rights to toughs (read: Shorts) enlist the help of hired guns. At some point, however, they stand up to the challenge themselves. That movie had one of the highest testosterone levels in cinema history, with Yul Brynner, Steve McQueen and Charles Bronson charging into this small Mexican town to save the day.

Joining the fight yesterday were the California State Teachers Retirement System, CALPERS and the New York States Common Retirement Fund, all refusing to lend out shares of Goldman Sachs (GS) or Morgan Stanley (MS) to shorts. But the biggest blow came from the Financial Services Authority in the UK, which has banned shorting of financial stocks for the remainder of the year.

The market was oversold -- and putting up a better fight than preceding sessions -- but many will say the news from the UK was most instrumental in sparking that sparked that last magical hour of trading.
No positions in stocks mentioned.
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