Putting the Paulson Plan to Work

Today’s market action was a lot like a football game where the final score doesn’t tell the whole story. Often times fans get three quarters worth of a blowout and then the losing team pulls closer as the clock runs out. The Dow on Monday was a lot like that.

The DJIA plummeted 800 points – a one-day record – before recovering to end the day 370 points down. Today was the first time the Dow closed below 10,000 since 2004. This is exactly the type of event that Cramer warned investors about during his Monday Today Show appearance.


The message was that if you need money for any reason – retirement, your kids’ college tuition – for the next five years, then switch out of stocks an into cash. The hit the market is most likely going to continue to take could put that money in jeopardy. Just to be clear, though, Cramer wasn’t in any way calling for all investors to bail out completely. He only wanted those investors who know they need cash on hand for the near term to protect themselves. Everyone else should consider staying with his or her long-term stock strategies.

For the short-term, though, Washington needs to take action to stabilize this market. And of course, Cramer has a plan for how our government can do just that.

He wants Sheila Bair and the Federal Deposit Insurance Corp. to stop seizing banks. Rather than have the government take on billions of dollars in bad loans, and wipe out holders of the company’s stock and bonds in the process, the FDIC should allow a struggling bank to be acquired.

Case in point: Wells Fargo, instead of Citigroup, buying Wachovia . Wells could take tax deductions on Wachovia’s bad loans, thanks to a new law recently put into effect, which means the government wouldn’t have to bear the burden. Nor would Wachovia’s shareholders be hung out to dry. When the FDIC was forcing Wachovia into Citi’s arms, shareholders got nothing. But Wells offered $7 a share for a stock trading near $2 just days before. Plus, Cramer thinks Wells is a much stronger bank than Citi and therefore makes more sense as a buyer.

Now that the FDIC has increased its deposit insurance to $250,000 from $100,000 and Bush signed into law the Troubled-Asset Relief Program, there’s no need for shotgun marriages between banks. This alone, Cramer said, should get money flowing back into bank preferred stock, bringing capital into the market for banks. And that’s the issue right now.

Cramer also wants the TARP facility to buy whole loans. Focus on those first, rather than mortgage-backed securities. That way the government can work with the owner of the loan to prevent foreclosure. Cramer said there could be as much as $100 billion of these loans that can be bought and removed from banks’ balance sheets and taken out of the foreclosure pool. This would return to banks the ability to lend money, their primary business function and one they’ve been unable to perform since this whole credit/housing mess started.

Next, buy collateralized-debt obligations. If the government can put a floor in these toxic investments, and pricing them has been the whole problem – no one knows what they’re worth – then that might lure pension and hedge funds into the market. Washington would lend a much-needed air of confidence to CDOs that could jump-start their buying and selling.

Cramer admitted that his plans aren’t perfect. But this is an opportunity to clear the market of some of the worst mortgages out there for just $700 billion. And these loans are all backed by houses that are most likely worth more than what the government will be paying, as long as unemployment doesn’t sink below 10%. If that happens, the $700 billion won’t be enough and Washington will need to do more to stabilize the markets.

How long will it take for this to play out? Cramer thinks six months is a good estimate for pricing these troubled assets and getting them off the balance sheets of American banks. Once that happens, then a repeat of the Great Depression is off the table.

And that’s “about the best we can hope for right now,” Cramer said. Whether it's through worldwide coordinated rate cuts, more bailouts, another stimulus package or even buying homes the way Europe does, “we must get that scenario off the table no matter what.”

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