Readers may recall that we hated the TARP from its inception. Recall that the TARP was so named because the TA stood for “troubled asset”. The plan was to buy crappy assets from banks because this would leave them with nice pristine balance sheets and they could go forth and
be reckless lend once again.
But any though beyond the high concept immediately revealed what a crock that idea was. How would you go about buying the bad paper? If you pay market price (or the “marked” price, which is in all likelihood somewhat finessed, since a fair bit of this paper traded only by appointment even in normal times), you have not helped the banks, merely ratified the status quo (although one has removed the fear that the crap investments could go lower, so that is a benefit of sorts).
But the only way for this concept, no matter how it is branded, to aid financial institutions is for the buyer to pay above “marked” prices, which are guaranteed to be above market. That sticks the taxpayer with likely losses and does not increase confidence in the financial system (there are too many dodgy assets for the government to take up all of them, and the phony pricing mechanism moves the system even further from price transparency).
George Soros, in a comment in today’s Financial Times, “The right and wrong way to bail out the banks,” takes issue with the idea of reviving TARP 1.0 in new dress and suggests another approach for dealing with the banking crisis:
According to reports in Washington, the Obama administration may be close to devoting as much as $100bn of the second tranche of the troubled asset relief programme funds to creating an “aggregator bank” that would remove toxic securities from the balance sheets of banks. The plan would be to leverage this amount up 10-fold, using the Federal Reserve’s balance sheet, so that the banking system could be relieved of up to $1,000bn (€770bn, £726bn) worth of bad assets…..
[T]his approach harks back to the approach originally taken – but eventually abandoned – by Hank Paulson, the former US Treasury secretary. The proposal suffers from the same shortcomings: the toxic securities are, by definition, hard to value. The introduction of a significant buyer will result, not in price discovery, but in price distortion.
Moreover, the securities are not homogeneous, which means that even an auction process would leave the aggregator bank with inferior assets through adverse selection…..
These measures – if enacted – would provide artificial life support for the banks at considerable expense to the taxpayer, but would not put the banks in a position to resume lending at competitive rates….
In my view, an equity injection scheme based on realistic valuations, followed by a cut in minimum capital requirements for banks, would be much more effective in restarting the economy. The downside is that it would require significantly more than $1,000bn of new capital. It would involve a good bank/bad bank solution, where appropriate. That would heavily dilute existing shareholders and risk putting the majority of bank equity into government hands.
Yves here. Conceptually, this is in keeping with the Swedish model, widely seen as the most successful resolution of a banking crisis. Back to the piece:
The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets. Choosing the first course would inflict great pain on a broad segment of the population – not only on bank shareholders but also on the beneficiaries of pension funds. However, it would clear the air and restart the economy.
Yves again. The experience in Sweden and countries that took similar approaches was a sharp fall in GDP that lasted roughly 2 years, but then a strong growth rebound. However, the other test cases took place against a less awful global economic backdrop. Back to the article:
The latter course would avoid recognising and coming to terms with the painful economic realities, but it would put the banking system into the same quandary that proved the undoing of the government sponsored enterprises (GSEs) – Fannie Mae and Freddie Mac. The public interest would dictate that the banks should resume lending on attractive terms. However, this lending would have to be enforced by government diktat because the self-interest of the banks would lead them to focus on preserving and rebuilding their own equity.
Political realities are pushing the Obama administration towards the latter course. It cannot go to Congress and ask for the authorisation to spend an additional $1,000bn on recapitalising the banks because Mr Paulson has poisoned the well in the way he demanded and then spent the money for Tarp. Even the second tranche of Tarp – the remaining $350bn – could only be pried loose by a congressional manoeuvre. That is what is leading the Obama administration to contemplate reserving up to $100bn of that tranche for the “aggregator bank” solution.
The stock market is pressing for an early decision by putting pressure on financial stocks. But the new team should avoid repeating the mistakes of the previous one and announcing a programme before it has been thoroughly thought out….
Congress and the public are right in feeling that too much has been done for the banks and not enough for beleaguered householders. The government ought to take the GSEs out of limbo and use them more actively to stabilise the housing market. Having done so, it could go back to Congress for authorisation to recapitalise the banking system the right way.