The effort to get the second half of the TARP approved (or more accurately, not force Obushma to nix a Congressional turndown) is all feeling a bit Groundhog Day-ish, without the backdrop of a Lehman collapse and AIG implosion to add a sense of urgency and high drama.
The officialdom is again using its access to the media to make its case, as as before, countervailing views are not getting much airplay.
For the record, I am not opposed to the idea of recapitalizing banks, In fact, this blog was talking about the Swedish model long before it was popular to do so. However, the TARP falls so short in so many respects that it is hard to justify the official support for it, save that having started with a bad plan, it is now too hard and time consuming to come up with a better one.
Welcome to democracy in America, or what passes for it.
Some of the problems have been beaten into the ground in the media and are now at least getting lip service from politicians, namely, the lack of accountability, the lack of meaningful limits on pay. I happened to catch a bit of CNN today, and the announcer was waxing surprisingly eloquent on the fact that the new Citi-Morgan Stanley Smith Barney JV might set aside as much as $3 billion for retention bonuses. He enumerated how much each bank had gotten in bailout money and pointed out that it had to be funding the bonus pool. That is a sea change.
However, the version 1.0 of the TARP, “let’s buy troubled assets,” which failed to see the light of day for good reason, is now being trotted forth.
The right way to do this is to recognize losses, which requires realistic pricing of dud assets. Then the powers that be need to make a determination if the bank can be saved or not. Some banks will no doubt be such goners that they should be liquidated or merged. Dud assets get spun out to a liquidation vehicle which is separately capitalized.
However this model assumes nationalization, which is frankly what is called for here. Little and medium sized banks, in roach hotel fashion, go to the FDIC and they don’t come out, at least in not in their previous form. But our regime for dealing with big troubled banks stinks. We keep incumbent management in place, we don’t make shareholders (and bondholders, which may selectively be appropriate) take their lumps, and we come up with goofy ideas like “buy troubled assets” as a workaround.
Why is that such a bad idea? It is a hidden subsidy. There is NO point in buying bad assets at market value (you don’t need the Feds to do that). The entire point of the exercise is to pay an above market price to recapitalize the banks. But this has the effect of disguising the amount of the recap AND preventing the taxpayer from getting any upside. In a nationalization case, the taxpayers pony up the dough, but they get all the bennies when the bank is later sold. And in Sweden, the government showed a profit on the exercise.
Oh, and the side benefit of the TARP: other banks can use the phony above market prices paid by the TARP for valuing similar assets. This is straight out of Japan, where banks kept dodgy loans on their books for years at above market prices. Banks that have too much of that garbage will dump it on the Treasury, but banks with less than terminal amounts will get to value them at fantasy levels.
If you are worried about lack of accountability, you should hate the TARP. The Fed and Treasury have stonewalled on disclosure on the TARP and the Fed’s alphabet soup of special facilities. The TARP by design will muff how much of the amount paid is fair value versus subsidy. And how can one EVER evaluate the effectiveness of this program if there is no notion of what was spent on bank recapitalization? This is a banana republic exercise, by design.
But you see merely “this is ugly but necessary” in the media. Now the officialdom has gotten smart enough to acknowledge that this is distasteful, but you still see the press effectively running with government spin. While the dissent is acknowledged, look at the prominence given to the official line and the lack of discussion of the problem of how to price the bad assets.
From the Wall Street Journal:
Top Federal Reserve officials said Tuesday that the incoming Obama administration must pump more money into ailing financial institutions and might need to take bad assets off the hands of banks, a stance that injected the central bank into a tense political debate.
President-elect Barack Obama visited Capitol Hill Tuesday to lobby Senate Democrats for the remaining funds in the financial-rescue plan passed in October, amid deep concerns among lawmakers about the program’s effectiveness. Lawmakers are pushing for new conditions as well as substantial new spending to prevent foreclosures, while some would like to scrap the program altogether….
Fed Chairman Ben Bernanke made a push Tuesday for a new effort to help banks get bad loans off their balance sheets, the TARP’s original purpose. In a speech at the London School of Economics, he warned that while TARP funds helped prevent a global financial meltdown last year, bad assets continue to clog the balance sheets of financial institutions. Fixing that problem, he said, is paramount….
Donald Kohn, the Fed’s vice chairman, delivered a similar message in testimony before the House Financial Services Committee Tuesday. Both men also talked about the need to aid homeowners, but their emphasis was on securing the workings of the banking system.
Lawmakers have been highly critical of the TARP, arguing that taxpayer funds haven’t led to more bank lending as planned and that the Bush administration failed to use the funds as it promised it would, such as to advance programs to prevent mortgage foreclosures.
During Tuesday’s meeting, Mr. Obama’s pitch for release of the bailout funds framed the issue as something that could help define “our ability to govern together,” said Connecticut Sen. Joseph Lieberman, an independent who caucuses with the Democrats. Lawrence Summers, a top Obama economic aide, made his own pitch to members of the Senate Finance Committee Tuesday.
The request for the remaining TARP money has set in motion action on a resolution of disapproval, which could block the funds’ release. The Obama team and top Democratic congressional leaders have little hope of defeating the resolution in the House, where wariness of the program runs high. But they hope to derail it in the Senate. A vote on the issue could come by week’s end….
Bad loans are now rising as the weak economy drives more borrowers into default. The presence of bad loans on banks’ balance sheets “significantly increases uncertainty about the underlying value of these institutions, and may inhibit both private investment and new lending,” Mr. Bernanke said Tuesday.
He laid out three approaches to get bad assets off banks’ books. One is to buy them outright. Another is to provide federal guarantees under which the government would agree, for a fee, to absorb losses if these assets fall further in value. A third is to help set up “bad banks,” which would purchase bad assets from financial institutions in exchange for cash or equity in the bad bank.
Bernanke’s analysis is dishonest. Banks ALWAYS clamp down on lending in recessions. Some of it is due to the cortisol-generating effect of looking at all those loan losses from the last cycle (cortisol is a stress hormone and studies of traders have found that when they lose money, they make lots of cortisol, and cortisol makes one risk averse. Maybe we need a designer pil for lenders rather than the TARP, if you buy Bernanke’s logic, Much cheaper).
But there are completely valid reason for banks to curtail lending. First, they lent to people they shouldn’t have, they learned their lesson and won’t do that for maybe five years until they forget how stupid it was. Second, the economy is getting worse, Until there are signs of a bottom, risk aversion is completely rational. A fair percentage of borrowers will suffer lower incomes (or job loss) and will become deadbeats. Being stringent is the only sensible course of action now.