TARP: A Cloudy Clarification?

Last week, in our round-up on financial market conditions, we made brief mention of "TARP", the special U.S. Treasury "Troubled Asset Relief Program". We indicated that its funds have not yet been spent in size. This is actually not a correct characterization of what's going on with that program. In fact, $115 billion has been spent, no small piece-of-change. Our own confusion comes mainly from the fact that the funds are not going to buy troubled assets in the way that was initially conceived. Secretary Paulson explained soon after we wrote that the Treasury no longer thinks that buying mortgage-backed bonds is the best use of these funds, so the headline we kept watching for, "Treasury Buys $25 billion MBS" or whatever, will never show up exactly that way.

"Capital Purchase Program"
The "troubled assets" the Treasury has been buying in size are pieces of banks themselves. Few will argue that the banks are troubled, at least to some degree; even if the vast majority of them are still earning profits, those are slimmer than before. And Secretary Paulson is right, buying stock in the banks is much more helpful than buying specific securities. In mid-October, the Treasury announced a Capital Purchase Program, whereby the federal government would buy as much as $250 billion worth of a special class of preferred stock in a number of the nation's banks. The first half of that went to the nine largest, Bank of America, JPMorgan Chase, Citigroup, etc. We assumed that it would take some time to consummate these transactions, but they were completed on October 28 and $115 billion in funds were paid out. Applications for the second half of this offering were due just a few days ago. According to a list published Friday by the Wall Street Journal, so far, 54 more banking institutions have applied for $49 billion, and the Treasury is processing an investment of $40 billion in American International Group (AIG).

If the Treasury's funds were dedicated to a specific asset, it would be only those assets that could be helped by TARP. But putting the money into underlying capital means it can be used to shore up the overall operations of each institution. There is then some discretion in what individual banks can do with it, and the intention is that they will increase lending and help needy borrowers work through difficult situations. At the same time, Treasury officials were said to have complained already that they hadn't yet seen evidence that lending was picking up. Certainly, news instead of still another "retreat" at a posh resort for employees and agents of AIG was not well received. Federal Reserve weekly data on bank balance sheets lags a bit, so hardly enough time has passed to see any major change in the aggregate numbers; what the figures do show through November 5 is a marked reduction in the banks' borrowing from the Federal Reserve, that is, possibly they cut their current liabilities first. That's not a wholly bad thing for them to do. We're not sure, though, if this read of the data is a correct interpretation or only a numerical coincidence. We'll keep up with this to see how it develops, now that we know what to look for!

There Is Help for Consumers
Meantime, there seems to be a lot of public comment about whether anybody is actually reaching out to consumers. Secretary Paulson suggested the other day that some of the remaining TARP funds would be directed at consumer debt, but he didn't offer any specifics. Members of Congress and even the President-Elect continue to beat a drum for mortgage foreclosure prevention. But, as we've talked about before, here, this is already happening. We described here in our article about the Hope Now program (October 27) how more than 1.5 million homeowners have been involved in their efforts so far this year. Just days after that article, a couple of major banks announced on their own similar programs for seriously delinquent mortgage loans that they hold in their portfolios. A third major effort is coming from Fannie Mae and Freddie Mac, sharply increasing the Hope Now activity. Delinquencies are still mounting, so expansion of this work is still needed. But consumers are hardly being neglected.

Inconsistent Policy Choices
We're talking about these issues for a couple of reasons. One is that we needed to correct an error we made here a week ago, albeit an innocent one. But that in itself brings the second reason for our discussion. These are your tax dollars. No one can say that they're not going to good use. And we're glad the government is stepping in with support. But the Treasury is not using the money the way they themselves originally proposed. Congress was not in session in October, so officials couldn't go back to get the changes formally approved. Time was of the essence, and as Secretary Paulson explained*, the program was implemented so quickly it set a "land-speed record" for such government action. But we would caution that this massive revision of the policy does not set good precedent; Members of Congress have indeed criticized him. It highlights the danger of putting too much power in the hands of government officials. If it's a single firm that encounters trouble, that's bad enough. But if someone has broad public authority and changes their mind about a policy, many people can be harmed. This isn't likely to be the outcome here, but the way it has come about rings all kinds of alarm bells for us. Further, the shift has only encouraged other firms and industries to reach for some of the money. One major business finance company became a bank in order to qualify, another insurance company is trying to buy a bank. And the beleaguered U.S. auto companies believe they should be eligible for something. Thus, there is now no way to draw a clear line.

One other recent development of note: late Sunday, even as we were drafting the first few paragraphs of this article, Goldman Sachs announced that its executives would forgo their bonuses this year. Partly, we want to say, good thing! as a couple of our friends were victims of the latest round of that company's layoffs. However, on the whole, Goldman has done well, not becoming overly involved in excessive mortgage investment and other risky trading; if any Wall Street executives deserve "performance-based compensation", it is likely them. So their decision on this question is a constructive one for the entire industry. It addresses the one aspect that has the most public ire: really enormous compensation for the big shots while people's loans are going sour and their friends are getting laid off.
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* U.S. Treasury. "Remarks by Secretary Henry M. Paulson, Jr. on Financial Rescue Package and Economic Update", November 12, 2008. http://www.ustreas.gov/press/releases/hp1265.htm