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Does Paulson Have Any Idea How to Spend Our $700 Billion? |
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Does anyone else get the funny feeling that we’re going to discover very soon that the $700 billion has been spent and no one is quite sure what it got spent on? — Carrie Dann, MSNBC’s First Read
If you remember back to September when Treasury Secretary Henry Paulson was explaining to us why he needed $700 billion in taxpayer funds, he explained that:
The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy.
When the bill, the Emergency Economic Stabilization Act (PL 110-343) was passed in early October, it created the Troubled Asset Relief program, or TARP. TARP had two main pieces, a troubled asset purchase program and a troubled asset insurance program. Treasury was also given the power to inject capital directly into financial institutions and to directly help homeowners to help forestall foreclosures. The asset purchase program was expected to be the biggest piece, as Treasury would buy up high risk mortgage-related assets, often at high discounts, in order to stabilize the portfolios of financial institutions and create incentives to revise mortgages so that they don’t face default. Also, the hope was that once these assets stabilized, that Treasury could then sell them back on the market, thus making a profit for the government and thus the taxpayer.
Yesterday Paulson stated, in essence, “Never mind.”
Over these past weeks we have continued to examine the relative benefits of purchasing illiquid mortgage-related assets. Our assessment at this time is that this is not the most effective way to use TARP funds…
Instead Treasury is injecting capital directly into various financial entities, such as American Express, now that it has been characterized as a bank, as well as into the credit card, auto loan and student loan industries. Of course there was that purchase of another stake in AIG. One of the many concerns is that if this is direct capital injection, what assets do the taxpayers get in order to recoup losses. What we have been getting is “preferred stock.” This stuff is only a good purchase if everything works out well and the stock rises. It may be better than nothing, but it still isn’t the plan that was sold to Congress.
The key issue is still the home foreclosure problem, and it is unclear how billions of taxpayer dollars injected into these various financial entities will actually address that. Representative Barney Frank, Chairman of the House Financial Services Committee, focused on thisafter Paulson’s announcement:
House Financial Services Chairman Barney Frank (D., Mass.) said Wednesday he was disappointed Mr. Paulson was scrapping the asset-purchase plan. “I think he’s wrong not to use it that way,” Mr. Frank said…
“Using some of the TARP money to reduce foreclosures was not only contemplated in it, it was one of our major focal points,” Mr. Frank said. It’s unclear just what, if anything, the Bush administration will be able to do to help stem the tide of foreclosures.
There has been some progress on the foreclosure issue, but not as much as there could be. Citigroup has taken the leadin the private sector. The second largest U.S. bank has announced that they will stop foreclosures when borrowers have enough income to afford a reworked mortgage. Citigroup plans on contacting 500,000 borrowers over the next six months to rework their mortgages at lower interst rates that they may be able to afford. This is the attitude that other major financial institutions need to follow. Another example is IndyMac, which Paulson referred to in his own remarks.
FDIC Chairman Bair has given us a model, in the mortgage modification protocol she developed with IndyMac Bank. Through the end of October, the FDIC has completed loan modifications for 3,500 borrowers, with several thousand more modifications currently being processed. These modifications have reduced payments for participating homeowners by an average of $380 month, or about 23 percent.
That seems to be the most effective strategy overall. Reducing payments so that they become affordable means these assets stay as assets and not liabilities. The modified mortgages also help when it comes to getting the credit market flowing again as these loans become less likely to default, improving the health of bank’s overall portfolio.
Meanwhile, as Treasury continues to buy into a wide array of financial institutions, transparency and oversight, as required by the law passed by Congress, is nowhere to be seen. Over $290 billion of the $700 billion allocated by law has already been allocated without outside supervision. As The Washington Post reports:
Yet for all this activity, no formal action has been taken to fill the independent oversight posts established by Congress when it approved the bailout to prevent corruption and government waste. Nor has the first monitoring report required by lawmakers been completed, though the initial deadline has passed.
“It’s a mess,” said Eric M. Thorson, the Treasury Department’s inspector general, who has been working to oversee the bailout program until the newly created position of special inspector general is filled. “I don’t think anyone understands right now how we’re going to do proper oversight of this thing.”
That’s right — $290 billion and so far it seems like this has been a patchwork of capital injection. Billions to an insurance company here, a small bank there, a newly minted bank around here somewhere. And there is nobody overseeing the process to question the moves that Treasury is making. The philosophy seems to be, if you are a financial institution and ask for funds, you will get your wish. It seems as though it would be more effective if the strategy was to assist institutions in their purchases of failing banks to help those assets and let the healthy institution absorb the bad debt in such a way to make it a good deal for them.
An example of the existing Treasury strategy can be found from late October when Fifth-Third Bank received $3.5 billion from Treasury:
As a result, the company officially pulled the plug on plans to sell off a non-core business to raise capital - and hinted that it might be looking for acquisitions…
Fifth Third said last week that it would suspend the business unit sale as it considered participating in the Treasury’s capital investment plan. The government is taking non-voting stock stakes in large financial institutions, using $250 billion of the $700 billion financial bailout approved earlier this month.
So a fairly healthy institution, needing a bit more capital, was ready to sell off one of its non-core entities. Seems like a rational business decision. Now that Treasury has infused cash into Fifth-Third, it is looking for new business opportunities. Now if Treasury had helped Fifth-0Third buy a troubled bank somewhere, this transaction would have made a lot of sense. But right now I don’t see why this particular capital injection is of the sort that was immediately required by the dire circumstances of the financial sector.
There are other concerns. Japan went through a similar, though not exact problem in the late 1990s and the early part of this decade. Their experience seems to point out that the Paulson strategy is NOT the most effective, but more on that later.
In the meantime, I just don’t understand Treasury’s strategy even after reading Paulson’s statement. What are the requirements that an institution must meet in order to get funds from the Treasury for this program? What would disqualify an institution from getting these funds? Has anyone yet been rejected?
Right now the program is a mystery, and Henry Paulson has not yet inspired confidence in Treasury’s actions.
