Alan Blinder was my choice for Treasury Secretary, which tells you something about me because I'm going to disagree with him here in the NY Times:
"Missing the Target With $700 Billion “First you say you do, and then you don’t. And then you say you will, and then you won’t. You’re undecided now, so what are you gonna do?”
— “Undecided,” by Sid Robin and Charlie Shavers
UNFORTUNATELY, Treasury Secretary Henry M. Paulson Jr. has turned this old song into the unofficial theme of the Troubled Assets Relief Program, the $700 billion bailout. His frequent changes of direction are not only embarrassing, they also upset the very markets this program was designed to calm.( VERY TRUE )
It pains me to say this, because I was among the first to call upon Congress to create two institutions to deal with the financial crisis: one to buy and refinance home mortgages, the other to buy what came to be called “troubled assets.” The legislation signed in October empowered the TARP to do both. Sadly and amazingly, it has done neither( I WAS FOR TAKING OVER THE BANKS ).
Regarding mortgages, Mr. Paulson is in a tong war with Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, who wants to deploy( THAT WORD AGAIN ) a small fraction of the TARP money to refinance millions of mortgages. Her plan may not be perfect — whose is? — but she’s pushing in the right direction. But he, apparently, disagrees and has devoted no money to this purpose( TRUE, BUT THE FED HAS ).
Regarding mortgage-related securities — the “troubled assets” themselves — Mr. Paulson stunned markets on Nov. 12 by announcing that he wouldn’t spend a dime on that purpose, either. Oh? As one of my students asked me the next morning, shouldn’t they at least change the name?
Instead, taxpayer money has been used mainly to recapitalize ailing banks. To be sure, this use of the TARP is perfectly legal. The legislation gives the secretary broad authority to buy “any other financial instrument” that he deems “necessary to promote financial market stability.” That certainly includes buying bank stock. ( VERY TRUE )
The question is not one of legality, but of judgment. Old-fashioned believers in democracy may recall that a reluctant Congress was sold on the idea of buying troubled assets, not on injecting capital into banks. No wonder members are crying foul. ( I AGREE. )
In fairness, Mr. Paulson was not alone in advocating capital injections. Many economists and financial experts agreed. But I doubt that many of them intended for the government to buy preferred stock with no control rights, at above-market prices and with no public-purpose strings attached( I HOPE NOT ). The automakers are not being treated this way in their $13.4 billion loan ( FUNNY THING ).
Because about half of the $700 billion remains uncommitted, let’s review the arguments supporting the three main uses of the TARP:
MORTGAGES The financial crisis began with falling home prices and fears of rampant mortgage defaults — fears that are now coming true. Those fears depressed the values of securities based on mortgages, making them “troubled.” Foreclosures are painful and costly events that destroy real estate values and force fire sales of homes — which depress prices further. It is hard to see a way out of this mess without seriously reducing foreclosures( THIS IS VERY HARD TO DO ). Understanding that, Congress directed the Treasury secretary to use the TARP to get mortgages refinanced. But he has not.
MORTGAGE-RELATED SECURITIES There were several rationales for buying troubled mortgage-backed securities. First, panic had virtually shut down the markets for these securities — markets that must be restarted to restore our system of mortgage finance. Second, one source of that panic was that nobody knew what the securities were worth. A functioning market would establish objective valuations. Third, many mortgages are buried in complex securities. Buying the securities would let government refinance the underlying mortgages.( I STILL DON'T SEE WHY THE GOVERNMENT NEEDS TO DO THIS. IN FACT, BY HOLDING OUT THE POSSIBILITY THAT THIS MIGHT HAPPEN, IT ENCOURAGED OWNERS OF THESE TROUBLED ASSETS TO BE RECALCITRANT AND HOLD OUT FOR A BETTER DEAL. WHEN IT DIDN'T LOOK LIKE IT WOULD HAPPEN, THESE ASSETS FELL IN PRICE AND SOME OF THEM ARE NOW BEING PRIVATELY BOUGHT. THIS LEADS ME TO BELIEVE THAT MY POINT IS CORRECT )
Mr. Paulson says he changed his mind about buying troubled assets because the facts changed. I’m sure that many facts changed. But what new facts invalidate the rationales above?
Furthermore, there are clear synergies among the main uses: Buying mortgage-backed securities helps the government acquire mortgages to refinance, refinancing mortgages to avert foreclosures enhances the values of these securities, and both policies support the one position that Mr. Paulson has embraced wholeheartedly, bolstering the finances of banks ( IT MIGHT WORK, WITH THE RIGHT PEOPLE RUNNING IT ).
RECAPITALIZING BANKS Granting the secretary catch-all authority to buy “any other financial instrument” was a sensible addendum to the law. It offered much-needed flexibility to respond to unforeseen circumstances — an auto bailout, for example. But whoever imagined that the addendum would consume nearly all the TARP money, leaving nothing for its two stated purposes? ( THE BANKS )
But suppose you believe (though I don’t) that recapitalizing banks was the best use of all the money. Even then, the secretary’s execution leaves much to be desired. Never mind the lack of transparency and the management issues recently cited by the Government Accountability Office. Think about this:
Treasury has bought preferred stock with no control rights. The 5 percent dividend rate that taxpayers will generally receive is half what Warren Buffett got from Goldman Sachs. Banks receiving capital injections through the front door are generally allowed to pay dividends out the back door. And there are no public-purpose quid pro quos, such as a minimal lending requirement. So banks can just sit on the capital, which is what most of them have done, or use it to make acquisitions, as a few have. ( THAT'S IT. HOWEVER, THAT'S THE NATURE OF A HYBRID PLAN, SINCE THE GOVERNMENT AND BANKS DO NOT HAVE THE SAME INTERESTS )
Clearly, Mr. Paulson bent over backward to make the terms attractive to banks. He contended that wide participation was essential in order to avoid stigma. To that end, he even forced money on several bankers who didn’t want it( STIGMA ONE ). Naturally, the strong banks that didn’t want the money made that fact known to the markets immediately ( THE STIGMA EXPLANATION NEVER REALLY PASSED MUSTER ). Throwing taxpayer money where it was not needed wasted a precious resource.
So here we are, looking at an all-too-familiar story. The administration that brought you the Iraq war and the Katrina response is locking in another disaster before it leaves town. What to do?( WAIT FOR THEM TO LEAVE. I ACTUALLY BELIEVE THAT THE PERCEPTION OF THE BUSH ADMINISTRATION IS A CAUSE OF THIS CRISIS. MAYBE THIRD, AFTER GOVERNMENT GUARANTEES AND FRAUD )
Fortunately, the TARP legislation authorized a first tranche of $350 billion but wisely gave Congress a mechanism for blocking release of the second $350 billion. With the first tranche now committed, Mr. Paulson said he would soon request release of the second. Based on his performance to date, Congress should reject that request unless he agrees to spend most of the next installment on TARP’s two stated purposes.( DON'T LET HIM SPEND IT )
Failing that, we can wait a month for the new Treasury secretary, Timothy Geithner. ( LET'S WAIT )
Even Blinder's version of the Hybrid Plan would go sideways in practice.
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1596, “mark made on skin by burning with a hot iron,” from L. stigma (pl. stigmata), from Gk. stigma (gen. stigmatos) “mark, puncture,” especially one made by a pointed instrument, from root of stizein “to mark, tattoo,” from PIE *st(e)ig- (see stick (v.)). Fig. meaning “a mark of disgrace” is from 1619, as is stigmatize in this sense.
I’m a bit puzzled by the “Stigma Problem”. Surely a stigma can be deserved. It is only a problem if it is undeserved, which I originally took the “Stigma Problem” to be. The problem was that people were drawing incorrect conclusions about, say, banks, based on whether or not they participated in a program like TARP. So said W.Poole in the WSJ:
“Treasury’s argument, as I understand it, is that it needs to require some participation in the capital-infusion program to avoid stigma. Because participation carries terms objectionable to banks, such as limits on executive compensation, only weak banks will want to participate willingly. If some banks participated and others did not, those who did would be in effect declaring they were weak and scaring away depositors and investors.”
This sounded like a shell game called “Hide the Insolvent Bank”. Mr. Poole recommended the following:
“The stigma argument does carry some weight. But the way to deal with it is for participating banks to raise private capital as well as Treasury capital — so that they can demonstrate that they are unquestionably solvent and strong. One way to demonstrate strength would be to hold capital clearly in excess of the regulatory minimum.”
In other words, the way to solve the “Stigma Problem” is for banks to show that they are solvent. If they aren’t, well, you get the picture.
Then, low and behold, the “Stigma Problem” was transformed. As John Carney posted on Clusterstock:
“No wonder thousands are lining up for TARP money. It’s now one of the only signs of financial health the markets trust these days.
From the Wall Street Journal: The Treasury Department doesn’t disclose to the public which banks have applied, have been approved or have been rejected for capital. Publicly traded institutions are supposed to get an answer from the government by Dec. 31, with closely held banks told later.
Until then, U.S. banks will continue to be whipsawed by rumors of who will get money and who won’t, analysts say. Those who can’t say they have been approved could face pressure to sell to another bank or line up additional capital from private investors.”
So, now, the “Stigma Problem”, from being a consequence of participating in TARP, has become a problem of not being able to participate in TARP.
Basically, any hint that a financial institution is having a problem causes the “Stigma Problem”, which means that they are at a competitive disadvantage because people might withdraw their money from them.
The same problem occurs in asking the Fed for help, as Chairman Bernanke says.
As far as I can tell, the whole point is to play the shell game “Hide the Insolvent Bank”, so as not to cause a run on it, giving us time to either help it or seize it, I suppose.
The problem now is that taxpayers are a bit leery of trusting these kinds of decisions, precisely because TARP’s stigma changed once the terms of the deal were announced and digested. TARP went from a sign of weakness to an advantageous government subsidy, without so much as an announcement that the “Stigma Problem” had changed in respect to TARP.
In this crisis, there’s more than a whiff of favoritism based on the constant revision and redefinition of the plan. Huge sums of taxpayer money are being spent for a constantly changing set of reasons and beneficiaries. It is simply not possible to avoid being completely public in everything that’s being done in the taxpayer’s name in this crisis, without causing political problems stemming from the perception that one group of citizens are receiving undeserved preferential treatment at the expense of another group. The precedents of how forthcoming the Fed and Treasury are in this crisis are important to establish, and they should be established as having given a completely clear explanation of what’s being done. Otherwise, the Treasury and Fed will face a stigma problem of their own.
Posted by: Don the libertarian Democrat | December 1st, 2008 at 3:25 pm |