I talked to Peter Wallison of AEI yesterday about Paulson’s statement and about-face and he sent this e-mail today with his considered take on it:
Having now read Paulson’s speech, I am more puzzled than ever about why he decided not to pursue the purchase of assets from banks. He notes that “Although the financial system has stabilized, both banks and non-banks may well need more capital given their troubled asset holdings, projections for continued high rates of foreclosures and stagnant U.S. and world economic conditions.” This is exactly the reason that Treasury should be purchasing the banks’ toxic assets. If the housing and mortgage markets continue to weaken, the losses on the assets the Treasury hasn’t bought will eat through the capital that it has injected into the banks.
We still don’t have an explanation for why TARP funds were not used to purchase assets. If there is some technical or other reason, Paulson ought to say what it is. Instead he says,” “Our assessment at this time is that this is not the most effective way to use TARP funds.” One of the reasons that Paulson and Treasury have lost investors confidence is that they issue opaque statements like this. If they want investor confidence they have to explain why the purchase of assets—the original idea—has turned out not to be “the most effective way” to help the banks. Looking at it from outside, if one is hoping to prevent continuing bank losses, one would relieve the banks of their toxic assets. If the price of the assets is lower than the price at which the banks are carrying the assets, that would reduce their capital. In that case, an injection of capital by Treasury makes sense. The net effect would be to stabilize the banks by assuring counterparties of their solvency, which was the original purpose of TARP.
It’s not possible at this point to determine what Paulson is talking about when he refers to supporting credit cards, car loans, and other consumer credit. Treasury, he said, is “exploring the development of a potential liquidity facility for highly-rated AAA asset-backed securities. A “liquidity facility” could mean almost anything. One idea might be guaranteeing the asset backed securities issued after a certain date. That would bring investors back to the market, and would obviously make it easier to fund car loans and credit cards. The problem with this might be that a government guarantee would compete with many other non-guaranteed investments and weaken them. Alternatively, Treasury or the Fed could also simply buy the receivables or the securities. That would take the pressure off the market by reducing the supply. The remaining receivables would bring higher prices, and thus lower interest rates for the banks and others that are selling them. This would produce lower interest rates down the line for car loans and credit cards, or more willingness on the part of banks to extend credit card financing. Right now, however, it’s impossible to determine what they’ve got in mind.
The problem is that these shifts in direction have caused investors and others to lose confidence that Paulson knows what he’s doing, and that in itself could be causing some of the distress in the markets. The whole idea of TARP was to increase confidence, and that’s now been frittered away. If you go to Congress with a plan, it better be the plan you are actually going to carry out, or you better have a good explanation for why it isn’t going to be implemented. If Paulson has lost faith in his original plan, he has to explain why, and his failure to do so is probably worse than his constantly shifting objectives. When you’re Treasury Secretary, you don’t have the luxury of saying “Oh, never mind.”
UPDATE:
An e-mail:
Rich
Paulson’s original plan would not have fixed a damn thing. There is absolutely no history showing that buying toxic assets to clear off balance sheets leads to more lending. The goal is to get the big banks lending to one another again, right? Then the recapitalization efforts, no matter how much I eschew them due to my free market proclivities, are the right way to go. It has worked in the past and it has worked well to thaw out the credit freeze. LIBOR is way down, Treasury notes have some semblance of a yield these days and the TED spread is back to normal levels.
The problem with the banks was a true solvency issue, not a liquidity issue.
Buying huge stakes in the banks solves that problem. Now we need to push for even more massive writedowns of those toxic assets so private investors can get off the sidelines and have faith in those companies, the same way we need to push for GM and Ford to be sent into Chapter 11.
$700 billion, to be honest, was not nearly enough to clear the books via purchasing toxic assets. But it is enough to give banks capital to stay in business, keep lending and avoid death-blow calls on their debt.
Should Paulson go out there and admit that the mortgage problem is more around the $2-3 trillion mark and concede that we came within a hair of Morgan Stanley, Citigroup and even Wells Fargo from going under, followed by basically every worldwide bank aside from JPMorgan Chase and freak everyone out again? Or should he quietly solve things by recapitalizing banks the way it should have been done in the first place and speak about how close we came to not just a depression but honestly the end of the financial world later?