Missing the Target With $700 Billion
By ALAN S. BLINDER | The New York Times
"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.
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.
Regarding mortgages, Mr. Paulson is in a tong war with Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, who wants to deploy 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.
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.
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.
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. The automakers are not being treated this way in their $13.4 billion loan.
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. 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.
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.
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?
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.
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. Naturally, the strong banks that didn't want the money made that fact known to the markets immediately. 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?
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.
Failing that, we can wait a month for the new Treasury secretary, Timothy Geithner.
Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve. He has advised many Democratic politicians.