James Pethokoukis

Interesting piece by former FDIC head Bill Isaac on the bank bailout:

In truth, customers of money market funds had already been calmed when Treasury issued a 100% guarantee of their money – before TARP was enacted.  The FDIC had the authority to reassure depositors under existing law, as was in fact done shortly after the TARP was enacted.

Two weeks after the TARP was enacted, Paulson abandoned the toxic asset plan and announced that the money would instead be used to shore up the capital of banks.  I had argued against the TARP in part because I believed capital infusions would support much more new lending than would the purchase of toxic assets.  Moreover, I believed capital infusions would be far less costly to taxpayers.

However, the TARP was not needed for capital infusions because the FDIC had existing authority to provide capital to banks.  I preferred strongly that the FDIC manage a capital infusion program rather than the highly politicized program Treasury implemented.

Treasury made two egregious mistakes on the capital program and many smaller ones.  The first blunder was to order nine large financial institutions – CitiGroup, JPMorgan Chase, Wells Fargo, Goldman Sachs, Bank of America, Bank of New York/Mellon, Merrill Lynch, Morgan Stanley and State Street – to accept $125 billion of taxpayer money that most of them did not need or want.

To some extent he adopts the John Taylor theory that it was the chaotic nature of the TARP roll-out that destabilized markets. Yet he also says he was in favor of capital injections.

So says Paul Kasriel of Northern Trust: “I consider this financial sector net credit contraction the major headwind for the economy, preventing a more normal robust cyclical recovery.”

And here are some eye-opening charts:

This one, too:

So says Larry Kudlow:

Think of this: The U.S. government bailed the banks out with TARP. Then the banks repaid TARP last year, including the stock warrants that provided a handsome taxpayer profit from the banks. And now the government wants to tax them? In other words, help the banks get healthy, and then punish them? I don’t understand it.

And here’s yet another ridiculous part of this story: The largest banks that de-TARPed, and are regaining their health, are now, with this tax, supposed to cover the government-owned failures like GM, GMAC, AIG, and Fannie and Freddie, which are running up huge deficits because they may be on the taxpayer dole in perpetuity. In other words, the healthy banks that made good decisions and paid down TARP are now getting taxed so that the government can finance the bad actors. This makes no sense at all.

Look, the big guys have de-TARPed. Now it’s time to get off their backs. As I wrote yesterday, bankers should not get bonuses for the period in which they were TARPed. But for the new year, since the bankers met their TARP obligations, Team Obama should leave them alone. Let the bankers help the economy grow, create wealth, and create jobs.

As usual, Ed Yardeni is exactly on point:

1) While Washington wants them to lend more, the bank examiners sent by Washington’s regulators are all over them to improve their credit quality and to tighten their lending standards.

2) They also observe that most of the big banks were forced to take TARP money they didn’t need or want last October 2008.

3) The bankers can’t deny that they contributed to the financial mess, but so did the government by pushing them to make subprime loans through the Community Reinvestment Act and by encouraging Fannie and Freddie to purchase these loans. In his recent book titled “The Housing Boom and Bust,” Thomas Sowell carefully documents this sordid tale of corruption in Washington and on Wall Street.

4) One of the main reasons that the banks are not lending is that the Federal Reserve is pegging the federal funds rate at zero. As a result, investors have scrambled to buy corporate bonds at a record pace. So corporations with access to the bond market have been able to raise lots of money. Indeed, many have raised more than they need, and they used some of the proceeds to pay down their bank lines of credit. Less fortunate borrowers are stuck with trying to get loans from their bankers. The problem is that many of them have become less credit worthy because the economy remains weak. The banks already have lots of problem loans and don’t want to make more such loans, especially with bank examiners on their backs.

Henry Blodget explains how to prevent TARP 2.0 when the next financial crisis hits, which the WH embrace of TBTF makes more likely:

What’s the solution?

Debt that automatically converts to equity when a bank’s capital ratio falls below the required level.  What does that mean? It means that equity holders will still get hit first if the bank makes dumb-ass loans. But it also means that if the bank makes so many dumb-ass loans that its equity gets wiped out, bondholders, not taxpayers, will pick up the rest of the tab.

How does it work?  When the bank’s equity falls too far, some of the convertible bonds convert to equity, thus restoring the bank’s capital ratio. This happens automatically, without bankruptcy or fuss. It happens without surprise. It happens without threatening to bring the whole economy to its knees. It happens without Congressional moaning and hand-wringing and without Treasury secretaries dropping to their knees to beg and plead.

Bondholders who buy these bonds–now called CoCo’s, or “contingent convertibles”–know full well what they are buying, and the bonds are priced to reflect the equity conversion risk. Lloyds just sold a bunch of these in the UK, and there was a market for them.

To fix the banking system, all regulators would have to do would be to require banks to issue enough CoCos that they could withstand financial Armageddon without the taxpayer getting involved. The banks’ ability to make huge bets (and huge bonuses) with small amounts of equity would be preserved, so perhaps the bank lobbyists would agree to stand down for a while. The world could rest assured that SOMETHING had been done to prevent the same mess from happening all over again. And we could all return to peace, happiness, and prosperity.

The oversight panel led by television funnywoman Elizabeth Warren has concluded that TARP has been asset for the economy. Except for this part (in the panel’s own words):

1) It is apparent that after fourteen months the TARP’s programs have not been able to solve many of the ongoing problems Congress identified. Credit availability, the lifeblood of the economy, remains low.

2) In light of the weak economy, banks are reluctant to lend, while small businesses and consumers are reluctant to borrow.

3) In addition, questions remain about the capitalization of many banks, and whether they are focusing on repairing their balance sheets at the expense of lending.

4) The FDIC, facing red ink for the first time in 17 years, must step in to repay depositors at a growing number of failed banks. This problem may well worsen, as deep-seated problems in the commercial real estate sector are poised to inflict further damage on small and mid-sized banks.

5) Large banks have problems of their own. Some of them, waiting for a rebound in asset values that may still be years away, continue to hold the toxic mortgage-related securities that contributed to the crisis. Consequently, the United States continues to face the prospect of banks too big to fail and too weak to play their role adequately in keeping credit flowing throughout the economy.

6) The foreclosure crisis continues to grow.

7) Furthermore, the market stability that has emerged since last fall’s crisis has been in part the result of an extraordinary mix of government actions, some of which will likely be scaled back relatively soon, and few of which are likely to continue indefinitely. The removal of this support too quickly could undermine the economy’s nascent stability.

8) While strong government action helped prevent a worse crisis, it may have done so at a significant long run cost to the performance of our market economy. Implicit government guarantees pose the most difficult long-term problem to emerge from the crisis. Looking ahead, there is no consensus among experts or policymakers as to how to prevent financial institutions from taking risks that are so large as to threaten the functioning of the nation’s economy. Congress is currently grappling with this issue as it considers how to respond legislatively to the financial crisis. It is clear that a failure to address the moral hazard issue will only lead to more severe crises in the future.

Me: Oh, and then you have the devolution of TARP into a slush fund to bail out AIG, union auto workers and congressional Democrats worried about how the high unemployment rate will hurt their 2010 chances. Thus the new jobs bill. But it did stop the panic, unless you believe John Taylor that it really made the panic worse through uncertainty.

The New Normal may be a bummer, but it’s not life-threatening for the economy. The only systemic risk at the moment is the political prospects of Democratic incumbents on Capitol Hill. They dread standing for reelection in 2010 if the unemployment rate remains anywhere near double digits. The forthcoming jobs bill is a product of political panic. And using TARP to pay for it confirms the fears of those back in the fall of 2008 who thought the bank bailout fund would eventually become a political slush fund.

Budget guru, raconteur and helluva nice guy Stan Collender takes issue with my recent TARP post over at his must-read Capitol Gains and Games blog. I wrote that

First, as the WSJ story says, the White House is talking about the current fiscal year — 2010 — and it has already made an estimate of the spending that will occur and the revenues that will be collected.  What the administration is saying now is that some of the spending it projected might not be needed and, if so, that it is planning not to find some other use for the funds.  As a result, the projected deficit and the amount the government was expected to borrow could be lower, in this case at least $100 billion or so lower, than was originally assumed. … You definitely can reduce the projected deficit and the debt by not spending funds that were projected to be spent.  That, in fact, is how you do it.  Spending that has occurred has already increased the deficit and the only way to reduce it in the future is not tto continue to spend the dollars again.

On these issues, my default mode is to defer to Stan. (I am waiting a reply from my source.) But then he adds this interesting nugget:

A question should be asked about whether the Obama administration deliberately overestimated how much TARP would cost in 2010 so that it would be able to claim savings later in the year.  This has been a favorite tactic of Office and Management and Budget directors in the past.  Indeed, everyone from David Stockman to Dick Darman to Leon Panetta liked, and it was clearly something that the G.W. Bush administration used with impugnity. But regardless of whether it was intentional or fortuitous, not spending TARP money that had been projected to be spent will in fact lower the deficit and the amount of government borrowing compared to what otherwise would have been spent.

First, the nub of the WH idea:

The White House is looking to cut its budget deficit by using some unspent funds from the U.S. government’s Troubled Asset Relief Program (TARP), the Wall Street Journal said, citing people familiar with the matter.

Members of the Obama administration are still debating the idea, the paper said, adding that the administration would still like to keep some of the unspent money in case of emergencies.

A U.S. Treasury source told Reuters that it was shifting the focus of the TARP program toward helping small business and the housing sector rather than large banks.

“As that focus shifts, we expect to use significantly less TARP funding than authorized,” the source said. “We will maintain the flexibility to deal with a future crisis, and uninvested TARP money is dedicated to reducing the debt.”

But as my pal Dan Clifton of the  Strategas Group points out, this idea neglects certain budget realities:

Is this really news? The US government has already issued the debt for the funds and any unused money would logically be used to retire that debt. There is about $300bn in unspent TARP funds now. But none of that can be used as deficit reduction. Why? Because the money has not been spent yet. And is it really $300bn? Absolutely not, the administration decided to change the accounting to a net present value basis. So any savings would be negligible. The punchline: This story makes a great headline against the concerns over deficits, but will have zero impact on debt issuance and the deficit.

Treasury Secretary Timothy Geithner has the option of extending his authority to spend TARP money until October 2010. Congress should forcefully discourage him from doing so, even if it means stripping that authority.

The bankruptcy of CIT despite a $2.3 billion TARP infusion provides one reason. But the story of GMAC is even more compelling. Treasury has already sunk $12.5 billion into it, with perhaps another $5.6 billion on the way. Then there’s GMAC’s FDIC-guaranteed debt.

And given the amount of taxpayer dough on the line, government has become a less-than-silent partner. The FDIC, according to the Wall Street Journal, has ordered GMAC to abandon key components of its new business strategy — offering high rates to depositors and making more auto loans to borrowers with lower credit ratings — because it considers them too risky.

Conflicts and bad incentives abound. Sheila Bair of the FDIC is inclined to caution, given the taxpayer risk. Yet she also needs the company prosperous enough to make good its obligations.

GMAC might indeed be incentivized to take more risk than is prudent, counting on a continuation of the government backstop. But perhaps those risks are actually what GMAC should be doing to revitalize its business. When market discipline and the profit motive are entangled by government subsidy, clarity can prove elusive.

The GMAC bailout is part of the wider bailout of GM and Chrysler. The Bush administration started it in fall 2008 to keep the swing states of Michigan and Ohio in play. Then Team Obama signed on, not wanting to risk the potential jump in unemployment, especially among union autoworkers. But few in Obamaland thought GM and Chrysler to be “systemically” important.

The end result is a sort of crony capitalism where TARP money — originally meant for buying toxic bank assets — is propping up a politically sensitive sector of the economy while subjecting it to political control.

“Slush fund” may be too inflammatory, but recall that the administration is also proposing helping small business by funneling TARP money to community banks that increase lending to the sector. Small business, by the way, has been opposing both the president’s healthcare and cap-and-trade energy plans.

TARP was conceived in a time of crisis. The White House says the crisis has ended. Let TARP end with it.