What is wrong with TARP II

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Tim Geithner’s presentation of TARP II (now called the ‘Financial Stability Plan’) to Congress yesterday fell far short of expectations.  That was to be expected.  This was the same man that was called ‘to indispensible to throw away’ when issues came up during his confirmation.  Democrats and the public assumed that he would be the smartest man in the room, and find a magic bullet for the economic problems.

Not quite.

Instead, his testimony to Congress yesterday raised doubts about his ability (and in turn, the Obama administration’s ability) to confront the economic crisis.  Heck, when Obama sycophant Maureen Dowd is dumping on you, things are bad:

There’s a weaselly feel to the plan, a sense that tough decisions were postponed even as President Obama warns about our “perfect storm of financial problems.” The outrage is going only one way, as we pony up trillion after trillion.

Geithner is coddling the banks, setting it up so that either we’ll have to pay the banks inflated prices for poison assets or subsidize investors to pay the banks for poison assets.

The first problem is how the Obama people are confronting the ‘crisis’. If it is a crisis, then they need decisive and forceful action.  That was the criticism of TARP I.  The problem is, the sequel has many of the same issues.

With Geithner’s plan, the government will create a private consortium to try and buy the ‘toxic’ loans that are on banks ledgers.  Where that private money will come is a huge question.  Second, because one of Geither’s goals is to reduce mortgage payments for individuals in order to decrease foreclosures (a goal I agree with wholeheartedly), the reduction of these payments will further devalue those toxic loans, and make them even more worthless.  A deadly spiral.

Now, this would all be fine if the only question was illiquidity.  And certainly, there is some proof of that.  Goldman Sachs has estimated that banks now hold about $3.4 Trillion in debt, and their actual worth may be only $2.5 Trillion; meaning, that they are basically insolvent.

The Financial Times’ Martin Wolf put is best about what is the right question we should be asking:

That is whether, in the presence of such uncertainty, it can be right to base policy on hoping for the best. The answer is clear: rational policymakers must assume the worst. If this proved pessimistic, they would end up with an over-capitalised financial system. If the optimistic choice turned out to be wrong, they would have zombie banks and a discredited government. This choice is surely a “no brainer”.

The correct advice remains the one the US gave the Japanese and others during the 1990s: admit reality, restructure banks and, above all, slay zombie institutions at once.

Ultimately, the government must take over this bad debt; not to save the banks, per se, but to stabilize the market.  I actually could care less if Citibank or JP Morgan Chase goes out of business.  But the stability of the markets is essential to any success of the world economy.  As long as these large losses sit on the banks books, they refuse to provide private capital to the market, which is the life’s blood of capitalism.  I am not for nationalization, but in this case there is no alternative.  Hank Paulson was actually right in the first place, when he suggest the Federal Government buy up the bad ‘toxic’ loans; unfortunately he got distracted, and just gave out money to the banks.  This did help the credit freeze, but no where close to enough.

Ultimately, this is not a moment for shyness.  The Obama Administration must take bold action.  They at the same time need to be wary that too much government intrusion could actually backfire, and even further erode faith in the markets.  It is a tough balancing act.  But Tim Geithner’s proposal yesterday came no where close to what is  needed.  They needed fresh, bold thinking.  Yesterday, Tim Geithner, the ‘smartest man in the room’, provided neither.