Banks and Consumers Are the Problem, Not Bad Assets

Treasury Secretary Henry Paulson announced that he has shelved the original plan to buy troubled mortgage assets via the recently approved $700 Billion Troubled Asset Relief Program (TARP). Instead he will use the remaining funds to assist non-bank financial institutions and promote consumer finance initiatives. In a striking admission, Paulson said that buying up distressed mortgage assets "is not the most effective way" to use government funding. "Illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards. This is creating a heavy burden on the American people and reducing the number of jobs in our economy."

Purchasing these so-called "toxic" assets was once the cornerstone of the rescue plan for financial markets and was almost the entire focus of Congress when the TARP package was being debated before its enactment in September. But almost as soon as Treasury received the money, it decided that giving capital to banks in return for preferred stock was a better use of the funds. Some analysts have accused Paulson of "flip-flopping" on every plan and it doesn't look like he has a plan at all.

No definitive plan has been identified as to how the redirected efforts of the TARP will take place. "We are carefully evaluating programs which would further leverage the impact of a TARP investment by attracting private capital, potentially through matching investments," Paulson said. "In developing a potential matching program, we will also consider capital needs of nonbank financial institutions not eligible for the current capital program; broadening access in this way would bring both benefits and challenges."

Paulson's remarks are an acknowledgment that the pitch he made to Congress for the bailout hasn't delivered what was promised. Paulson sold the TARP as a way to rid bank balance sheets of illiquid mortgage assets, and he may encounter resistance from Congress for the remaining $350 billion after using most of the first half to buy bank stakes and assist distressed insurer American International Group (AIG). Lawmakers will "put his feet to the fire,'' said Kevin Petrasic, a former official at the Office of Thrift Supervision. Paulson said he has no regrets for the revised plan. "I will never apologize for changing a strategy or an approach if the facts change."

Paulson said he has no timeline for notifying Congress of his intent to use the remaining TARP funds, and reiterated that he's "comfortable'' that $700 billion is "what we need'' to stabilize the financial system. This arrogance is not going to sit well with Congress or voters. President-Elect Barack Obama, who assumes the U.S. presidency on January 20th, said last week his economic team will "review the implementation'' of the rescue plan, suggesting he may have different priorities for its use. It is also likely that Obama will replace Paulson based on recent transition reports.

Asked about possible aid for the automobile industry using the TARP, Mr. Paulson said, "My focus is on the financial sector." Thus, while declaring that "we care about our auto industry," he ruled out any role in the TARP effort for bailing out Detroit, an issue that is now occupying Congress, President-elect Barack Obama and President Bush.

I don't think the new direction being taken for the TARP is wrong, it's just that every time Paulson changes course, the longer it takes for the TARP actions and benefits to flow through. I also feel that more than $700 billion will be needed over the next few years (just look at the relative size of China's recent Economic Stimulus), meaning that the next treasury chief will have to go to Congress hat in hand to ask for more tax-payer funds. It is more than likely though that a Democratic President and Congress will approve the additional funds. I just hope after months of talking and politicking the brains behind the TARP have got a real plan in place that they can execute on now, rather than "flip-flopping" as events unfold. If we have until the presidential transition before anything happens, the economy and our own individual situations will get significantly worse.

Stock position: None.

Comments

[bosun.j:]

Andy: You wrote: "If we have until the presidential transition before anything happens, the economy and our own individual situations will get significantly worse."

Indeed. Now is a good time to protect yourself and your family from the rapidly accelerating collapse.

While the machinations of the Banksters hold a degree of macabre fascination it amounts to little more than theater. Fall Street theater.

2008 Nov 14 07:33 AM

[James Blount:]

With financial markets stabilising, falling realised volatility and likely further cuts in cash returns, cash-heavy investors are likely to begin an extension of risk horizons.
This should relieve near-term corporate liquidity pressures. However, we need an acceleration in private investment capital growth - though the group-reinforced psychology of fear and uncertainty will inevitably take many months to alleviate.
However growth in total investment should remain positive; any private investment shortfall should be offset by public investment.
US domestic growth should not shift into a long-term slide, given that government and monetary authority activism will be extreme in the medium-term.

While I believe Paulson's move is an improvement on TARP, the capitalization of the old banking regime stymies the entry of new and better banks. The old regime is impaired as a transmitter of monetary impetus, but new entrants cannot be created quickly.

As for protecting yourself and your family, go back to school as quickly as possible. Education is the product most-valued by our trade-surplus partners. Our value is in our knowledge.

2008 Nov 14 09:44 AM

[socrateazz:]

I think those with cash will not significantly invest in companies they think will be hurt by the coming administration. There could be some kind of rally. But the number of middle class ( those with free spending money) has droped greatly in the last 15 years. And when a country has a great middle class then the economy booms if the goods produced exceeds the goods bought. If there is greater demand than goods produced then inflationary problems exist. the greatest countries have a good balance between the two. Policies which move wealth to the few will cause more problems like we see now

2008 Nov 14 09:58 AM

[robert.b.fe...:]

socrateaz: Greetings. I'm not cognizant of a decline in the middle class. Where did you get your numbers? Figures from Morning Star indicate that small investors read that as middle class investors was at an all time high just before the crash in October. Those numbers include 401K, IRA and individual brokerage accounts. Taxing the rich to enrich the poor sounds like a great idea but is sorely lacking in practice just look at France. In fact no nation has ever been able to tax itself to prosperity. I can't remember who said it first but it is still true you can't make the poor rich by making the rich poor.

2008 Nov 14 01:45 PM

[Vee:]

Nov 14, 2008 9:40 PM

Beranake is the problem, he lowered the interest rates, when they should have been increased. Banks are in business to make money and not on
low interest.

2008 Nov 14 10:44 PM