What Would You Do With Just $350 Billion to Spend?

By Simon Johnson

Larry Summers made a convincing case yesterday that Congress should release the remaining $350bn of the TARP. It’s good to see the Obama team emphasizing themes beyond the fiscal stimulus, including banks and housing. Stronger governance and greater transparency are timely commitments for this program, and who can object to limits on executive compensation in today’s environment? Some Congressional debate makes sense and could be productive, but it’s hard to see this request being turned down.

Still, what exactly should the money be spent on? I’m tempted to say: housing, because this continues to be a major unresolved problem that looms over both consumers and their balance sheets. Unfortunately, however, the banks remain a greater priority. The latest developments for both Citigroup (C) and Bank of America (BAC) suggest the banking situation is (again) seen by insiders as more desperate than we outsiders wished to believe.

The next round of bank recapitalization (again) needs to be big and bold, for example along the lines we have been suggesting for some time (but I’ll take another comprehensive plan, if you have one, with strong expected taxpayer value). The problem today is that we just don’t know if any major bank is well capitalized; there are too many black boxes that may contain toxic assets. At best, this is a brake on the positive effects that should come from the fiscal stimulus. At worst, we still have a major system issue on our hands.

And there is no reason to think that $350bn is enough to handle this problem. The original $700bn was obviously an arbitrarily chosen number, and the money has been spent so far in a rather unplanned manner. What we do next should not be constrained by the fact that there is a check for $350bn waiting to be picked up. We should design a systematic recapitalization program, figure out what it will cost, and get on with it. My working assumption, based on the published analysis of the IMF regarding losses relative to private capital raising, is that $1trn - properly deployed - should do the trick.

Then we should get to work on housing (yes, this needs more money).

Update: Ben Bernanke seems to be thinking aloud along similar lines.

Comments

[John Polomny:]

"Still, what exactly should the money be spent on? I’m tempted to say: housing, because this continues to be a major unresolved problem that looms over both consumers and their balance sheets. Unfortunately, however, the banks remain a greater priority."

No and No. Housing got into trouble because of malinvestment, greed, and flat out fraud. The only thing that can solve the problem is to let the price of houses fall until they reach market clearing prices. As far as the banks, quite a few of the large regional banks are not in trouble. I have no problem with letting the likes of Citigroup go under along with their inept management. Other investors, banks, managers will then come in buy the bankrupt assets and then the healing process will begin. Rewarding failure and the losers who made bad calls at the banks during the bubble is no way to fix this problem.

Jan 13 01:42 PM

[E Thomas St.:]

Unemployment benefits.

Jan 13 01:54 PM

[Chris B:]

Why should we reinflate the housing bubble? Young American workers still cannot afford their own home and overpriced housing is the reason why.

The government should prevent banks from collapsing. That's a lesson from the depression. This has been done.

The rest of the money should be reinvested into resolving our nation's problems (energy independence, affordable college educations, crime, addiction treatment, roads, mass transit, disaster preparedness, lack of preventative healthcare) and rebuilding our infrastructure. Jobless people won't buy houses even if the banks lended - much less reinflate the housing bubble. Besides, if we resolve any one of our problems or end up with fresh, efficient infrastructure, we will earn the dividends (some tangible, some not) for years.

Jan 13 03:26 PM

[John Lounsbury:]

I agree with Simon Johnson's statement: "The latest developments for both Citigroup (C) and Bank of America (BAC) suggest the banking situation is (again) seen by insiders as more desperate than we outsiders wished to believe."

This means I have to debate Chris B's statement: "The government should prevent banks from collapsing. That's a lesson from the depression. This has been done." The part I want to debate is the last sentence. I keep seeing the spectre of Citi's balance sheet becoming better defined, with skeleton's appearing not yet imagined. I fear the job may not yet be done (stabilizing banks).

As Simon mentions, BAC may still have problems, and now WFC's digestion of Wachovia is rumored to possibly have some need of "government Maalox".

What to do with $350? A better question is: Is it enough to finish stabilizing the banks? Simon does put the question in those exact words, but he is asking that question.

Jan 13 06:47 PM

[John Lounsbury:]

I have no problem with the broadest sense of John Polemy's arguments. I would impose some qualifications. While housing may be able to suffer some dislocations in getting to the right equilibrium price levels, the financial system must be eased into equilibrium. If we allow "the law of the jungle" to sort out the banking system, the likely outcome is a lot of babies in the sewer with the discarded bath water.

As badly as the operations of the financial sector got out of control, it is still the only system we have. Without a functioning financial system, we will not have "just" a 2-4 year recession without a financial system. It could be a decade-long depression with much more citizen suffering than a more structured approach would produce.

Jan 13 06:58 PM

[John Lounsbury:]

Sorry about the typo (two comments above). The word "not" was omitted. Should have read: Simon does NOT put the question in those exact words, but he is asking that question.

Jan 13 07:01 PM

[NotSeriousU...:]

It's such a burden and time sink to go through these rubber-stamping exercises with Congress. Let's streamline the process by allowing all troubled domestic and international financial institutions to print US dollars in unlimited quantities. It's a given that they'll use the money responsibly and in the public interest. I'm sure that the irresponsible speculators running the institutions have learned a lesson and turned over a new leaf.

Jan 13 08:33 PM

[secmaven:]

The money will be spent in a way that gets votes for the spenders.

Jan 14 11:11 AM

[Urbane Gori...:]

Why Mr. Johnson. I would take you and myself to Paris for a very nice dinner overlooking the lights of Paris in the upper level restaurant. I'd leave a nice tip and maybe we could go rustle up a couple of cute French girls for the night.

The next day, we'd return home and I'd give the balance to the banks, and auto manufacturers and even the commercial REITs... Why not. Isn't that what we've already done anyway?

jegan ;-)

Jan 14 11:57 PM

[House Poor:]

I used to think like you until my husband got transferred in his job.
We bought a house in 2005. The price of the house was 2X our income. We put 20% down and have been making our payments for over 3 years. Imagine our shock last week when we contacted a realtor. She told us the value of the house now is worth less than the loan amount. We know all the money we saved for our down payment is gone. What we don't know is what to do now. Do you try to rent an out of state property at a monthly loss? Do you walk away and ruin your credit? It was a new housing development when we bought, so every other family that bought there is in trouble as well, whether they know it yet or not. Hopefully none of them will lose a job or have to move for another job. Insanity!!!


On Jan 13 01:42 PM John Polomny wrote:

> "Still, what exactly should the money be spent on? I’m tempted to
> say: housing, because this continues to be a major unresolved problem
> that looms over both consumers and their balance sheets. Unfortunately,
> however, the banks remain a greater priority."
>
> No and No. Housing got into trouble because of malinvestment, greed,
> and flat out fraud. The only thing that can solve the problem is
> to let the price of houses fall until they reach market clearing
> prices. As far as the banks, quite a few of the large regional banks
> are not in trouble. I have no problem with letting the likes of Citigroup
> go under along with their inept management. Other investors, banks,
> managers will then come in buy the bankrupt assets and then the healing
> process will begin. Rewarding failure and the losers who made bad
> calls at the banks during the bubble is no way to fix this problem.

Feb 09 01:30 PM