Why TARP 2.0 Won't Be Much Better than TARP 1.0

TARP 1.0 didn’t get lending going and TARP 2.0 won’t be much better. The problem is that TARP 2.0 continues to focus on banks as the primary lending institutions despite the fact that banks aren’t the primary source of non-real estate credit for consumers or businesses. Most non-real estate lending takes place through the “shadow banking” system which was bypassed by TARP 1.0; and it doesn’t look like TARP 2.0 is going to help non-bank institutions either. Until Geithner addresses the liquidity issues of non-bank lenders and investors, normal lending won’t restart.

TARP 1.0 didn’t restore the normal function of the consumer and commercial credit markets because it used flawed logic. Paulson incorrectly believed in a “cause and effect relationship” that didn’t exist. He thought that increasing bank equity would result in increased lending. Unfortunately, he was wrong because most because most non-real estate lending takes place outside of the banking system and lenders and investors outside the banking system didn’t get helped by TARP 1.0. So, while banks benefited from TARP 1.0, it didn’t help the companies that lend the most to consumers and businesses.

Also, TARP 1.0 didn’t work because it was “backward leaning”, i.e., it didn’t provide capital for new loans but tried to fill in capital holes created by old loans turned bad. To stimulate new lending, TARP 2.0 needs to be “forward leaning policy” and focus on new loans while having other programs fix past problems. Replacing lost capital and a meltdown are great policy objectives but they are different from making new loans.

While one section of TARP 2.0 is forward leaning, it doesn’t work because it almost entirely misses non-bank institutions. Instead of looking for ways to restart non-conventional lenders and investors, Geithner reverted to what he is familiar with and focused on using the ultimate banking institution, the Federal Reserve, to restart lending. But non-bank lenders and investors don’t normally interface with the Federal Reserve, and the AAA ratings requirements to qualify for Federal Reserve stimulus puts even more distance between non-bank lenders and Treasury’s programs. Geithner made the rookie mistake of retreating into his “comfort zone” to solve the problem without examining alternatives. He is comfortable in the sterile world of Fed technocrats and not experienced in the down-and-dirty world of decentralized non-bank institutions.

But Geithner is a quick learner so there is hope that he will ditch policy initiatives that don’t work.

Set forth are four suggestions for initiatives that will get the non-bank system working again.

• Form new government sponsored financial guaranty and bond insurance companies. The failure of the financial guaranty and bond insurance industry led the U.S. into the financial crisis, and the restarting of this industry will help lead America out. These insurance companies work because they create operating efficiency for investors and back up their work by assuming risk. The bond insurers serve a function similar to rating agencies but unlike rating agencies, the bond insurers align their interests with investors by putting “skin” in the game. Bond insurers were essential to the capital markets for decades. Newly formed and well capitalized bond insurance companies can be started by Treasury in a matter of weeks and, if formed, will help restarting lending.
  
• Amend the mutual fund and tax laws to promote the formation of tax efficient pools of investment money for lending. The interplay of the laws governing mutual funds and taxes make it difficult, if not impossible, for investors to form tax efficient investment pools that originate and own high quality commercial and consumer loans. The laws are antiquated, restrict capital formation, inadvertently encourage risky behavior and make little common sense. A passive investment in a non-mutual fund direct lending pool can have disastrous tax consequences for foreigners, not for profits, pension funds and individuals (because of state taxation issues in the case of individuals). And, the laws regulating mutual funds have the unintended side effect of encouraging risky behavior instead of prudent lending. Geithner can fix these laws and encourage the formation of investment capital to restart lending. And, there will be no impact on Federal spending.
• Expand the Community Development Financial Institutions Fund. Every year the IRS grants several billion of tax credits to lenders through the Community Development Financial Institutions Fund (”CDIF”). This program is supposed to encourage economic development through tax credits that are earned by lending in low income and blighted areas. Unfortunately, over the years the CDIF has favored real estate-related lending rather than core business lending. If CDIF were reoriented to encourage business lending, an existing program that is annually costing taxpayers billions could be converted into an important tool to restart commercial finance.
  
• Encourage the SBA to license non-bank lenders and update and modernize the program. The last non-bank lender to receive a new “Section 7A” license was during the Reagan Administration. Under pressure from critics, SBA programs have been cut back year after year and are almost totally dependent upon banks. The SBA lending industry is almost virtually irrelevant.
  

  Thirty years ago the SBA had a terrible reputation because its programs were badly administered. Since then the SBA has shrunk as a proportion of the economy. But the SBA’s poor history doesn’t mean that the SBA can’t restart itself and contribute to American business health. A top-down review of SBA programs with an eye towards modernization and inclusive lender eligibility, including non-bank participants, could fix the SBA.
  

Geithner’s current proposals won’t get bank lending going again and certainly aren’t going to get non-bank lenders excited. The Treasury Secretary needs to get out of his comfort zone and start to look at supporting non-bank lenders and investors. They make up most of the market for consumer and business loans, and ignoring non-bank lenders won’t get the economy going again.

Comments

[atlasman:]

"But Geithner is a quick learner so there is hope that he will ditch policy initiatives that don’t work."

Umm, I thought the reason why Congress looked the other way with his tax cheating was because he was the only person with the necessary experience to manage the situation. If he is a quick learner, should not he have learned by now?

Sorry, Geithner is a pet-peeve of mine. My real question is with this sentence:

"Newly formed and well capitalized bond insurance companies can be started by Treasury in a matter of weeks and, if formed, will help restarting lending"

My real question is can it be done in a way that after a short period of operation the USG can sell off its portion of the entity through a sell or IPO and pocket the profit to be returned to the tax payers (OK, returning the profit to the tax payers was a little bit of a joke).

Feb 13 08:54 AM

[prudentinve...:]

You state : "Until Geithner addresses ....... normal lending won’t restart."

This sort of statement is incomplete without a definition of "normal lending". Do you mean the reckless lending of the past few years? Or do you mean old-fashioned lending which required the 3C's (Creditworthiness, Collateral, and Character). There is a certainly a paucity of the former, and all responsible people should hope it stays that way. Resumption of reckless lending will precipitate collapse.

Feb 13 08:58 AM

[Speedspirit:]

Remember Geithner is a player for the Power Eite, he was president of the Federal Reserve. His bias is to finance his interest and not the american people. He is a proponent of failed academics of Keynes a principle source of all this failure. Our forefathers ( Alexander Hamilton) developed this GREAT nation to get away from this type of statistical forecasting. Franklin Roosevelt reinstated the American system intended to run this country only to have it undermined by Truman. In layman terms those who hold the Real power now believe their HIGH SOCIETY is better then the rest of the human race.The world has become a Global economy and now has to become a Global village. It is this denial of universal principle which influences there continued actions of failure and greed. The author comments are sound and a few in Washington agree but they are fighting a very steep uphill battle. God Bless America! And that my friends is THE KEY to what it will take to turn the tide. One Nation Under God ...

Feb 13 09:10 AM

[Mark Sunshine:]

The author here...

Altasman, in response to your question, definitly newly formed bond insurers can be privatized in a few years. Please take a look at a previous article that I wrote seekingalpha.com/artic.... This should be a money maker for the Treasury if they do it correctly (believe it or not).


Prudentinvestor, thanks for your comment. You make a good point and my article is deficient because I didn't make the issue that you raise clear. I am definitly talking about prudent lending standards. Not even a question. I am very much a "back to the basics" person. My experiences in life have taught me that it is always better to follow the rule book that worked for decades. My experiences especially apply to credit. Sorry for being unclear.

Thanks for reading.

Feb 13 09:39 AM

[User64738:]

You got a green from me but I still need to make some comments.

On Feb 13 09:10 AM Speedspirit wrote:

> In layman terms those who hold the Real power now believe
> their HIGH SOCIETY is better then the rest of the human race.

And in reality is it. Look at the facts - they're up and getting richer and we're down and getting poorer. That means they're doing something better than the rest of us.

> It is this denial of universal principle which influences
> there continued actions of failure and greed.

It depends how you look at failure. Remember, wealth is never really lost but rather just transferred. Printed money is not wealth. I honestly don't think they failed themselves.

Feb 13 10:46 AM

[NITRAM:]

Tarp 2 will make Tar 1 look very good. Tarp 1 only screwed the American taxpayers out of $350,000,000,000. Now tarp 2 with the balance of Tarp 1 will cost the present and future taxpayers trillions of dollars. Thats how many zeros?000,000,000,000. However I believe this is the plan for our new SOCIALISTIC COUNTRY. With Mr. and Mrs Tzar Obama and Princess Pelosi with her court Jesters(franks,dodd,re... etc) will rule a conrupt, and bankrupt Socialistic country. To me its obvious that the man in the white house wnated Geigner to help him take control of our financial structure

Feb 13 11:10 AM

[atlasman:]

Mark - Thanks. I agree. You have my vote as the next sectreas after Obama cans Geitner.

Feb 13 11:17 AM

[kmarkt2:]

Mark Sunshine, alluded to the failure of TARP 1 due to Paulson's wrong conclusion of 'causality'. Paulson was not concern about the causality relationship - he was interested to bail out his Wall Street friends.

TARP 2 with Geithner is to a slow and uncertain start and the fact that Wall Street was expecting Geithner, a former ally, at the FED, to continue business as usual- i.e playing according to Wall Street rules. Well, Wall Street needs to get it - game's over - i.e expecting forward sniff of fiscal policy directions to provide the excuse to buy/sell - this do not create real wealth.

The other unsaid difficulty I suspect, which is a clever strategy, is the reality that there is no new money available, but the show needs to go on. He has to balance the lesser of many evils between Main Street and Wall Street. With the money that's already disbursed and balance on the table, he has to choose Main Street over Wall Street, which makes the latter uncomfortable.

Feb 13 12:10 PM

[ken wender:]

The powers players just love Geithner,but he has been wrong so far. I think he is a little tool with friends in high places.

Feb 14 11:05 AM

[tinman:]

As one who dared to hope Obama meant change from the disaster of the last 8 years, Pelosi and Geithner have been singularly disappointing. The housing collapse was the catalyst for the economic collapse; until house prices stop dropping there can be no sustained recovery, yet nobody in position of authority seems capable of addressing this central fact head on.

Getting banks to lend would certainly be helpful but it can't really happen in a sustained fashion until the recession finds a bottom, and that means housing prices stabilize. Ditto for business hiring. Ditto for creating work for the jobless in the interim.

Feb 14 08:22 PM

[Speedspirit:]

To user 6478

If we measure sucess by accumulatiing money at all cost then yes they have done well for themselves. But my point is that thier greed has a price that all of humanity must pay. There children do not fight the wars. There families do not starve. They live by a diffrent set of morals. While our planets resources have been destroyed for their gains. It is yet to be seen how severe this crisis is but if the few experts like LaRouche are right this will be a general breakdown-crisis of a magnitude that could cause the "new dark age." The coincidences of forewarned conspiracy theories and prophesy is alarming. Giethner needs to develop a plan that portrays confidence so that the estimated trillions of dollars on the sidelines can begin to repair the Global community. Thoughts and theories by great minds like Johannes Kepler, Einstein, Tesla, Riemannian all speak of " Universal Laws" that up to now have been dismissed for the gains of the Power Elite. Those laws cannot be denied for the gains of the few without destroying us all. In their quest for ultimate power and money humankind will suffer greatly. It is likely that it wouldnt be a world they wish to rule.

Feb 15 07:28 PM

[monday1929:]

Responsible lending now would be the death of the system.


On Feb 13 08:58 AM prudentinvestor wrote:

> You state : "Until Geithner addresses ....... normal lending won’t
> restart."
>
> This sort of statement is incomplete without a definition of "normal
> lending". Do you mean the reckless lending of the past few years?
> Or do you mean old-fashioned lending which required the 3C's (Creditworthiness,
> Collateral, and Character). There is a certainly a paucity of the
> former, and all responsible people should hope it stays that way.
> Resumption of reckless lending will precipitate collapse.

Feb 15 10:29 PM

[tinman:]

Isn't that exactly what threw the global financial heartbeat into fibrillation last summer?

On Feb 15 10:29 PM monday1929 wrote:

> Responsible lending now would be the death of the system.
>
>
> On Feb 13 08:58 AM prudentinvestor wrote:

Feb 17 08:16 PM