Sunday, December 21, 2008

Defending the TARP's Execution

Below is my response to Alan Blinder's Op-Ed in the New York Times.

The original plan was abandoned because 1) there isn't enough money to buy all the toxic securities out there 2) Since these securities are non-standard and have various structures and terms, buying them through an auction would be a difficult and time consuming process 3) buying securities at market value would expose many banks as being insolvent or below regulatory capital requirements 4) it would be hard to limit purchases to US banks, we would in effect, have to buy all the toxic stuff in the world, how do you prevent foreign banks from selling toxic assets to US banks so that they can be sold to the Treasury? 5) Now you know why there isn't enough money.

The author is indeed dazed and confused. The terms of the capital infusions were favorable because the banks are in trouble. Predatory terms, as with the initial AIG deal, would have been too onerous. Banks need to make money so that they can use the earnings to write off their bad loans, if Treasury takes all of the earnings or even most, then it will take more time for the banks to get better. The whole point of a "bailout" is to HELP, not put banks out of business, thus the 5% preferred shares. And as for non-voting shares, it allows room for private equity investment as it leaves control to the private sector and minimizes government interference on the Board. Furthermore, preferred shares eliminate the need for the government to find people to run the companies they invest in. There are too many companies, and Treasury or FED are ill-equipped to run dozens of companies. Who are the heads to report to? Who will call the shots? Paulson has enough on his hands and even he can't run dozens of separate companies.

Forget about stopping foreclosures, it's a foolish idea and would only prolong the crisis. Real estate prices have fallen so much that it's not possible anymore to pretend that they are anywhere near what someone in foreclosure paid for them. Thanks to that fact, there's very little incentive for a person to continue paying on a mortgage when he'll never see a penny from the eventual sale. Remodify the mortgage and he still has no incentive other than it allows him to rent the property. If rent is cheaper elsewhere, then he'll default again, why should a person pay extra for rent? And that house is, by all accounts, being rented since the mortgage defaulter will never see a penny of profit.

I'm glad Paulson wisely saw the above and chose the best course of action left to him. It's ridiculous to expect a quick or painless end to this crisis. Else it wouldn't be a crisis. There are no easy solutions. Whatever the criticism, the downturn will take its course and NOTHING can change the fact that the losses are real and have to be borne by someone. Nationalizing the banks would just transfer the losses to the taxpayer and cause panic in the stock markets. When government seizes private equity, then appetite for that equity disappears.

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