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Showing posts with label TARP. Show all posts
Showing posts with label TARP. Show all posts
Wednesday, April 15, 2009
Thursday, April 09, 2009
Congressional Oversight Report -- Assesing Six Months of TARP
The Panel adopted this report with a 3-2 vote. Senator John Sununu and Rep. Jeb Hensarling voted against the report. Additional views are available in the full version of this report at www.COP.Senate.gov.
Assessing Treasury's Strategy -- Six Months of Tarp
Executive Summary
With this report, the Congressional Oversight Panel examines Treasury’s current strategy and evaluates the progress it has achieved thus far. This report returns the Panel’s inquiry to a central question raised in its first report: What is Treasury’s strategy? While there is disagreement among Panel members about whether it is appropriate to present alternatives to Treasury’s strategy at this time, this report also examines potential policy alternatives available to Treasury, in the event such alternatives become necessary.
This report comes on the six month anniversary of the passage of the Emergency Economic Stabilization Act of 2008 (EESA). In a letter received by the Panel on April 2, 2009, Treasury Secretary Timothy Geithner described four major challenges that Treasury’s strategy seeks to address: (1) the collapse of the housing market; (2) frozen secondary markets that “have constrained the ability of even creditworthy small businesses and families” to get credit; (3) uncertainty about the health of financial institutions and the valuation of assets on their balance sheets; and (4) the existence of “troubled legacy assets” on the balance sheets of financial institutions that affect their capitalization and limit their ability to make loans.
The Panel appreciates Treasury’s explanation of its goals, and it hopes this report inspires a more informed conversation over the fundamental questions raised by Treasury’s strategy. In addition to drawing on the $700 billion allocated to Treasury under the EESA, economic stabilization efforts have depended heavily on the use of the Federal Reserve Board’s balance sheet. This approach has permitted Treasury to leverage TARP funds well beyond the funds appropriated by Congress. Thus, while Treasury has spent or committed $590.4 billion of TARP funds, according to Panel estimates, the Federal Reserve Board has expanded its balance sheet by more than $1.5 trillion in loans and purchases of government-sponsored enterprise (GSE) securities. The total value of all direct spending, loans and guarantees provided to date in conjunction with the federal government’s financial stability efforts (including those of the Federal Deposit Insurance Corporation (FDIC) as well as Treasury and the Federal Reserve Board) now exceeds $4 trillion. This report reviews in considerable detail specific criteria for evaluating the impact of these programs on financial markets. Six months into the existence of TARP, evidence of success or failure is mixed.
Evaluating the wisdom and success of these efforts requires a broader understanding of the basic choices available to policymakers during this crisis. To deal with a troubled financial system, three fundamentally different policy alternatives are possible: liquidation, receivership, or subsidization. To place these alternatives in context, the report evaluates historical and contemporary efforts to confront financial crises and their relative success. The Panel focused on six historical experiences: (1) the U.S. Depression of the 1930s; (2) the bank run on and subsequent government seizure of Continental Illinois in 1984; (3) the savings and loan crisis of the late 1980s and establishment of the Resolution Trust Corporation; (4) the recapitalization of the FDIC bank insurance fund in 1991; (5) Sweden’s financial crisis of the early 1990s; and (6) what has become known as Japan’s “Lost Decade” of the 1990s. The report also surveys the approaches currently employed by Iceland, Ireland, the United Kingdom, and other European countries.
Experiences from other times and other countries illustrate the benefits and problems these basic approaches present to dealing with failing banks. In the 1980s savings and loan crisis, for example, the U.S. government liquidated unhealthy financial institutions by transferring depositors to another bank, selling off assets, writing down some debt and wiping out investors. There can be considerable political barriers to this approach, and a surprise or poorly-explained liquidation can reduce market confidence and heighten uncertainty about future government interventions in financial markets. But liquidation also avoids the uncertainty and open-ended commitment that accompany subsidization. It can restore market confidence in the surviving banks, and it can potentially accelerate recovery by offering decisive and clear statements about the government’s evaluation of financial conditions and institutions.
Another option is government reorganization of troubled financial institutions using conservatorships, as in the case of Continental Illinois in the U.S. and the financial crisis in Sweden in the 1990s. This approach entails an in-place reorganization in which bad assets are removed, failed managers are replaced, and parts of the business are spun off. Depositors and some bondholders are protected, and institutions can emerge from government control with the same corporate identity but healthier balance sheets. This option also offers clarity to markets about the balance sheets of the reorganized financial institutions and encourages capital investment in the newly-reorganized entity. But reorganization can also tax government capacity and resources. If they are not quickly returned to private hands, government-run financial institutions also pose a risk that political pressure will press the institutions to lend to favored interests and support public policy at the expense of the bank’s health, although there is no evidence that this has occurred in recent banking crises.
The third option is government subsidization of troubled institutions. Japan’s approach was characterized by a series of direct and indirect subsidizations. Subsidies may be direct, by providing banks with capital infusions, or indirect, by purchasing troubled assets at inflated prices or reducing prudential standards. Cash assistance can provide banks with bridge capital necessary to survive in tough economic times until growth begins again. But subsidies carry a risk of obscuring true valuations. They involve the added danger of distorting both specific markets and the larger economy. Subsidization also carries a risk that it will be open-ended, propping up insolvent banks for an extended period and delaying economic recovery.
A review of these historical precedents reveals that each successful resolution of a financial crisis involved four critical elements:
• Transparency. Swift action to ensure the integrity of bank accounting, particularly with respect to the ability of regulators and investors to ascertain the value of bank assets and hence assess bank solvency
• Assertiveness. Willingness to take aggressive action to address failing financial institutions by (1) taking early aggressive action to improve capital ratios of banks that can be rescued, and (2) shutting down those banks that are irreparably insolvent.
• Accountability. Willingness to hold management accountable by replacing – and, in cases of criminal conduct, prosecuting – failed managers.
• Clarity. Transparency in the government response with forthright measurement and reporting of all forms of assistance being provided and clearly explained criteria for the use of public sector funds.
Historical precedents always involve some differences from the current crises. Nonetheless, experience can provide an important comparison against which current approaches can be tested.
One key assumption that underlies Treasury’s approach is its belief that the system-wide deleveraging resulting from the decline in asset values, leading to an accompanying drop in net wealth across the country, is in large part the product of temporary liquidity constraints resulting from nonfunctioning markets for troubled assets. The debate turns on whether current prices, particularly for mortgage-related assets, reflect fundamental values or whether prices are artificially depressed by a liquidity discount due to frozen markets – or some combination of the two.
If its assumptions are correct, Treasury’s current approach may prove a reasonable response to the current crisis. Current prices may, in fact, prove not to be explainable without the liquidity factor. Even in areas of the country where home prices have declined precipitously, the collateral behind mortgage-related assets still retains substantial value. In a liquid market, even under-collateralized assets should not be trading at pennies on the dollar. Prices are being partially subjected to a downward self-reinforcing cycle. It is this notion of a liquidity discount that supports the potential of future gain for taxpayers and makes transactions under the CAP and the PPIP viable mechanisms for recovery of asset values while recouping a gain for taxpayers.
On the other hand, it is possible that Treasury’s approach fails to acknowledge the depth of the current downturn and the degree to which the low valuation of troubled assets accurately reflects their worth. The actions undertaken by Treasury, the Federal Reserve Board and the FDIC are unprecedented. But if the economic crisis is deeper than anticipated, it is possible that Treasury will need to take very different actions in order to restore financial stability.
By offering this assessment of Treasury’s current approach and identifying alternative strategies taken in the past, the Panel hopes to assist Congress and Treasury officials in weighing the available options as the nation grapples with the worst financial crisis it has faced since the Great Depression.
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Assessing Treasury's Strategy -- Six Months of Tarp
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Executive Summary
With this report, the Congressional Oversight Panel examines Treasury’s current strategy and evaluates the progress it has achieved thus far. This report returns the Panel’s inquiry to a central question raised in its first report: What is Treasury’s strategy? While there is disagreement among Panel members about whether it is appropriate to present alternatives to Treasury’s strategy at this time, this report also examines potential policy alternatives available to Treasury, in the event such alternatives become necessary.
This report comes on the six month anniversary of the passage of the Emergency Economic Stabilization Act of 2008 (EESA). In a letter received by the Panel on April 2, 2009, Treasury Secretary Timothy Geithner described four major challenges that Treasury’s strategy seeks to address: (1) the collapse of the housing market; (2) frozen secondary markets that “have constrained the ability of even creditworthy small businesses and families” to get credit; (3) uncertainty about the health of financial institutions and the valuation of assets on their balance sheets; and (4) the existence of “troubled legacy assets” on the balance sheets of financial institutions that affect their capitalization and limit their ability to make loans.
The Panel appreciates Treasury’s explanation of its goals, and it hopes this report inspires a more informed conversation over the fundamental questions raised by Treasury’s strategy. In addition to drawing on the $700 billion allocated to Treasury under the EESA, economic stabilization efforts have depended heavily on the use of the Federal Reserve Board’s balance sheet. This approach has permitted Treasury to leverage TARP funds well beyond the funds appropriated by Congress. Thus, while Treasury has spent or committed $590.4 billion of TARP funds, according to Panel estimates, the Federal Reserve Board has expanded its balance sheet by more than $1.5 trillion in loans and purchases of government-sponsored enterprise (GSE) securities. The total value of all direct spending, loans and guarantees provided to date in conjunction with the federal government’s financial stability efforts (including those of the Federal Deposit Insurance Corporation (FDIC) as well as Treasury and the Federal Reserve Board) now exceeds $4 trillion. This report reviews in considerable detail specific criteria for evaluating the impact of these programs on financial markets. Six months into the existence of TARP, evidence of success or failure is mixed.
Evaluating the wisdom and success of these efforts requires a broader understanding of the basic choices available to policymakers during this crisis. To deal with a troubled financial system, three fundamentally different policy alternatives are possible: liquidation, receivership, or subsidization. To place these alternatives in context, the report evaluates historical and contemporary efforts to confront financial crises and their relative success. The Panel focused on six historical experiences: (1) the U.S. Depression of the 1930s; (2) the bank run on and subsequent government seizure of Continental Illinois in 1984; (3) the savings and loan crisis of the late 1980s and establishment of the Resolution Trust Corporation; (4) the recapitalization of the FDIC bank insurance fund in 1991; (5) Sweden’s financial crisis of the early 1990s; and (6) what has become known as Japan’s “Lost Decade” of the 1990s. The report also surveys the approaches currently employed by Iceland, Ireland, the United Kingdom, and other European countries.
Experiences from other times and other countries illustrate the benefits and problems these basic approaches present to dealing with failing banks. In the 1980s savings and loan crisis, for example, the U.S. government liquidated unhealthy financial institutions by transferring depositors to another bank, selling off assets, writing down some debt and wiping out investors. There can be considerable political barriers to this approach, and a surprise or poorly-explained liquidation can reduce market confidence and heighten uncertainty about future government interventions in financial markets. But liquidation also avoids the uncertainty and open-ended commitment that accompany subsidization. It can restore market confidence in the surviving banks, and it can potentially accelerate recovery by offering decisive and clear statements about the government’s evaluation of financial conditions and institutions.
Another option is government reorganization of troubled financial institutions using conservatorships, as in the case of Continental Illinois in the U.S. and the financial crisis in Sweden in the 1990s. This approach entails an in-place reorganization in which bad assets are removed, failed managers are replaced, and parts of the business are spun off. Depositors and some bondholders are protected, and institutions can emerge from government control with the same corporate identity but healthier balance sheets. This option also offers clarity to markets about the balance sheets of the reorganized financial institutions and encourages capital investment in the newly-reorganized entity. But reorganization can also tax government capacity and resources. If they are not quickly returned to private hands, government-run financial institutions also pose a risk that political pressure will press the institutions to lend to favored interests and support public policy at the expense of the bank’s health, although there is no evidence that this has occurred in recent banking crises.
The third option is government subsidization of troubled institutions. Japan’s approach was characterized by a series of direct and indirect subsidizations. Subsidies may be direct, by providing banks with capital infusions, or indirect, by purchasing troubled assets at inflated prices or reducing prudential standards. Cash assistance can provide banks with bridge capital necessary to survive in tough economic times until growth begins again. But subsidies carry a risk of obscuring true valuations. They involve the added danger of distorting both specific markets and the larger economy. Subsidization also carries a risk that it will be open-ended, propping up insolvent banks for an extended period and delaying economic recovery.
A review of these historical precedents reveals that each successful resolution of a financial crisis involved four critical elements:
• Transparency. Swift action to ensure the integrity of bank accounting, particularly with respect to the ability of regulators and investors to ascertain the value of bank assets and hence assess bank solvency
• Assertiveness. Willingness to take aggressive action to address failing financial institutions by (1) taking early aggressive action to improve capital ratios of banks that can be rescued, and (2) shutting down those banks that are irreparably insolvent.
• Accountability. Willingness to hold management accountable by replacing – and, in cases of criminal conduct, prosecuting – failed managers.
• Clarity. Transparency in the government response with forthright measurement and reporting of all forms of assistance being provided and clearly explained criteria for the use of public sector funds.
Historical precedents always involve some differences from the current crises. Nonetheless, experience can provide an important comparison against which current approaches can be tested.
One key assumption that underlies Treasury’s approach is its belief that the system-wide deleveraging resulting from the decline in asset values, leading to an accompanying drop in net wealth across the country, is in large part the product of temporary liquidity constraints resulting from nonfunctioning markets for troubled assets. The debate turns on whether current prices, particularly for mortgage-related assets, reflect fundamental values or whether prices are artificially depressed by a liquidity discount due to frozen markets – or some combination of the two.
If its assumptions are correct, Treasury’s current approach may prove a reasonable response to the current crisis. Current prices may, in fact, prove not to be explainable without the liquidity factor. Even in areas of the country where home prices have declined precipitously, the collateral behind mortgage-related assets still retains substantial value. In a liquid market, even under-collateralized assets should not be trading at pennies on the dollar. Prices are being partially subjected to a downward self-reinforcing cycle. It is this notion of a liquidity discount that supports the potential of future gain for taxpayers and makes transactions under the CAP and the PPIP viable mechanisms for recovery of asset values while recouping a gain for taxpayers.
On the other hand, it is possible that Treasury’s approach fails to acknowledge the depth of the current downturn and the degree to which the low valuation of troubled assets accurately reflects their worth. The actions undertaken by Treasury, the Federal Reserve Board and the FDIC are unprecedented. But if the economic crisis is deeper than anticipated, it is possible that Treasury will need to take very different actions in order to restore financial stability.
By offering this assessment of Treasury’s current approach and identifying alternative strategies taken in the past, the Panel hopes to assist Congress and Treasury officials in weighing the available options as the nation grapples with the worst financial crisis it has faced since the Great Depression.
 Bob DeMarco is a citizen journalist and twenty year Wall Street veteran. Bob has written more than 500 articles with more than 11,000 links to his work on the Internet. Content from All American Investor has been syndicated on Reuters, the Wall Street Journal, Fox News, Pluck, Blog Critics, and a growing list of newspaper websites. Bob is actively seeking syndication and writing assignments. |
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- Roubini Predicts U.S. Losses May Reach $3.6 Trillion
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Tuesday, April 07, 2009
Get Your TARP Before it is Too Late
Last one in is a rotten egg.
I moved to Florida just before the run of monster hurricanes. I had to look on as shortage of tarps caused additional hardship. People with leaking roofs couldn't get tarps, so when it rained the water just poured through the roof causing additional damage.
Now I find myself wondering if there are enough TARPs (Troubled Asset Relief Program) to go around.
The Treasury Department has decided to extend bailout funds to a number of struggling life-insurance companies.It appears that if you own a bank holding company or a savings and loan, you are qualified for a TARP.
A number of life insurers, including Hartford Financial Services Group, Genworth Financial, and Lincoln National bought savings and loans last fall so they could call themselves banks and qualify for government funds. Some existing insurance companies like Prudential Financial and MetLife already qualify.
Soon these insurance companies will be crying "pour mouth" because they aggressively sold variable rate annuities tied to the performance of the stock market.
It won't be much longer before the supposedly good part of the business at AIG--insurance--starts to turn south and puts them in even more jeopardy.
Sooner or later, the Treasury is going to run out of TARP. Reminds me of the saying--"last one in is a rotten egg".
If the stock market returns to the lows it is going to be ugly. The big question right now is, will inflation click in soon enough to save the day?
Stay tuned.
There is a good article in the Wall Street Journal where you can read more about this topic --
U.S. to Offer Aid to Life Insurers.
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| Bob DeMarco is a citizen journalist and twenty year Wall Street veteran. Bob has written more than 500 articles with more than 11,000 links to his work on the Internet. Content from All American Investor has been syndicated on Reuters, the Wall Street Journal, Fox News, Pluck, Blog Critics, and a growing list of newspaper websites. Bob is actively seeking syndication and writing assignments. |
More from All American Investor
- 30 Year Conventional Mortgage Rate (Chart)
- Top Hedge Fund Managers Make Billions in 2008
- Systemic Risk Defined--Too Big to Fail
- Ray Dalio on the current state of affairs in the market
- Roubini Predicts U.S. Losses May Reach $3.6 Trillion
- Option ARM--The Toxic Mortgage
- Warren Buffett's Annual Letter to Investors (Cliff Notes Version)
Follow All American Investor on Twitter
Thursday, February 26, 2009
Food for thought on the Budget Deficit
One thing that is being overlooked in this budget deficit mess is payback. If these TARP loans get paid back the future deficits are likely to be better than is currently being forecast in the market.
New bull market down the road? Remember these factors always influence stock market action:
Feel free to comment or share you thoughts on this and the budget deficit.
New bull market down the road? Remember these factors always influence stock market action:- Perception
- Better than expected
- Consumer and investor confidence
Feel free to comment or share you thoughts on this and the budget deficit.
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Friday, February 20, 2009
TARP money aimed at wrong target
We need to get some people in Washington that understand how things work. Obama has surrounded himself with a lot of bright people that are mostly ex-academics. Not a bad thing, but, he needs some people with hands on experience that understand had banks operate.For reasons that remain unclear, the Troubled Asset Relief Program has channeled aid to bank holding companies rather than banks. The Obama administration’s new Financial Stability Plan will have more influence on bank lending if it actually directs its support to banks.
Banks take deposits and make loans to consumers and corporations. Bank holding companies own or control these banks. The big holding companies also own other businesses, including ones that execute trades both on their clients’ behalf and for themselves.
OP-ED CONTRIBUTORS
The Bailout Is Robbing the Banks
By JOHN C. COATES and DAVID S. SCHARFSTEIN
Cambridge, Mass.
MANY Americans are angry at banks for taking bailout money while still cutting back on lending. But the government is also to blame. For reasons that remain unclear, the Troubled Asset Relief Program has channeled aid to bank holding companies rather than banks. The Obama administration’s new Financial Stability Plan will have more influence on bank lending if it actually directs its support to banks.
To see why, it’s important to understand the distinction between banks and bank holding companies. Banks take deposits and make loans to consumers and corporations. Bank holding companies own or control these banks. The big holding companies also own other businesses, including ones that execute trades both on their clients’ behalf and for themselves.
It would seem obvious that helping banks, not holding companies, would be the most direct way to stimulate bank lending. But when TARP purchased preferred stock and warrants, it bought them from holding companies, not their bank subsidiaries.
While TARP has been generous with bank holding companies, these companies have not been so generous with their banks. Four large holding companies — JP Morgan, Citigroup, Bank of America and Wells Fargo — initially received a total of $90 billion in TARP money in the fall, but by the end of 2008 they had contributed less than $15 billion in equity capital to their subsidiary banks.
The holding companies seem to have invested most of their TARP money in their other businesses or else retained the option to do so by keeping it in deposit accounts, even as the capital of their banks decreased. At the same time the banks, which provide the majority of loans to large corporate borrowers, drastically reduced lending to new borrowers.
It’s easy to see why holding companies would withhold capital from their troubled banks. If a bank is insolvent — as many are now believed to be — and the government has to take it over, the holding company loses any capital it gave to the bank. Rather than take that risk, the holding company can opt to spend its money elsewhere, perhaps on trading of its own.
But this is not a good use of scarce capital. We might end up with too much of this proprietary trading and too little lending. It also means that when it comes time to recapitalize banks there is a bigger hole to fill, and when banks fail there is less capital available to meet the government’s obligations to insured depositors and other creditors. Keeping money at the holding company may benefit its shareholders, but it is costly for taxpayers.
Bailouts, at the very least, should reach their target. When Washington wanted to help Chrysler, it gave money to Chrysler. It did not write a blank check to Cerberus, the private equity firm that owns Chrysler, in the hope that the money would somehow find its way to the carmaker and not to the other companies Cerberus owns.
Some politicians, frustrated that the government’s costly interventions have not had their desired effect, have wanted to mandate higher levels of bank lending. Others have tried shaming chief executives of financial institutions into lending more, as when Representative Mike Capuano of Massachusetts admonished eight of them who came before the House Financial Services Committee: “Start loaning the money that we gave you. Get it on the street!”
It would be more effective to simply ensure that the Financial Stability Plan is directed at banks. When the government buys stock, it should buy bank stock. And if it chooses to buy stock in holding companies, it should at least require that the new capital reaches the bank and non-bank subsidiaries that the government wishes to support. If the government chooses to help private investors buy toxic bank assets, as the planned Public-Private Investment Fund is supposed to do, it should not allow the banks to send those investments to their holding companies. And if the government decides to guarantee debt, it should guarantee the debt of banks, not of holding companies.
The Obama administration seems to understand that reviving bank lending is key to economic recovery. Now it needs to make sure that the banks get the money.
John C. Coates is a professor at Harvard Law School. David S. Scharfstein is a professor of finance at Harvard Business School.
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Tuesday, January 27, 2009
Six Errors on the Path to the Financial Crisis
Alan Blinder wrote an interesting article in the New York Times last week. He spells out in easy to understand terms the six errors that led us into this financial mess. He points out that if simple choices has been made along the way the situation would not be as dire as it is today. He goes on to point out that the current situation is not the failure of capitalism but about human errors. By putting a clear, concise "frame" around the current situation he makes it easier to understand. A better basic understanding of the problem would help our politicians in Washington to make decisions about how "taxpaper" money should and could be used to exacerbate the current financial problems. The real issue right 
now is whether or not the way taxpayer money is being used is helping or just delaying the inevitable.
By ALAN S. BLINDER
WHAT’S a nice economy like ours doing in a place like this? As the country descends into what is likely to be its worst postwar recession, Americans are distressed, bewildered and asking serious questions: Didn’t we learn how to avoid such catastrophes decades ago? Has American-style capitalism failed us so badly that it needs a radical overhaul?
The answers, I believe, are yes and no. Our capitalist system did not condemn us to this fate. Instead, it was largely a series of avoidable — yes, avoidable — human errors. Recognizing and understanding these errors will help us fix the system so that it doesn’t malfunction so badly again. And we can do so without ending capitalism as we know it.
My list of errors has six whoppers, in chronologically order. I omit mistakes that became clear only in hindsight, limiting myself to those where prominent voices advocated a different course at the time. Had these six choices been different, I believe the inevitable bursting of the housing bubble would have caused far less harm.
WILD DERIVATIVES In 1998, when Brooksley E. Born, then chairwoman of the Commodity Futures Trading Commission, sought to extend its regulatory reach into the derivatives world, top officials of the Treasury Department, the Federal Reserve and the Securities and Exchange Commission squelched the idea. While her specific plan may not have been ideal, does anyone doubt that the financial turmoil would have been less severe if derivatives trading had acquired a zookeeper a decade ago?
SKY-HIGH LEVERAGE The second error came in 2004, when the S.E.C. let securities firms raise their leverage sharply. Before then, leverage of 12 to 1 was typical; afterward, it shot up to more like 33 to 1. What were the S.E.C. and the heads of the firms thinking? Remember, under 33-to-1 leverage, a mere 3 percent decline in asset values wipes out a company. Had leverage stayed at 12 to 1, these firms wouldn’t have grown as big or been as fragile.
A SUBPRIME SURGE The next error came in stages, from 2004 to 2007, as subprime lending grew from a small corner of the mortgage market into a large, dangerous one. Lending standards fell disgracefully, and dubious transactions became common.
Why wasn’t this insanity stopped? There are two answers, and each holds a lesson. One is that bank regulators were asleep at the switch. Entranced by laissez faire-y tales, they ignored warnings from those like Edward M. Gramlich, then a Fed governor, who saw the problem brewing years before the fall.
The other answer is that many of the worst subprime mortgages originated outside the banking system, beyond the reach of any federal regulator. That regulatory hole needs to be plugged.
FIDDLING ON FORECLOSURES The government’s continuing failure to do anything large and serious to limit foreclosures is tragic. The broad contours of the foreclosure tsunami were clear more than a year ago — and people like Representative Barney Frank, Democrat of Massachusetts, and Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, were sounding alarms.
Yet the Treasury and Congress fiddled while homes burned. Why? Free-market ideology, denial and an unwillingness to commit taxpayer funds all played roles. Sadly, the problem should now be much smaller than it is.
LETTING LEHMAN GO The next whopper came in September, when Lehman Brothers, unlike Bear Stearns before it, was allowed to fail. Perhaps it was a case of misjudgment by officials who deemed Lehman neither too big nor too entangled — with other financial institutions — to fail. Or perhaps they wanted to make an offering to the moral-hazard gods. Regardless, everything fell apart after Lehman.
People in the market often say they can make money under any set of rules, as long as they know what they are. Coming just six months after Bear’s rescue, the Lehman decision tossed the presumed rule book out the window. If Bear was too big to fail, how could Lehman, at twice its size, not be? If Bear was too entangled to fail, why was Lehman not?
After Lehman went over the cliff, no financial institution seemed safe. So lending froze, and the economy sank like a stone. It was a colossal error, and many people said so at the time.
TARP’S DETOUR The final major error is mismanagement of the Troubled Asset Relief Program, the $700 billion bailout fund. As I wrote here last month, decisions of Henry M. Paulson Jr., the former Treasury secretary, about using the TARP’s first $350 billion were an inconsistent mess. Instead of pursuing the TARP’s intended purposes, he used most of the funds to inject capital into banks — which he did poorly.
To illustrate what might have been, consider Fed programs to buy commercial paper and mortgage-backed securities. These facilities do roughly what TARP was supposed to do: buy troubled assets. And they have breathed some life into those moribund markets. The lesson for the new Treasury secretary is clear: use TARP money to buy troubled assets and to mitigate foreclosures.
Six fateful decisions — all made the wrong way. Imagine what the world would be like now if the housing bubble burst but those six things were different: if derivatives were traded on organized exchanges, if leverage were far lower, if subprime lending were smaller and done responsibly, if strong actions to limit foreclosures were taken right away, if Lehman were not allowed to fail, and if the TARP funds were used as directed.
All of this was possible. And if history had gone that way, I believe that the financial world and the economy would look far less grim than they do today.
For this litany of errors, many people in authority owe millions of Americans an apology. Richard A. Clarke, former national security adviser, set a good example when he told the commission investigating the 9/11 attacks that he wanted victims’ families “to know why we failed and what I think we need to do to ensure that nothing like that ever happens again.” I’m waiting for similar words from our financial leaders, both public and private.
Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve. He has advised many Democratic politicians.
My list of errors has six whoppers, in chronologically order. I omit mistakes that became clear only in hindsight, limiting myself to those where prominent voices advocated a different course at the time. Had these six choices been different, I believe the inevitable bursting of the housing bubble would have caused far less harm.
Six Errors on the Path to the Financial Crisis
By ALAN S. BLINDER
WHAT’S a nice economy like ours doing in a place like this? As the country descends into what is likely to be its worst postwar recession, Americans are distressed, bewildered and asking serious questions: Didn’t we learn how to avoid such catastrophes decades ago? Has American-style capitalism failed us so badly that it needs a radical overhaul?
The answers, I believe, are yes and no. Our capitalist system did not condemn us to this fate. Instead, it was largely a series of avoidable — yes, avoidable — human errors. Recognizing and understanding these errors will help us fix the system so that it doesn’t malfunction so badly again. And we can do so without ending capitalism as we know it.
My list of errors has six whoppers, in chronologically order. I omit mistakes that became clear only in hindsight, limiting myself to those where prominent voices advocated a different course at the time. Had these six choices been different, I believe the inevitable bursting of the housing bubble would have caused far less harm.
WILD DERIVATIVES In 1998, when Brooksley E. Born, then chairwoman of the Commodity Futures Trading Commission, sought to extend its regulatory reach into the derivatives world, top officials of the Treasury Department, the Federal Reserve and the Securities and Exchange Commission squelched the idea. While her specific plan may not have been ideal, does anyone doubt that the financial turmoil would have been less severe if derivatives trading had acquired a zookeeper a decade ago?
SKY-HIGH LEVERAGE The second error came in 2004, when the S.E.C. let securities firms raise their leverage sharply. Before then, leverage of 12 to 1 was typical; afterward, it shot up to more like 33 to 1. What were the S.E.C. and the heads of the firms thinking? Remember, under 33-to-1 leverage, a mere 3 percent decline in asset values wipes out a company. Had leverage stayed at 12 to 1, these firms wouldn’t have grown as big or been as fragile.
A SUBPRIME SURGE The next error came in stages, from 2004 to 2007, as subprime lending grew from a small corner of the mortgage market into a large, dangerous one. Lending standards fell disgracefully, and dubious transactions became common.
Why wasn’t this insanity stopped? There are two answers, and each holds a lesson. One is that bank regulators were asleep at the switch. Entranced by laissez faire-y tales, they ignored warnings from those like Edward M. Gramlich, then a Fed governor, who saw the problem brewing years before the fall.
The other answer is that many of the worst subprime mortgages originated outside the banking system, beyond the reach of any federal regulator. That regulatory hole needs to be plugged.
FIDDLING ON FORECLOSURES The government’s continuing failure to do anything large and serious to limit foreclosures is tragic. The broad contours of the foreclosure tsunami were clear more than a year ago — and people like Representative Barney Frank, Democrat of Massachusetts, and Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, were sounding alarms.
Yet the Treasury and Congress fiddled while homes burned. Why? Free-market ideology, denial and an unwillingness to commit taxpayer funds all played roles. Sadly, the problem should now be much smaller than it is.
LETTING LEHMAN GO The next whopper came in September, when Lehman Brothers, unlike Bear Stearns before it, was allowed to fail. Perhaps it was a case of misjudgment by officials who deemed Lehman neither too big nor too entangled — with other financial institutions — to fail. Or perhaps they wanted to make an offering to the moral-hazard gods. Regardless, everything fell apart after Lehman.
People in the market often say they can make money under any set of rules, as long as they know what they are. Coming just six months after Bear’s rescue, the Lehman decision tossed the presumed rule book out the window. If Bear was too big to fail, how could Lehman, at twice its size, not be? If Bear was too entangled to fail, why was Lehman not?
After Lehman went over the cliff, no financial institution seemed safe. So lending froze, and the economy sank like a stone. It was a colossal error, and many people said so at the time.
TARP’S DETOUR The final major error is mismanagement of the Troubled Asset Relief Program, the $700 billion bailout fund. As I wrote here last month, decisions of Henry M. Paulson Jr., the former Treasury secretary, about using the TARP’s first $350 billion were an inconsistent mess. Instead of pursuing the TARP’s intended purposes, he used most of the funds to inject capital into banks — which he did poorly.
To illustrate what might have been, consider Fed programs to buy commercial paper and mortgage-backed securities. These facilities do roughly what TARP was supposed to do: buy troubled assets. And they have breathed some life into those moribund markets. The lesson for the new Treasury secretary is clear: use TARP money to buy troubled assets and to mitigate foreclosures.
Six fateful decisions — all made the wrong way. Imagine what the world would be like now if the housing bubble burst but those six things were different: if derivatives were traded on organized exchanges, if leverage were far lower, if subprime lending were smaller and done responsibly, if strong actions to limit foreclosures were taken right away, if Lehman were not allowed to fail, and if the TARP funds were used as directed.
All of this was possible. And if history had gone that way, I believe that the financial world and the economy would look far less grim than they do today.
For this litany of errors, many people in authority owe millions of Americans an apology. Richard A. Clarke, former national security adviser, set a good example when he told the commission investigating the 9/11 attacks that he wanted victims’ families “to know why we failed and what I think we need to do to ensure that nothing like that ever happens again.” I’m waiting for similar words from our financial leaders, both public and private.
Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve. He has advised many Democratic politicians.
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