ON RE-THINKING TARP 1.0

ALTERNATIVES

Looks like the game of chicken between the politicians and the markets may have ended with the politicians blinking.  Both the Senate and the House may pass a slightly modified version of the so-called "bail-out" TARP (Troubled Asset Relief Program) bill by the end of the week.  The bad news is that it may be the wrong solution with the right motivations.

There is an increasing amount of discussion amongst market observers that there may be a better way to do what the TARP is trying to do, stabilize the current crisis in the credit markets, and put the economy on a footing to grow again.
Edmund Phelps, the Economics Nobel prize winner in 2006, has the following suggestion in a WSJ op-ed today:

"Right now our banking industry is barely operational. Whatever the corrective surgery indicated, the priority is to get the system operating again. Delay would be costly and risky.

The most discussed of the proposed programs would address banks' toxic assets by authorizing the Treasury to buy them, issuing debt to finance the purchase. Proponents of this program add that the government's eventual sale of the assets purchased might repay the investment with a profit -- grossing, say, an 8% rate of return while paying 4% interest..."

"...A program of asset purchases, however needed, is limited in scope. It cannot be counted on to increase the equity capital of the banks -- to shore up their solvency. Underpaying for the toxic assets would actually inflict a further loss of capital. Overpaying the banks for their toxic assets could contribute capital, but that may not be politically feasible or attractive.

So it is clear that the main prong of any "rescue" plan must serve to advance the recapitalization of the banks. Cash transfusions in return for warrants are a good way to do it, as it lets taxpayers share in the upside."

George Soros, the famed hedge fund manager and financier, proposes something similar in an FT editorial today:

"Instead of just purchasing troubled assets the bulk of the funds ought to be used to recapitalise the banking system. Funds injected at the equity level are more high-powered than funds used at the balance sheet level by a minimal factor of twelve - effectively giving the government $8,400bn to re-ignite the flow of credit.

In practice, the effect would be even greater because the injection of government funds would also attract private capital. The result would be more economic recovery and the chance for taxpayers to profit from the recovery."

Given the rushed nature of the current bill in the midst of a market meltdown, sounder alternatives have not had a fair chance to be considered.  Maybe there'll be time and opportunity to do so again with a TARP 2.0, assuming of course that we all survive TARP 1.0.

Comments

[Alex Tolley]

"So it is clear that the main prong of any "rescue" plan must serve to advance the recapitalization of the banks. Cash transfusions in return for warrants are a good way to do it, as it lets taxpayers share in the upside.""

Absolutely correct. But notice Paulson was very against that idea last week. Of course the problem is that this is effectively temporarily nationalizing the banks, something that is anathema to free-booting (or should be looting?) bankers. When the crisis is over, I think we need to look very, very carefully at banking regulations, recognizing that unfettered banking was never a good idea, something we learned after 1929 but took 2 generations to forget.