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October 15, 2008
The shift in tactics
A story in today's Washington Post describes the story behind the story of Paulson's Change in Rescue Tactics:
Treasury officials were probing deeper into the books of the nation's banks and concluding that there were so many troubled assets that simply using government cash to buy them up -- the strategy Paulson had pitched -- wouldn't be enough to jump-start the markets. The troubled bank Wachovia alone had $312 billion in such assets.
. . .
Federal Reserve Chairman Ben S. Bernanke had privately urged that approach [of direct injection] for weeks, but he vigorously endorsed Paulson's rescue package in part because he knew it left Paulson enough flexibility to change direction.
. . .
during the debate over the rescue bill, Paulson told lawmakers he was reluctant to inject capital into banks in part because direct investments smacked of big-government nationalization. Aside from his free-market inclinations, emphasizing that option could have led some Republicans to vote against the bill.
Moreover, if he had called attention to the provisions in the bill that made cash injections an option, stockholders in banks could have concluded that the government was about to wipe them out, as it had investors in mortgage firms Fannie Mae and Freddie Mac and insurance giant American International Group, driving stock prices down and making the need for a bailout all the more urgent.
I realize that this direct injection is the preferred method of many economists. But it is not without risks as well. As the Post story points out:
Through asset purchases, the government has considerable power to control exactly which assets get bought and which don't. With injections of preferred stock, the government has no explicit authority to ensure that banks use the new capital to increase their lending to ordinary families and businesses. There is a risk they could become "zombie banks," technically solvent but unwilling to make new loans.
The response:
Government officials said they have been deeply worried about that risk and intend to use their regulatory power to lean on the banks to take advantage of their new capital by making new loans.
I'm not sure these regulatory are a strong enough tool to prod zombies. Some are concerned that the Treasury plan doesn't go far enough in giving the US a shareholder vote through common stock. As Nobel laureate Joseph Stiglitz was quoted in the Wall Street Journal, "As we pour money in, they can pour money right out. We don't have a veto." I'm not sure that I would support Treasury voting common stock or sitting on the Board, ala the European plan. But I would like to see some clear "anti-zombie" provisions.
I would also like to have seen the banks pledge their intellectual property as collateral. I know this might seem an added complication to the process -- but we need to start thinking like we really are in the 21st Century.
Finally, we still have to deal with how to get the bankers' books cleaned up. No wonder Wachovia was in trouble -- with $312 billion of toxic assets on its books that the outside world didn't know about. It is examples like that which reinforce the hording instinct. So the sooner the TARP auctions are set up to start buying those assets, the better.
Posted by Ken Jarboe at October 15, 2008 7:59 AM
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