The Sad Truth About TARP
- 15 February 2009 by Author 0 Comments
The Sad Truth About TARP
By Richard Larsen
Published – Idaho State Journal, 02/15/2009
Last fall with the values of real estate declining, record foreclosures being recorded, diminishing confidence in financial markets and financial institutions, congress passed an emergency “rescue” package. The $700 billion TARP (Troubled Assets Relief Program) was created to stem the tide and was to be administered by the Secretary of the Treasury that had two primary functions.
In significantly simplified terms, the first function of the TARP was to purchase illiquid (difficult to convert to cash) and non-performing assets from banks and other financial institutions. Those assets were primarily securities in the form of collateralized debt obligations, partially comprised of sub-prime mortgages. Sub-prime mortgages are those issued to borrowers with questionable ability to repay the loan based on various criteria, including credit worthiness. By purchasing these illiquid assets the second objective of TARP was realized, as banks and other lending institutions could get those bad loans off their balance sheets, freeing them up to continue lending since that is such a crucial component of our growing economy.
The mortgage bond market is worth about $6 trillion, and is the largest single part of the whole $27 trillion US bond market, bigger even than Treasury bonds. Mortgage bonds consist of mortgages that are securitized and layered into securities that pay monthly interest to the bond holders. The total mortgage market (including mortgages held by banks and other lending institutions) at the end of 2007 was over $12 trillion, according to Federal Reserve data. According to the Mortgage Finance Statistic Annual for 2007, total subprime mortgage originations from 1994 through 2006 was $3.3 trillion.
With that much in subprime mortgages outstanding, and a default rate of nearly 5% of all mortgages, it was clear that the original TARP funding of $700 billion was not going to make much of a dent in removing these risky mortgages from bank balance sheets. That was undoubtedly why then Treasury Secretary Henry Paulsen quit using the TARP funds to buy them up; it wasn’t going to come anywhere close to what was needed.
Consequently, Paulsen changed the focus of the TARP from buying the “toxic assets” of distressed financial institutions, to purchasing the debt (corporate bonds and preferred stock) and equity (stocks) of distressed institutions. This was anticipated to increase the liquidity of those 250 institutions by improving their equity and debt ratios to get them in a position to be able to lend interbank and to customers again. That hasn’t seemed to ameliorate the situation either.
New Treasury Secretary, Timothy Geithner, has now unveiled his plan for implementing the last half of the TARP. He said the new plan will entail “a comprehensive housing program to assist the millions of Americans who have lost their homes, and the millions more who live with the risk that they will be unable to meet their payments or refinance their mortgages.” Paulsen’s plan can potentially return the capital invested by selling those securities at a profit for the taxpayer. Geithner’s plan seems to be a flushing of the remaining TARP funds down a black hole.
Could there have been other options? Undoubtedly yes, but the most logical would have been two-phased. First, temporarily suspend the portion of Sarbanes Oxley Act that requires mark-to-market accounting of all assets on financial institutions balance sheets. This would have allowed those institutions to take those “toxic assets” off their balance sheets and work through their bad mortgages and mortgage-backed securities without having to meet Federal Reserve liquidity or cash requirements. Some banks would have still gone belly up, but the strong ones would have survived, and the massive spending to “bail out” the struggling ones wouldn’t have been added to the federal debt.
The second phase could have included something like the Resolution Trust Corporation (RTC) that was put in place in the 1980s to salvage the savings and loan industry. The RTC, from 1989 to 1995 folded up 747 S&Ls and sold off a portfolio of assets of $660 billion, in current dollars. Total cost to tax payers to do that was $231 billion in today’s dollars, according to Investors Business Daily.
The most critical factors in this mess have yet to be corrected. The Community Reinvestment Act is still on the books and needs to be repealed. This is the program that forced banks to lend to non-creditworthy borrowers. And Fannie Mae and Freddie Mac are still around. The government should have never been in the mortgage business. Bad regulation made this mess, and undoing that bad regulation should be the top priority, not more regulation or non-stimulating “stimulus” plans.
Richard Larsen is President of Larsen Financial, a brokerage and financial planning firm in Pocatello, and is a graduate of Idaho State University with a BA in Political Science and History and former member of the Idaho State Journal Editorial Board. He can be reached at email@example.com.