Secretary Paulson announced on Wednesday that the $700 billion that Congress authorized under the Troubled Asset Reclamation Program for the purchase of asset-based securities will not be used to purchase any asset-based securities. Instead, the Treasury will continue to pump money into banks. This follows on the announcement of a renegotiation of the loan to AIG on terms much more favorable to the company - and much less favorable to the taxpayer - than had been negotiated earlier. That announcement follows on the gift of $125 billion to nine large, unnamed banks. At this point it seems salient to ask, what the hell is going on?
Start with the AIG loan. Originally, AIG received an $85 billion 2-year bridge loan, of which $61 billion has been drawn. The rate on the loan was Libor + 8.5% -- currently around 10.6% -- plus fees. In addition, AIG has drawn approximately $20 billion from a securities lending facility created by the Fed of New York, and is participating in the government commercial paper facility with a line of $20.9 billion of which $8 billion was outstanding. (Timothy Geithner, the president and CEO of the New York Federal Reserve, is on Obama's short list for a potential Treasury Secretary.)
The new plan, in addition to a new infusion of $40 billion, involves renegotiating the loan to a 5 year term at lower interest. It also involves creating two new facilities by the New York Fed. One is designed to purchase asset-based securities ("RMBS," or "residential mortgage-backed securities), using $1 billion supplied by AIG and $22.5 billion supplied by the New York Fed. With that program in place, as AIG executives put it in a conference call, "AIG's remaining exposure to losses from its U.S. securities lending program will be limited to declines in market value prior to the closing of this entity and our $1 billion of funding." The second new facility will provide $30 billion in government money to purchase up to $70 billion in credit default swaps at discounted prices, to accompany $5 billion in subordinated funding to come from AIG. Approximately 95% of the write-downs AIG financial products has taken to-date is in its CDS portfolio. (I have discussed the background issues involved in earlier posts.)
Critics of the plan are outraged, and with good reason. But as of Wednesday we learned that the renegotiation of AIG's loan was part of a larger strategy. As reported here, Paulson said that the administration will not, after all, use any of the $700 billion that was provided under the TARP program to purchase asset-based securities: instead, the Treasury will continue to use $250 billion of the program to purchase stock in banks and is looking at a major expansion of the program into the markets that provide support for credit card debt, auto loans and student loans. Paulson said that the consumer credit market urgently needs support. "This market, which is vital for lending and growth, has for all practical purposes ground to a halt." Of the $2.6 trillion in consumer credit outstanding in September, finance companies were the third largest holders with $600 billion after banks ($845bn) and ABS ($678b). To justify his actions, Paulson explained that the administration has decided that using billions of dollars to buy troubled assets is not, after all, "not the most effective way" to use the $700 billion bailout package. In other words, "we changed our minds."
What the hell is Paulson thinking? Never mind the economics of all this, what about the politics? I have to assume that members of Congress are going to be absolutely enraged. Remember the hard sell on the original bailout package? We had to immediately purchase toxic assets or a Depression would ensue, there would be riots in the streets, cephalopods would fall from the sky. "Really, seriously," said Paulson, "this is absolutely the only thing we can do and there's no time for discussion." Now he is saying "actually, we have a better idea." But the bait-and-switch aspects of the deal are not restricted to the original hard sell. Among the objections to the TARP plan from the outset was the argument that it was funneling money to the very entities that had created the problems (the stories about executive bonuses being paid by banks receiving money under the bailout plan have not done much to improve the image of the banks involved.) That objection is only made stronger by the declaration that buying assets is not, after all, as important as funneling money to banks.
In the face of a certain political firestorm, did Paulson first present this to congressional leaders and secure their support, or attempt to secure support from the incoming Obama team. Don't be ridiculous. No more than he is willing to identify the nine banks receiving $125 billion in public money (Bloomberg has sued under the FOIA to try to obtain that information), and no more than Neel Kashkari - the "bailout czar" and yet another Goldman, Sachs alumnus - was willing to entertain questions after a speech on Monday. The absolute arrogance of the Bush Executive has not diminished a whit.
Wait, there's more. Paulson also praised a new set of guidelines issued Wednesday by the Federal Reserve and other bank regulators. These guidelines "urge institutions to continue lending to credit worthy borrowers and to work with mortgage borrowers to avoid defaults," and "encourage the banks to set dividend payments for shareholders and compensation for executives with the current crisis in mind. "The Fed, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, and Office of Thrift Supervision said all financial institutions were expected to follow the new guidelines, even those not receiving federal assistance." Note the verbs, here. "Urge," "encourage," "expected"; it's the same old completely discredited game of voluntary compliance. We are still not learning from the British example that the way to get banks to lend money is to provide them with funds on the condition that they lend them. We - our President and his administration - are still parroting the tired old "magic of the markets" line even after Alan Greenspan's mea culpa (he was shocked, shocked, to learn that people will not voluntarily forego profit in order to preserve the integrity of the system.)
Meanwhile, is all of this shoveling of money at banks working? Keep in mind that the TARP program is not by any means the only game in town. All told, nearly $2 trillion has been lent by the Fed, more than $1.1 trillion just since September 14th when the rules governing collateral for such loans were relaxed. These loans have been made under 11 different programs, 8 of which have been created in the past 15 months. In addition, there is the $300 billion that was allocated in July for the Federal Housing Finance Agency, which is authorized to buy back and renegotiate an estimated 400,000 mortgages. Then there is the Commercial Paper Funding Facility that was mentioned earlier in connection with AIG. Under that program, which went into operation at the end of October, the Federal Reserve Bank of New York agree to buy outstanding unsecured and asset-backed 3-month loans. The New York Fed loaned the money to a newly created purchasing entity, which will hold the commercial paper until maturity and will use the proceeds from maturing commercial paper and other assets of the SPV to repay its loan from the New York Fed. What is extraordinary about the CPFF is that it actually seems to make sense.
The results of all this for the credit markets? The Labor/Treasury spread, which was up to 480 in October, is now "down" to a little over 200; prior to Sept. the all-time record was 250 and the 10-year average was 22. The total amount of "Asset Backed Credit Products" - i.e. total pool of all credit for car loans, student loans, floorplan loans, fleet loans, mortgages - is down 51% ($748b) since June 2007.
By the time Obama takes office, the Bush administration will have transferred a staggering amount of money, measured in trillions of dollars, to private banks. That money will no longer be available for the kind of employment-based stimulus package that we desperately need, nor for targeted and potential more effective mechanisms to increase liquidity in the credit markets such as an expanded version of the CPFF, nor to secure access to education. On their own, large private lenders - including Citigroup, Bank of America, and JP Morgan Chase -- are renegotiating mortgages, but there is no organized, centralized effort and no leadership coming from the government (my own lender, Countrywide, called while I was writing this post to see if I want to refinance.) Only advisory "guidelines" and buckets of money. And once again, the Bush administration is seeking to jam this enormous program down the throats of Congress and the American people without consultation, oversight, or transparency. Will Congress just stand there and watch this happen? What is Paulson thinking?