Badlands

Last week Treasury Secretary Tim Geither appeared before Congress to unveil his approach to solve the financial crisis. While many were disappointed with the lack of details, more telling, perhaps, was the lack of any change in approach, from the previous administrations philosophy to his. Rather than forcing the banks to write-off the bad loans on their balance sheet, the plan calls for a $1 trillion investment fund and a $1 trillion consumer and business lending fund. the investment fund appears to be to inject more capital into banks. The top twenty banks will be given a stress test to see if they are strong enough to lend. The fund will be their to provide a safety net for them, if necessary. The lending fund will privide funds to back up to $1 trillion in auto, credit card, and student loan debt. The USA TODAY reported that investors were disappointed that the Treasury was not more creative, hoping it would help weak banks restructure in an orderly way, forcing them to deal with their bad loans. "Investors want the government to stop propping up weak banks, and instead help the losers dissolve," says Axel Merk of Merk Investments. Even without details, it is safe to say that this will not be the approach, though.



The same article further reported that "The administration may have hoped that the sheer scale of the plan would send a strong message that it is committed to doing whatever is necessary to pull the U.S. economy out of its worse crisis since the Great Depression."



The major difference in Geithner's approach and Paulsen's approach is the stress test for the top twenty banks. According to this and the previous administration, last year's capital injection was not enough to make the banks comfortable enough to lend, as they worried that they might need that capital to help their balance sheet, if they had to take any loan losses. Let's not forget we are in a recession. Typically banks and consumers get more conservative during a recession, both worried about whether the loan applicants will have jobs long enough to pay the loan back. Banks are lending, but not at the rate Washington would like to see. Of course, that is what got us in this mess in the first place, so Congress and the administration should be careful for what they wish for.



The crux of the problem is what to do about the bad loans on the banks balance sheets. The plan appears to try to establish a market for these loans with a combination of public (taxpayer) and private (investor) money. This would allow the banks to sell these bad loans, taking the stress off their balance sheets. The problem is that the government risks over-paying for these assets, as it reportedly did last year. An article in the February 6, 2009 WSJ said that theTreasury significantly overpaid for the assets it purchased last year, unde the TARP program. Specifically, it paid $254 billion for assets worth $176 billion.



Why not simply let the market buy the loans? Why involve the taxpayer? An article in the January 27, 2009 WSJ said that investors are ready to buy troubled debt. Two-thirds of those surveyed believe 2009 would be a good year for them to buy and are raising money for just that purpose. The problem is that they would not pay enough to make the banks want to sell, but, that begs the question, why should banks have a choice? Why not force the sale, use the funds to provide for an orderly dismantling of those banks that do not survive, and move forward? Rather than cause a panic, I believe this would be a good first step to restoring consumer and market confidence, which is the heart of any free market economy. Consumers and investors understand that there needs to be winners and losers. No one likes being on the losing end, but that is easier to understand than propping up the folks that are primarily responsible for getting us in this mess, in the first place.

An editorial on January 29, 2009 in USA TODAY suggested bringing back the Resolution Trus Corporation (RTC). this is not the first time the RTC has been mentioned, but it always seems to get swept under the carpet. Paul Volcker suggested this last Fall in the WSJ. I am not a genius, but it is the first thing I thought of when this all started. I still cannot understand how something that was proven, was not used. the editorial recapped the Savings and Loan crisis and discussed how the RTC bought the bad assets, and the governement then the healthy S & Ls used the proceeds to prop up their balance sheets. As I recall, there was not much of a market back then for all of this real estate. Alan Greenspan noted in his book, Age of Turbulence, that the assets included a uranium mine and a resort that no one wanted. yet, everything was sold and the program made a profit. While this current crisis is bigger, the editorial showed that the program could still work. What it would do, more than anything is allow the market, not the banks, to set the price for these assets. This would help restore the confidence in the economy. I believe that the U.S. economy could weather the downturn much easier if the consumers and investors had confidence in the economy and the markets, rather than looking at it as a rigged game. Whoever cries the most gets the handouts. None of the options are pleasant, so let's get past that. There is not short-term solution. However, the basis of any free market economy is allowing the market to determine prices, who succeeds, and who goes out of business. Investors and consumers have come to rely on that. That is why investors flock to the U.S. in times of trouble. They want the reliablility of our free market. Rather than continue to pour money down a hole with no bottom, let's do an about face, set up the RTC again, buy up the assets, and use what ever money is left over to provide for an orderly dismantling of the banks that cannot pass this stress test. Of all the options, this is the only one that allows the market to do its job, and thus, the only one with a chance to work.