Apr. 25--You should read the Warren report. Not the one about the Kennedy assassination, but the one about the TARP, the $700 billion Troubled Assets Relief Program that has bailed out big banks and American International Group, the giant insurer. Elizabeth Warren chairs the panel appointed by Congress to oversee the TARP.
In its latest report (cop.senate.gov/documents/cop-010909-report.pdf), the panel finds that six months into TARP's existence, evidence of its success or failure is mixed. But the panel doesn't stop there. It provides alternatives to the strategy that Treasury Secretary Tim Geithner appears to be following. The more we read, the more we were convinced that Treasury policy is both opaque and drifting, and that this does not bode well for ending the banking crisis.
More specifically, it appears that the current strategy of subsidizing large financial institutions is merely postponing an inevitable day of reckoning that will entail liquidating or reorganizing them. It may be cheaper for the taxpayer and hasten the recovery to tear the Band-Aid off now, identify failed banks and liquidate or reorganize them.
There's no doubt this would be painful. But postponing it merely prolongs the agony and magnifies the cost.
One disadvantage of the current policy is that it masks which institutions have strong balance sheets and which ones are weak or insolvent. In this uncertainty, investors don't know where to put their money. That delays
recovery as government subsidies distort the financial markets.
A central problem in the whole mess is how to value troubled assets. The Treasury's strategy assumes that declining home prices caused a liquidity crisis, but that the collateral behind mortgage-backed assets retains substantial value. However, the so-called liquidity discount continues to weigh down prices in a self-reinforcing cycle.
The Treasury has proposed the Public-Private Investment Program in which the government will subsidize purchases of troubled assets as a means to put a value on them. But, the panel says, the Treasury has not explained its assumptions about values that underlie this program. Moreover, the panel says, "Without non-subsidized buyers, market functioning is an illusion." The panel is right.
Nevertheless, the panel says that if the Treasury is right about the liquidity discount, its public-private program may succeed, to the benefit of taxpayers. If not, the Treasury and the Congress will have to try something else.
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