Troubled Assets Relief Program
The United States is clearly at the epicentre of the global financial crisis and credit crunch. The scale of the havoc and damage already wreaked on the financial sector of the United States is one of the two clearest indicators of the awesome seriousness of what confronts the global economy today. The other indicator is the unprecedented magnitude and scope of the United States government’s response to this threatening situation. In previous columns I have discussed the first of these indicators. In this week’s column I start a discussion on the second indicator.
Response
To begin with, the range of the US government’s res-ponse has been breathtaking. At its core is the Troubled Assets Relief Program, called TARP. This was introduced by Henry Paulson, Secretary to the US Treasury and approved by the US Congress and President. A sum of US$700 billion was allotted to this programme, to be issued in two equal tranches of US$350 billion. I shall discuss the provisions of the TARP in the next section after I give readers some brief indication of the other important steps taken by the US authorities.
A key complementary measure was to increase the size of the deposit insurance guarantee offered to bank depositors by the Federal Deposit Insurance Corporation. This was increased from US$100,000 to US$250,000 per customer. This action was done to quell fears among millions of depositors of likely bank failures. As indicated in earlier columns there were lists of scores of US banks circulating on the internet that could collapse. The risk was that these rumours could lead to be a run on banks if depositors sought to withdraw their deposits for safety.
Another action was to adopt a policy stance supporting the precept of financial firms considered as being too big to fail, known as TBTF. As we saw in previous columns this means that some financial institutions would cause so much economic and financial damage to the US economy that failure of these would under all circumstances be considered unacceptable. As I had pointed out previously, such a policy stance encourages firms to practise ‘moral hazard’ because it removes the primary disincentive firms face in the capitalist system − the failure to make profit would lead to their certain closure.
Action was also directed at the Stock Exchange where a temporary ban was placed on short selling. In other economies stock exchanges were temporarily closed (Russia). Although focused on rescuing troubled assets in financial depository institutions the TARP also included a commercial paper funding facility which supported in effect short-term loans to firms engaged in non-bank activities.
Troubled Assets
Rescue Plan
Originally, the primary goal of the TARP was expressed as the removal of “illegal assets that are weighing down the financial institutions and threatens the US economy.” The focus was on financial depository firms. To achieve this objective the TARP had to command sufficient funds, hence the large sum of US$700 million. The expectation was that the TARP would provide stability to the US financial system, remove the credit crunch, and prevent the US economy from going into depression.
As Secretary Paulson posited when introducing the programme to the US Congress, “the underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded.” This statement supports the claim I made last week that the housing bubble was the proximate cause of the financial crisis and credit crunch that erupted in the US. The official Treasury view was that the illiquid mortgage assets were toxic, poisoning financial markets and threatening a deepening recession or worse in the real economy.
In the original presentation of the TARP the US authorities placed most of the blame for what was happening on 1) predatory lenders in the sub-prime private housing market 2) the lax supervisory and regulatory agencies which allowed irregularities and illegalities to spread in these markets 3) the securitizers who repackaged and resold these toxic assets as good value ones and 4) irresponsible households and housing speculators who succumbed to their own greed when the price of housing was rising way beyond its normal rate.
The long-run trend in US house prices tends to pattern closely the US overall inflation rate. At the height of the private housing bubble the rate of increase in house prices was several multiples higher than the inflation rate. This and other issues raised in the previous paragraph will be considered in later columns in the series.
As the crisis has progressed several new policy dimensions have been added to the US government’s response, including as was mentioned last week, direct support for Freddie Mac and Fannie Mae, the two giant mortgage institutions in the US, and AIG, the largest insurance company in the US. Two other policy actions will be considered in detail beginning with next week’s column. One of these is that the TARP programme has made a180° turn and is now to be focused on the purchase of preferred stock in the banks and their direct capitalization as a way of solving the problems posed by the illiquid assets parked in their portfolios.
The other policy stance is that the US government has worked very hard for a coordinated global response as the crisis spread at a rapid pace worldwide. The action culminated in the G20 Summit of leading financial authorities held last week in Washington DC (November 19-20, 2008).
