An abrupt about face: From the Troubled Assets Relief Program to partial nationalization
From the inception the US Treasury authorities have made it clear that the primary objective of the Troubled Assets Relief Program (TARP) is to stabilize the US financial system and free the flow of finance to business. As they see it the problem facing them is located in the accumulation of illiquid mortgage assets parked in the portfolios of the major banks.
However, in the two months that have passed since the programme was introduced no noticeable progress has been achieved towards this objective. This has led to a dramatic turnaround in the approach of the authorities to the financial crisis and credit crunch.
Many critics have been pointing out that the TARP is providing a bail-out to the very institutions that have in their reckless pursuit of profits acquired these toxic assets. It is unfair to ask taxpayers to pay the cost of this risky behaviour. Moreover it is not only US financial firms that hold these assets, but foreign firms as well. The US taxpayer should not be asked to bail out foreign firms.
A related consideration is that the bail-out will add to the US budget deficit thereby placing inflationary pressure on the US and global economies. Additionally, the amount of funds available in the TARP is US$700B, which is only 5 per cent of the estimated value of US$14 trillion in toxic assets parked in the portfolios of financial firms.
Over the past two months the US economy and its financial system have encountered several reverses. The financial system has seen the bail-out of Citigroup bank, one of the largest banks in the country. It is now being reported that 171 US banks are at serious risk. In the real economy the three giant US automobile makers are also seeking US government help as they face bankruptcy (General Motors, Ford and Chevrolet).
TARP’S new focus
The TARP has been re-focused to purchasing preferred stock in banks and other financial firms rather than the purchase of their toxic assets. This measure extends US government ownership over its private banking system, much to the chagrin of some capitalist ideologues.
As the US authorities themselves describe it, the new goal is:
“The direct recapitalization of troubled banks and financial institutions through federal government purchase of preferred stocks, rather than the purchase of their toxic assets. This would better protect taxpayers and prevent unjust enrichment of negligent executives and investors.’ The problem being identified here is that when toxic assets were being purchased under the TARP, the US authorities had no control over the use of the funds they released to the banks and financial institutions. Critics observed that in practice these funds were being passed on for the exorbitant remuneration of the very executives and investors who had created the problem in the first instance. In some instances the banks and financial institutions have also been using TARP funds to acquire smaller and/or weaker firms.
What the authorities have now done with the TARP is logical. Taxpayers would clearly prefer that their money is used to acquire stock in on-going and functioning businesses rather than to buy complicated bundles of securities, with unknown values based as they are on delinquent or foreclosed mortgages. One factor prompting this change in approach has been the continued volatility of financial markets. As I have argued the crisis is centered in the US private housing market bubble of the past few years, even though it is now truly global in its scope. Symbolically, several US economists point out that this new approach of the TARP patterns that previously introduced in Britain to cope with the spreading effects of the financial crisis and credit crunch.
Issues to follow
Over the next few columns I shall explain the global dimensions of the financial crisis and credit crunch as well as US-led efforts at a globally coordinated response. After that I shall proceed to examine the economic dimensions of the present situation, focusing on their likely effects on Caricom.
Having identified the private housing market bubble in the US as the proximate source of the difficulties the world economy and financial system now face, it is clear that in my view there can be no lasting solution until a way is found to remove the toxic mortgages from the financial system. The problem here is essentially two-fold. One is that the value of outstanding toxic mortgages exceeds the value of the houses now that the private housing bubble has burst. Foreclosure, therefore, does not recover the value of the debt (mortgage) outstanding. The other problem is that these mortgages have been securitized, that is, sliced, diced, and bundled into black-boxes of indeterminate securities that are unrelated to their underlying mortgages. The true price of these traded securities is both unknown and unknowable. There are no theoretical or mathematical methods that can determine their price, as the assets now have innumerable slices or tranches of mortgages embedded in them.
In theory given the supply of housing in an economy which is determined in large measure by the profits housing investors expect to make and the availability of investment funds, the price of this housing depends in large measure also on the demand for housing. Broadly speaking the demand for private housing is a function of household income, the availability of mortgage funds and demographic factors (the rate of formation of households). As we saw during a housing bubble this foundation price becomes divorced from the price of the mortgages as both lenders (financial firms) and borrowers (households) deceive themselves into believing the rapid inflationary housing prices prevailing reflect true values. Several ingenious solutions have been proposed to resolve this dilemma. Personally I believe the only one that might work is if the US bankruptcy courts were legally allowed to redefine mortgage values on houses being foreclosed, based on the good faith, due diligence determination of repayment schedules borrowers can afford and lenders are willing to accept − given their likely losses when foreclosures take place in these courts. This, however, would be a slow and long-term process as millions of mortgages are at risk. Steps will be needed to speed up this process.