March 18th, 2009 18:05 EST
Time to Put a Cover on TARP...The Road to Financial Recovery?
Following a recent heated discussion about the economy and our recovery, my friend and colleague Mark Pearl agreed to put his thoughts in writing for my readers to consider. Let me introduce Mark, and you can draw your own conclusions.
Mark J. Pearl is a graduate of the Boalt Hall School of Law and the Hass School of Business Administration at the University of California, Berkeley, where he received a JD and an MBA, and the University of California at Los Angeles, where he received a BA in Economics. He practices corporate and real estate law with the Los Angeles law firm of Fredman Lieberman LLP, and is a member of the Board of Governors of the Beverly Hills Bar Association.
Beginning of Contributor Comments:
To date most of the financial recovery plans for the banking system, like the Troubled Asset Recovery Program (TARP), have focused on replacing lost capital with Federal equity or subordinated debt. The theory goes something like this, (a) if the banking system fails a depression may be unavoidable, (b) some banks are so large that their failure will have broader repercussions, perhaps failure of the entire financial system, (c) we need banks to start lending to ease the credit crunch, and (d) weak banks can`t lend. Based upon this type of theory, Billions of dollars have been injected into major and regional banks.
The publicly state goals for TARP were to prevent the collapse of the financial system and jump start lending in hopes of maintaining economic activity. In theory, achieving these goals would have reduced deflationary pressures that have been causing asset values (like the value of real estate) to slide. How have we done?
So far, the system has not failed, many banks have likely been saved from imminent demise (though some large banks are still teetering), but normal patterns of lending have not been restored and asset values have continued to slide (home prices continue to decline, gas remains relatively cheap, and many categories of consumer goods, especially electronics, seem to become cheaper at ever increasing rates). For those with money to spend, falling prices seem like a bonus, which too will evaporate as falling prices translate into falling margins, salaries and profits.
So why aren`t banks lending? While different banks have different reasons, they typically fall into a few categories, uncertain asset values for secured loans, low margins, concerns with a bank`s own capital and liquidity and the need to reserve for future losses in other areas, like consumer credit. Essentially, banks are concerned about their own viability and are happy to receive Federal subsidies to insure survival, but are unwilling to use the money for its second intended purpose, making loans. Added to the mix is the debate over so called toxic " assets, the assets the TARP funds were intended to purchase, which have proven so difficult to value that a fair pricing policy has yet to emerge.
How do we change bank behavior in this crucial area? First, the Treasury needs to stop investing money in private banks without conditions. Second, the Treasury (and the Federal Reserve) need to establish a program that insures profitable lending, which will allow both the banks and the economy to recover. The program could include:
1. Not using TARP funds to purchase toxic assets ".
2. Establishing a minimal safe collateral value for toxic assets ", and using that collateral to secure special lines of credit to banks.
3. Making advances under the special lines of credit in installments, as funds are used to make new loans (e.g. only after the first billion dollars on a $25 billion facility has been used to make new loans, will the next billion dollars be available).
4. Issuing government secondary loss insurance through the Small Business Administration, or a similar existing agency, on qualifying new loans, so that the bank bears first risk of loss on each loan (e.g. the first 20%), and the government bears the remaining risk of loss.
5. Sponsoring an investor market for these new loans, so that banks have an opportunity to realize early profits from new lending activity, and maintain ongoing servicing revenue to support their operations generally.
Ironically, banks and investment banks, the risk takers that induced us all to spend what we did not have, have become the new prophets of fiscal conservatism. Unfortunately, that fiscal conservatism is too late in coming. What is needed now is a banking industry that participates in responsible, though not risk free, lending in support of industry and the economy. By structuring future disbursement of TARP funds in a manner that requires responsible lending activity, with measured risk, and creates rewards and incentives for banks to participate in the program, banks can become part of the recovery program, as opposed to remaining an obstacle to it.
* * * End of Contributor Comments * * *
These are exceedingly complex issues that even the best economists in the country can`t readily resolve " let alone agree on. My position on all of this is that it boils down to one word: confidence. The government can`t pump enough money into the system to make it work. What the government has to do is closely related to Mark`s comments. If the government governs how the money will be disbursed, used and put back into circulation, confidence will begin to be restored " which is the real key to unlocking the credit markets.
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