Wednesday, November 19, 2008

Is the TARP a 'bait and switch' plan?

Did Hank Paulson lie when, in defence of opting out of buying troubled assets, he said “It was clear to me by the time the (TARP) bill was signed on October 3rd that we needed to act quickly and forcefully, and that purchasing troubled assets—our initial focus—would take time to implement and would not be sufficient given the severity of the problem. In consultation with the Federal Reserve, I determined that the most timely, effective step to improve credit market conditions was to strengthen bank balance sheets quickly through direct purchases of equity in banks.”

Or did he actually plan on using the TARP from the very start simply to purchase bank assets and not to purchase troubled assets at all?

This seems to be the theme of speculation in Naked Capitalism’s post. During the TARP negotiations in Congress, Treasury was resisting the idea of inserting language that would allow for capital injections into banks but that some members of Congress thought it was necessary, and put statements into the Congressional record via floor debates to allow for that interpretation.

Yves Smith says Either Paulson let his intentions be misrepresented via his silence, or he is now falsely claiming to have changed direction earlier than he did….. The bill was drafted to be extraordinarily vague and sweeping, and yet did not clearly give Paulson the authority he now says he realized back then that he needed while it was still being renegotiated.

The way I understand this, it seems Paulson took the stance of resisting equity capitalization as a solution to the bank solvency crisis, such that Congress inserted that as a vague provision in the legislation, with no specific guidelines, limits, or constraints on how Treasury should do it, or conditionalities it should insist from those who end up getting the money.

It turns out that much of the money went to healthy banks, because as Pauslon put it, we need to put money into healthy banks before they became unhealthy, and to encourage the less healthy banks to also participate. In his words, if some banks participated and others did not, those who did would be in effect declaring they were weak and scaring away depositors and investors. The stigma argument does carry some weight.

So as soon as TARP was enacted, Paulson unveiled plans to provide $125 billion to nine banks on terms that were more favorable than they would have received in the marketplace. The government, however, offered no written requirements about how or when the banks must use the money. Treasury's new program provided that a bank can exit by repurchasing Treasury shares with newly raised private capital.

Does this indicate that TARP was negotiated to allow preferred banks get the bailout money at the best terms possible, given the circumstances?

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