What would become known as the Troubled Asset Relief Program (TARP – get it?) began as an incredibly vague and audacious 2-and-a-half page document designed by Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke.
After months of ad hoc attempts to stave off a financial crisis, which included the shotgun marriage of investment bank Bear Stearns to JP Morgan Chase and ministered by the Federal Reserve, the government takeover of insurance giant American International Group and home mortgage behemoths Fannie Mae and Freddie Mac, and various other moves by the Fed – such as cash infusions, lowering short-term interest rates and a plan to pay interest on commercial banks’ reserves being held by the Federal Reserve – and with credit markets getting colder and colder, and with signs of recession becoming more and more visible, government officials apparently decided that what now was needed was an actual “coherent” plan.
The original plan, which would have given Mr. Paulson near-dictatorial power over $700 billion dollars to buy the “so-called toxic paper” (the piles of bad debt clogging the financial system) from whatever institution he wished in an attempt to save U.S. credit markets.
It had gotten to the point that banks were unwilling to lend to pretty much anybody – including each other.
There were at least two rather substantial problems with Plan I – for one, as already mentioned, it would have given Paulson an almost unquestioned authority over the process. And by the time Congress got its hands on the deal it had grow to 106 pages. The Economists who accepted the need for a plan generally dubbed it “(barely) better than nothing, because something had to be done.” Still others were sticking to their faith in markets, and that they would work things out better left alone.
The public’s response to the plan was almost unanimous outrage. At first this surprised me, but on second thought, given the public’s recent (deserved) distrust and substantial lack of faith in the government, and a PR campaign (if you can call it that) that was perhaps one of the worst since the Philip Morris tobacco company’s infamous 2003 study in the Czech Republic which concluded that cigarette related deaths are beneficial to that country because it saves their government more than $100 million per year in healthcare costs (the unpopularity of the study among Czechs may or may not have been the reason for the company’s decision to change its name to Altria), I shouldn’t have been.
And, in a not-so-rare act of cowardice, the House (after passing in the Senate) rejected the plan. With the House’s rejection, the Paulson-Bernanke plan set stock markets into a free fall. So they decided to reconsider, and the new version of the bill – which would include additional provisions and several hefty portions of pork (makers of children’s wooden arrows were overjoyed – hmm, never knew they had such powerful lobbyists) – would eventually weigh in at over 400 pages (the plan is now of an indeterminate size).
The bloated bill passed 263-171. And, as an aside, it might be noted that the vast majority of those that voted “nay” are up for reelection in a few weeks. As Hemingway once wrote, “Courage is grace under pressure.”
That was almost two weeks ago, and since then a major change has taken place as to how some of that $700 billion will be administered. And, given that I am writing this early Wednesday afternoon, the plan in its current state could at this very moment be being tweaked further. So who knows how relevant this all will be when it sees the light of day?
The major alteration, and now the centerpiece of the deal, is that step one will consist of “capital (meaning here: money) injections” into the country’s banks (hmm, sounds kind of sexy). Some $250 billion worth. What this involves is taking an equity stake (hmm, sounds kinda tasty) with the purchase of preferred stock and warrants on common stock (preferred stock differs from common stock in that it pays a fixed “dividend,” carries with it no voting rights and, if the company runs into solvency issues, will get paid off before common stock; warrants are “rights” to buy stock).
The deal was brokered by Paulson, who reluctantly accepted the approach that had previously been favored by people like U.K. Prime Minister Gordon Brown, claiming that the direct cash injection approach – which many favored over the more indirect “toxic paper” purchase approach – was a sign of weakness (MEN!). In a scene that sounded a bit like something out of Hollywood (minus the sex and violence, as far as I know), Paulson called the heads of America’s major banks to the Treasury, who, somewhat reluctantly, agreed to participate on a “voluntary” basis to the, as one person put it, “take it or take it plan.” This amounts to an, at least temporary, semi-nationalization of the commercial banking system. Additionally, the option of using some of that $700 billion to buy bad debt is still on the table, on sort of “wait and see” basis. There are a few other elements included in the plan, but space here is too limited to name them.
First of all, let’s be clear about a few things. This is no magic elixir. Once the capital injections begin, the healing will take time. We currently have a huge “crisis in confidence” concerning much of our financial system, and considering that this fiasco didn’t just happen overnight, it won’t be fixed overnight either. Assuming that the recently approved plan works – as well as the other steps being taken or that will be taken to heal our wounds – I’ll leave the predictions as to when we can safely say this nightmare is behind us to the crystal ball gazers (or at least maybe another column on another day … ).
Another caveat is that this program is going to be managed by the same folks whose past missteps have helped get us into the mess we are now in. For one thing, both Paulson and Bernanke (and so many more – myself included) underestimated the massive spillover affects from the subprime crisis.
In addition, up to this point you may have noticed that I have not used the term “bailout.” This too was, in my opinion, a major gaffe. The emphasis should have been that the plan was not a bailout, per se, of a system that has failed so miserably, but rather a plan to rescue your way of life as you know it.
There was also massive failure in simply explaining to the public how the government’s plan was supposed to work. In times of uncertainty, clarity is essential. Consistency is also necessary, and, again, here the government failed when they let Lehman Brothers go belly-up after saving other institutions.
In short, with the banking system staggering from a series of blows, already acting rather chilly to potential borrowers – including each other – it was frozen nearly solid by the failure of Lehman.
Thus, let’s just try to carry on with our lives as normally as possible, and hope that the flawed but (again, in my opinion) necessary rescue plan will work its magic.
On second thought, let’s pray.
