December 18, 2008
A ray of sunshine on TARP
"Sunshine", Justice Brandeis famously said, "is the best disinfectant". Last week I had the interesting experience of seeing this in action at the hearing of the House Financial Services Committee to consider a report by the Government Accountability Office (GAO) on the Treasury Department’s implementation of TARP (you can see the full hearing on C-SPAN's web-site).
My first experience doing this sort of thing - it's fascinating to see the gears of government working up-close.
For those who haven't kept up on the day-to-day action on TARP, there is big debate about the use of the $700 billion approved by Congress this October. The Treasury secretary had initially suggested that the funds would be used to absorb mortgage debt and stabilize the market (both in the form of whole loans as well as debt securities - MBS, CDOs and other mortgage securities). Reacting to market events the Treasury instead used the first $350 billion tranche of these funds to buy preferred stock in various banks both large and small (see the latest Treasury Transaction's report for details). Secretary Paulson's argument for this decision is that the objective of saving the US financial system can be best met by better capitalizing the rather than buying up assets. This is certainly a viable argument for anyone who understands the multiplier effect of banking. The hope is that well-capitalized banks can inject credit into the economy as a whole, easing the crisis and letting ordinary Americans and their small businesses get on with their lives.
Lawmakers, on the other hand, are furious about the switch. Largely, I think, due to the perception it creates of helping "rich Wall Street bankers" at the expense of "Main Street". Trickle down economics, it appears, is a powerful argument when it comes to taxes, but not so in the credit markets. The promised expansion of credit has not reached the consumer - or in the minds of Congress - the voter. What has exacerbated this debate are some unfortunate, sensationalized, but coincidental events such as Bank of America's decision to exercise its options to buy an additional $7 billion stake in China Construction Bank. While it's not clear that Bank of America figuratively took this money from the same pot into which TARP capital infusions were made, the timing sure looks suspicious to anyone not familiar with the arcana of bank capital management. The call of the day is for increased transparency into how banks are utilizing the funds invested by the tax-payer.
The matter is of course not quite as simple as it sounds. Banks don't simply take capital infusions and "spend" it on loans. Rather they apply leverage to these funds by borrowing in the market (through depositors, the Federal Reserve or anyone else) and then lending these funds out to small businesses, individuals and other on "Main Street". If your simply following cookie crumbs to see where the money ended up, it comes to an abrupt halt at the point of the purchase of preferred stock. There is no obvious way to link the purchase of $25 billion in preferred stock to a $100,000 small business loan made to someone in Peoria.
If direct transparency is not possible, perhaps indirect methods must suffice. The report by the GAO (see here) lays out some of these methods. After all, what Congress is seeking to ensure is that the infusion of TARP money into the banking system results in actions that improve the overall condition of the economy and also have positive effects on individual consumers. For example, small businesses must find it easier to borrow to run their businesses. Another issue that has come up lately, given its little-guy appeal, is the easing of the crisis in the mortgage market by applying modifications to mortgage loans. All these purposes would be seen as legitimate use of TARP funds, at least in the eyes of lawmakers and those who hold the purse strings to the second tranche of TARP worth $350 billion.
In this sea of accusations and counter-recriminations, largely unsupported by actual facts, the situation is crying out for is more information. Anything that can correlate the infusion of TARP funds to economic stability would be useful at this point. This point is not lost on the government auditors. They note in the GAO report that there are several economic indicators that could suggest the impact of the TARP infusion on the markets. Among them:
1. Treasury-LIBOR spread (TED spread)
2. Corporate spreads
3. Mortgage market indicators: Mortgage Rates, Origination volumes, Foreclosure and default rates
A host of other indicators can also be used such as the prime lending rate, CP rates, Stock prices, House prices etc. The problem with all these indicators is a variety of factors affect them including the actions by the Federal Reserve, FDIC and FHFA. Global economic conditions will also have effects to the point that it may be difficult to show unequivocally that the $350 billion capital injection positively influenced the credit situation in the US economy.
One suggestion in the GAO report has intriguing possibilities - this is to study the FFIEC call report data that banks and thrifts have to report quarterly. This is a compendium of vast quantities of financial data on each bank, parts of which are available to the public (data hounds can find lots of interesting information here). The call report data - available in XML format as well as in a more traditional PDF format - can, over time, give a comprehensive overall picture of the functioning of the economy. The way I would see this happening is for Treasury to build some kind of dashboard showing key metrics from call-reports for all banks. Metrics such as "Other consumer loans (includes single payment, installment, and all student loans)" could be tracked over time and correlated with the infusion of funds to banks.
What would be even more compelling is if this analysis could show where the lending activity is going - for example by industry. A sure-fire attention getter in Congress would be to show this by state. Of course the data is not available at this level of detail. Nor is data available at frequent enough intervals - quarterly reports are just too slow for to meet the transparency needs of an angry public. But these are issues that can be addressed - especially since the advent of XBRL technology within this process.
Transparency to TARP funds is achieveable. These are problems will have to be addressed - but as the old saying goes where there's a will there's a way.
All comments will be much appreciated.
Posted by dkrishna at 09:44 PM
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