Catastrophe - Dick Morris [37]
That’s why the Federal Reserve, the Treasury, and Congress applied first aid to stop the bleeding by pouring $700 billion of TARP funds into these financial institutions to make their balance sheets look better. This is the money most of these banks and brokerage houses chose to keep in the Fed’s vault, rather than spending it as it was intended.
But better balance sheets didn’t bring liquidity. Aware that these banks were being propped up by TARP, investors stayed away from buying their stocks and bonds. Unable to raise capital, the banks never reopened their lending windows. So TARP stopped the banks from failing but didn’t do much to get the economy rolling.
All of which leaves Obama with two options:
Get the government and private investors to partner in buying up the toxic assets to get them off the bank balance sheets, or
Nationalize the banks and have the Treasury do it.
The hope that underpins both approaches, of course, is that the economy will recover, so that homes’ values will rise and their prices will become high enough to pay off the mortgages. It is inevitable that this will happen at some point, but it could take a lot of waiting around. If the loans that are in default are on the bank balance sheets in the interim, the banks won’t lend money. But if they are wiped off and the Treasury or outside investors hold the debt while waiting for the value of the underlying properties to appreciate, the banks will be free to lend again. At least that’s how it should work in theory.
Obama says he’s betting on a public-private partnership to buy up toxic assets at a fraction of their book value and hold them until the economy turns around. Then the plan would call for them to be sold them on the open market, with the private investors and the taxpayers sharing the gains. If the plan backfires and the assets never fetch a decent price, the investors and the government will share the loss between them.
The big problem is how to induce investors to share the risk and the outlay with the government. As Treasury secretary Timothy Geithner told the Wall Street Journal, “government cannot do this [clean up the bank assets] alone.” Geithner notes, correctly, that “the best way to get through this [crisis] is if we can work with the markets. We don’t want the government to assume all the risk. We want the private sector to work with us.”117
The problem, as the Journal noted, is that Geithner’s plea for private participation comes “at a time when Wall Street moneymakers are being vilified by the public and politicians.”118
Just as with the TALF program, Obama’s plan to rescue banks will be destroyed by his own populist rhetoric. When the president jumped in with both feet and decried the bonuses paid to AIG executives, calling for congressional or Treasury action to get the money back, he may have scored political points. But in doing so he sent a chill through the financial markets—a chill that makes it unlikely that they’ll participate in any bank rescue effort. After all, if they do join in and their risk taking is rewarded, can’t you see the Democrats demanding caps on their bonuses? Won’t the government seek a larger share of the winnings—especially if the taxpayers are still left with some amount outstanding—rather than allow those rich, evil investors to make millions or even billions of dollars of profit?
The lesson of AIG is: what the government wants, the government gets. By voting a special tax on AIG bonuses, the House of Representatives showed that, in today’s Washington, populism trumps good sense. Whether out of conviction or fear, legislators are willing to flay investors if that’s what it takes to appease the public’s bloodlust.
Since no investor wants to be the next one on the guillotine, the wisest course is to stay out of any bank rescue scheme. And, most likely, the investors will do just that.
To lure them in, Geithner has a backup plan: give away the store. His proposal for a public-private “partnership” is simple: