TARP Madness

As I listened to a replay of the House Financial Services Committee’s hearing this week a few things occurred to me. Conservatives are mad because government meddled in the holy grail of free markets which is Wall Street and banking. Poor liberals are mad because the leadership of the institutions which received TARP money make more in a day than they do in a year. The leadership of these institutions is mad because they have to answer to people like Chairman Barney Frank (D-MD). Frank and other lawmakers are mad because the former Secretary of the Treasury, Hank Paulson, pulled a better bait and switch than a used car salesman with the funds. The Obama Administration is mad because they have to sell the next 350 billion dollar installment of this program and probably a minimum of 500 billion more with the current TARP track record hanging over them. Finally, the American people are mad because no one has taken the time to explain a damn thing to them about anything associated with the TARP program. Paulson and the Congressional leadership pretend we are unaware of the severity of the situation. They feel as though giving us the details would somehow make it true and our financial system would grind to a halt. Well, we are just short of that today, so go ahead and tell us the horror stories. If you want our support, we need to know EXACTLY what could happen if we don’t do a TARP or a TARPalike.

Since TARP has become a four-letter word and the problem of the credit markets is still around, maybe it is time for a new approach. Last week Tim Geithner, the new Treasury Secretary, made a pitch for the something like a new approach for second installment of the 700 billion dollar bailout. It was a tough crowd. Bank stocks plummeted and everybody that is mad over TARP stayed mad. I am not an economist so the following proposal may be as hair-brained as a screen door on a submarine; but, let’s follow the logic and see where it goes.

Instead of government continuing to pick winning and losing financial institutions in this crisis, let’s go to the source. Let’s spend the rest of any bailout monies on the problem. Geithner and others seem to continue to try to do things with the securities generated by home loans both good and bad. Maybe a better approach would be to fix the loans. Now, I can already hear people screaming about moral hazards. It is a moral hazard, they say, to help people who obviously bought houses beyond their budget or on terms they knew they couldn’t pay.

Ironically, some pretend there is no moral hazard on Wall Street so it is ok to have what Barney Frank calls “collateral benefit” for financial institutions. I say the bankers who bought and sold the securities were by and large in a better position to determine the risk of mortgage product like an adjustable rate mortgage than the home buyers were. If anyone gets the benefit of the doubt, it should be the homebuyer.

So, what can we do for the homebuyer? One thing we can do is freeze all foreclosures immediately. Force the mortgage servicers and the homebuyers to renegotiate the loans. Change the bankruptcy laws so that the first to get paid will be the mortgage holders. We should do this because many banks will have to take reduced principle and interest or a “haircut” on most of the loans if forced to negotiate. These actions guarantee mortgage securities will have some value. They probably won’t have the value the investors hoped. Those securities however, will have a definable value.

The value of the home, mortgage and mortgage security will end up being what the homebuyers can afford. Mortgage security holders who expected to make double the return on investment should have also understood those high-paying securities had a higher risk. At least they get some of their investment back. Making the basic unit of a mortgage security, the individual mortgage, solid will also aid in other areas. Some of the other exotic financial instruments like credit default swaps will also be fixed by this approach because institutions may be better able to survive when large parts of their portfolios are re-valued in the program I have outlined.

There will be homeowners who are not able to participate in the renegotiations I describe. They may have lost a job, became sick or some other thing that would prevent it. These mortgages should be assumed by bailout money and resold to the market on an incremental basis after the housing market becomes healthy again.

There are devils in the details but we need a new plan. The current plan seems to make everybody mad.