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TARP 1.0 Didn’t Get Lending Going and TARP 2.0 Won’t Be Much Better" rel="bookmark">TARP 1.0 Didn’t Get Lending Going and TARP 2.0 Won’t Be Much Better

TARP 1.0 didn’t get lend­ing going and TARP 2.0 won’t be much bet­ter. The prob­lem is that TARP 2.0 con­tin­ues to focus on banks as the pri­mary lend­ing insti­tu­tions despite the fact that banks aren’t the pri­mary source of non-real estate credit for con­sumers or busi­nesses. Most non-real estate lend­ing takes place through the “shadow bank­ing” sys­tem which was bypassed by TARP 1.0; and, it doesn’t look like TARP 2.0 is going to help non-bank insti­tu­tions either. Until Gei­th­ner addresses the liq­uid­ity issues of non-bank lenders and investors, nor­mal lend­ing won’t restart.

TARP 1.0 didn’t restore the nor­mal func­tion of the con­sumer and com­mer­cial credit mar­kets because it used flawed logic. Paul­son incor­rectly believed in a “cause and effect rela­tion­ship” that didn’t exist. He thought that increas­ing bank equity would result in increased lend­ing. Unfor­tu­nately, he was wrong because most non-real estate lend­ing takes place out­side of the bank­ing sys­tem and lenders and investors out­side the bank­ing sys­tem didn’t get helped by TARP 1.0. So, while banks ben­e­fited from TARP 1.0, it didn’t help the com­pa­nies that lend the most to con­sumers and businesses.

Also, TARP 1.0 didn’t work because it was “back­ward lean­ing”, i.e., it didn’t pro­vide cap­i­tal for new loans but tried to fill in cap­i­tal holes cre­ated by old loans turned bad. To stim­u­late new lend­ing, TARP 2.0 needs to be “for­ward lean­ing pol­icy” and focus on new loans while hav­ing other pro­grams fix past prob­lems. Replac­ing lost cap­i­tal and a melt­down are great pol­icy objec­tives but they are dif­fer­ent from mak­ing new loans.

While one sec­tion of TARP 2.0 is for­ward lean­ing, it doesn’t work because it almost entirely misses non-bank insti­tu­tions. Instead of look­ing for ways to restart non-conventional lenders and investors, Gei­th­ner reverted to what he is famil­iar with and focused on using the ulti­mate bank­ing insti­tu­tion, the Fed­eral Reserve, to restart lend­ing. But, non-bank lenders and investors don’t nor­mally inter­face with the Fed­eral Reserve, and, the AAA rat­ings require­ments to qual­ify for Fed­eral Reserve stim­u­lus puts even more dis­tance between non-bank lenders and Treasury’s pro­grams. Gei­th­ner made the rookie mis­take of retreat­ing into his “com­fort zone” to solve the prob­lem with­out exam­in­ing alter­na­tives. He is com­fort­able in the ster­ile world of Fed tech­nocrats and not expe­ri­enced in the down and dirty world of decen­tral­ized non-bank institutions.

But, Gei­th­ner is a quick learner so there is hope that he will ditch pol­icy ini­tia­tives that don’t work.

Set forth are four sug­ges­tions for ini­tia­tives that will get the non-bank sys­tem work­ing again.

  • Form new gov­ern­ment spon­sored finan­cial guar­anty and bond insur­ance com­pa­nies. The fail­ure of the finan­cial guar­anty and bond insur­ance indus­try led the U.S. into the finan­cial cri­sis and the restart­ing of this indus­try will help lead Amer­ica out. These insur­ance com­pa­nies work because they cre­ate oper­at­ing effi­ciency for investors and back up their work by assum­ing risk. The bond insur­ers serve a func­tion sim­i­lar to rat­ing agen­cies but unlike rat­ing agen­cies, the bond insur­ers align their inter­ests with investors by putting “skin” in the game. Bond insur­ers were essen­tial to the cap­i­tal mar­kets for decades. Newly formed and well cap­i­tal­ized bond insur­ance com­pa­nies can be started by Trea­sury in a mat­ter of weeks and, if formed, will help restart­ing lend­ing.


  • Amend the mutual fund and tax laws to pro­mote the for­ma­tion of tax effi­cient pools of invest­ment money for lend­ing. The inter­play of the laws gov­ern­ing mutual funds and taxes make it dif­fi­cult, if not impos­si­ble, for investors to form tax effi­cient invest­ment pools that orig­i­nate and own high qual­ity com­mer­cial and con­sumer loans. The laws are anti­quated, restrict cap­i­tal for­ma­tion, inad­ver­tently encour­age risky behav­ior and make lit­tle com­mon sense. A pas­sive invest­ment in a non-mutual fund direct lend­ing pool can have dis­as­trous tax con­se­quences for for­eign­ers, not for prof­its, pen­sion funds and indi­vid­u­als (because of state tax­a­tion issues in the case of indi­vid­u­als). And, the laws reg­u­lat­ing mutual funds have the unin­tended side effect of encour­ag­ing risky behav­ior instead of pru­dent lend­ing. Gei­th­ner can fix these laws and encour­age the for­ma­tion of invest­ment cap­i­tal to restart lend­ing. And, there will be no impact on Fed­eral spending.


  • Expand the Com­mu­nity Devel­op­ment Finan­cial Insti­tu­tions Fund. Every year the IRS grants sev­eral bil­lion of tax cred­its to lenders through the Com­mu­nity Devel­op­ment Finan­cial Insti­tu­tions Fund (“CDIF”). This pro­gram is sup­posed to encour­age eco­nomic devel­op­ment through tax cred­its that are earned by lend­ing in low income and blighted areas. Unfor­tu­nately, over the years the CDIF has favored real estate related lend­ing rather than core busi­ness lend­ing. If CDIF was reori­ented to encour­age busi­ness lend­ing, an exist­ing pro­gram that is annu­ally cost­ing tax­pay­ers bil­lions could be con­verted into an impor­tant tool to restart com­mer­cial finance.


  • Encour­age the SBA to license non-bank lenders and update and mod­ern­ize the pro­gram. The last non-bank lender to receive a new “Sec­tion 7A” license was dur­ing the Rea­gan Admin­is­tra­tion. Under pres­sure from crit­ics, SBA pro­grams have been cut back year after year and are almost totally depen­dent upon banks. The SBA lend­ing indus­try is almost vir­tu­ally irrel­e­vant.


    30 years ago the SBA had a ter­ri­ble rep­u­ta­tion because its pro­grams were badly admin­is­tered. Since then the SBA has shrunk as a pro­por­tion of the econ­omy. But, the SBA’s poor his­tory doesn’t mean that the SBA can’t restart itself and con­tribute to Amer­i­can busi­ness health. A top down review of SBA pro­grams with an eye towards mod­ern­iza­tion and inclu­sive lender eli­gi­bil­ity, includ­ing non-bank par­tic­i­pants, could fix the SBA.

Geithner’s cur­rent pro­pos­als won’t get bank lend­ing going again and cer­tainly aren’t going to get non-bank lenders excited. The Trea­sury Sec­re­tary needs to get out of his com­fort zone and start to look at sup­port­ing non-bank lenders and investors. They make up most of the mar­ket for con­sumer and busi­ness loans and ignor­ing non-bank lenders won’t get the econ­omy going again.

Posted in: BANKS, Bond Insurance, Community Development Financial Institutions Fund, Credit Crisis, economy, Finance, Fiscal Policy, Mutual Funds, Obama, Paulson, Politics, Public Policy, SBA, Timothy Geithner


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