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 Better7 Comments
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.