December 23, 2008

Pressure Lending

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Many are up in arms about President Bush’s decision to allocate up to $17.4 billion of TARP money to the U.S. automakers, and rightly so. However, this only represents about 5 percent of the first $350 billion of TARP funds. The real issue at hand is why the economy, and specifically credit markets, has yet to improve despite all of the government’s efforts. This week, in a move of what some are calling desperation, the Federal Reserve lowered the fed-funds target rate to between .25 and 0 percent. Fed Chairman Ben Bernanke has pledged to use everything in his arsenal to stem the continued economic downturn. Nobody is quite sure what these additional measures may be, but the Fed has already turned on the printing press, loaned money to banks and backed loans. While rates have come down, the very companies that are receiving aid from taxpayers will not utilize the money.
The original plan was to purchase the illiquid assets. The plan then morphed into buying equity stakes in banks. The principle behind this measure is that banks can best decide how to utilize the money, not the government. This logic is flawed, however. The very companies that completely overlooked changing market conditions and ignored risk management by leveraging themselves in order to obtain ever-higher profits are now being entrusted with billions of taxpayer dollars without substantial restrictions.
The decision to both lend and give these companies access to capital was the proper one. However, the manner in which the plan has been carried out has lacked both certainty and success. The government should mandate that upon receiving TARP funds, a bank must loan a certain percentage of its funds to qualified borrowers. In addition, the government needs to make it clear what role it will play in these banks and how it will deal with the warrants it has issued. Otherwise, the top down approach to fixing financial markets that the government hoped for will not materialize.
The goal of TARP, TAF and other measures is to create incentives for financial institutions to begin borrowing and lending once again. To date, these measures have in fact failed to provide substantial incentives. The government has the power of the purse, but it also has the power of the government. Substantial pressure should be placed on banks receiving TARP money to lend. Of course, the banks themselves should establish the terms of lending agreements, but there must be pressure applied in order to open up the credit spigot.
A requirement that banks lend, rather than holding interest rates at virtually zero, is needed. In fact, the low fed-funds rate has the consequence of eliminating incentives to lend in the repo market, a critical lending market for many financial institutions. In a press statement released by the Treasury, FDIC and Federal Reserve, “The agencies expect all banking organizations to fulfill their fundamental role in the economy as intermediaries of credit to businesses, consumers, and other creditworthy borrowers.” Well, beneficiaries of the government programs are taking taxpayer money and thumbing their noses at Paulson and Bernanke. The next administration will have $350 billion to work with. Spending to stimulate the economy via infrastructure rebuilding and public works projects, while beneficial, may take years. A clear and decisive plan by the government, coupled with pressure on banks to stop hoarding TARP cash, will tackle the true, underlying problems of the economic downturn.