TARP performance examined

With Congress back in session, accountability is the theme of the week. Barney Frank announced the “TARP Reform and Accountability Act of 2009,” which I hope to get to in a day or two. But for now I want to talk about Elizabeth Warren and the Congressional Oversight Panel for TARP, which issued their second report on Friday. Of course, beating the accountability drum at Henry Paulson’s expense is politically easy, and a lot less controversial than, say, designing a stimulus package or a foreclosure reduction plan. But that doesn’t mean it isn’t important.

…According to Treasury, the goals of TARP are:

Stabilize financial markets and reduce systemic risk Support the housing market by avoiding preventable foreclosures and supporting mortgage finance; and Protect taxpayers.

I actually agree with those goals, and I think the first one is the most important. However, the Warren Panel (and the Democratic majorities of both houses of Congress, and the large majority of the American public who pay attention to this issue) think that the goal of TARP should be to increase lending and revive the economy. That’s why question 4 is “What Have Financial Institutions Done With the Taxpayers’ Money Received So Far?” and question 6 is “What Is Treasury Doing to Help the American Family?” (”The Panel asked whether Treasury’s actions preserved access to consumer credit, including student loans and auto loans at reasonable rates.” But remember, you can’t get everything for only $350 billion when you’re dealing with a $14 trillion economy.)

I know I sound like a Paulson apologist (although here are my anti-Paulson credentials), but here goes. When the EESA was approved and the first round of bank recapitalizations were announced in October, the widespread fear was that the banking sector would simply collapse altogether, causing catastrophic damage to the real economy. The problem was that no one trusted that the banks had enough money to keep operating, which can quickly become self-fulfilling. The solution was to give them cash. The terms were pretty generous, and there wasn’t enough cash, as I wrote at the time, but that was the first step in stopping the bleeding. And if a bank is facing a liquidity crisis, and it gets a capital injection, the last thing it should do is immediately lend the money out again, because that will just put it back into a liquidity crisis.

Since then, however, it’s become generally accepted that the purpose of bank recapitalization was to get credit flowing, to the point where even the Federal Reserve is confused. I agree that the point of having a financial sector is to get credit flowing; I just think that preserving confidence in the financial sector’s ability to continue existing is prior to increasing lending by the financial sector.

The Warren Panel thinks it’s not enough for banks just to have capital, and so they are pressing the question:

The Panel still does not know what the banks are doing with taxpayer money. . . . So long as investors and customers are uncertain about how taxpayer funds are being used, they question both the health and the sound management of all financial institutions.

I have mixed feelings about this. On the one hand, the charge doesn’t really make sense: the way to assess the health of a bank is to look at its financial statements, not to find out what it did with a particular bundle of money it got from Treasury.