TARP oversight panel skeptical about Treasury approach to bailout

Exclusive reporting for FinReg 21 by Darrell Delamaide

While it acknowledges that the Treasury’s Public-Private Investment Program using congressional bailout funds might work if its assumptions are correct, the bipartisan panel charged with oversight of the Troubled Asset Relief Program funds is decidedly skeptical.

“It is possible that Treasury’s approach fails to acknowledge the depth of the current downturn and the degree to which the low valuation of troubled assets accurately reflects their worth,” the panel, chaired by Harvard law professor Elizabeth Warren, says. “If the economic crisis is deeper than anticipated, it is possible that Treasury will need to take very different actions in order to restore financial stability.”

The panel’s main bone of contention with the Treasury plan is the level of subsidy involved in the PPIP, based on the assumption that the toxic assets on banks’ books really are worth a lot more than the market is currently willing to pay for them.

The six-month report mandated by Congress looks at other examples of banking crises, such as those in Japan and Sweden in the 1990s. It concludes that Japan tried for too long to subsidize the banks and only found an effective solution when it took more radical measures to restructure and recapitalize the institutions. Sweden took this approach from the beginning and resolved its crisis much more quickly.

“The Japanese case demonstrates the hazards of open-ended government assistance,” the report says. “Without predictable limits or a known exit strategy, investors suspected, rightly, that they could continue to rely on capital infusions to large, powerful institutions indefinitely. Important economic actors lacked the incentive to accept their losses, accurately value assets, and put the assets back into their most productive use.”

The panel is also skeptical about Treasury’s argument that PPIP will result in something like market prices for the assets, again because of the subsidies implicit in the government’s cash injections and guarantees. “Without non-subsidized buyers, market functioning is an illusion,” the report says. “History offers no examples in which subsidization of existing shareholders and management produced effective assessment of asset values.”

The report affirms that the objective of correctly valuing the assets is correct, but remains skeptical that Treasury’s approach is the best way to do it. It cites the historical precedents to suggest that stronger government intervention may be necessary. “All successful efforts to address bank crises have involved the combination of moving aside failed management and getting control of the process of valuing bank balance sheets,” the report says.

The panel also finds fault with the transparency of Treasury’s actions and seeks more disclosure. The panel’s February valuation report, for instance, showed that Treasury provided the top 10 TARP recipients with a subsidy of $78 billion over the market value of the preferred shares purchased, despite Treasury’s representations of these purchases as being made at par. This finding “reinforced the importance of a comprehensive explanation by Treasury of its strategy and approach,” the report concluded.

The panel’s other members are Rep. Jeb Hensarling, a Texas Republican; Richard Neiman, the New York state superintendent of banks; Damon Silvers, associate counsel at the AFL-CIO; and John Sununu, a former Republican senator from New Hampshire.

In an "additional view." Neiman and Sununu demurred somewhat from the report's tenor, arguing that it strayed too far from the panel's core mission of evaluating the effectiveness of TARP in dwelling so much on historic alternatives and casting doubt on Treasury's strategy. They affirmed that Treasury's economic assumptions are reasonable and the strategy could work.

In a second additional view, Sununu went so far as to say his differences about the scope of the report made him unable to support its release.

Darrell Delamaide is a veteran financial journalist who has worked for Dow Jones, Bloomberg, Institutional Investor, among others. He is based in Washington, D.C.