TARP: Take Two (Hopefully in Earnest This Time!)

It appears that the core of the original TARP idea is being resurrected: buying bad assets and securities from banks and putting them into a government-controlled vehicle with the intent of reselling at a later point. From the WSJ over the weekend:

"The U.S. government, recognizing that the banking crisis is far larger than originally thought, is laying the groundwork for a second phase of its rescue attempt, with plans to purge bad assets that are paralyzing the financial system.

Officials at the Treasury, Federal Reserve and Federal Deposit Insurance Corp., in consultation with the incoming Obama administration, are discussing a plan to create a government bank that would buy up the bad investments and loans that are behind the huge losses that U.S. banks continue to report, say government officials."

How is this different from the first incarnation of TARP? Well, even less detail on how the bad assets would be acquired -- at least Paulson had the idea of using an auction -- and also now there is talk of creating a government bank.

So leaving out talk of an auction and introducing the sketchy idea of a "government bank" makes things better (does a government bank take deposits from anyone other than the Fed?)

The allure of injecting equity was the idea of leverage: if we put $100 of equity into a bank, and they are leveraged 10 to 1, then we will get $1,000 of new loans made. Ah, but where does that $900 of capital to lend out come from? With toxic assets on the balance sheet, no new lenders want to throw new funds into the pot that will just go to protect all the existing creditors and equity holders. Indeed, judging from the last few months, the equity injections by themselves have done very little to create more lending.

The balance sheets of the banks have to get purged of the assets that are currently so hard to value. That was the genius behind TARP, and could still be implemented. I bet that we will soon see something very similar to the Resolution Trust Corporation. Hopefully we will not have to wait for banks to actually fail to get assets into the new institution. Talk to some auction theorists and get those auctions moving to buy assets from solvent but illiquid banks, put them into a new RTC, re-securitize them (this time with only one class of pass-through certificates) and return the profits to the taxpayer.