Larry Summers made a convincing case yesterday that Congress should release the remaining $350bn of the TARP. It’s good to see the Obama team emphasizing themes beyond the fiscal stimulus, including banks and housing. Stronger governance and greater transparency are timely commitments for this program, and who can object to limits on executive compensation in today’s environment? Some Congressional debate makes sense and could be productive, but it’s hard to see this request being turned down.
Still, what exactly should the money be spent on? I’m tempted to say: housing, because this continues to be a major unresolved problem that looms over both consumers and their balance sheets. Unfortunately, however, the banks remain a greater priority. The latest developments for both Citigroup and Bank of America suggest the banking situation is (again) seen by insiders as more desperate than we outsiders wished to believe.
The next round of bank recapitalization (again) needs to be big and bold, for example along the lines we have been suggesting for some time (but I’ll take another comprehensive plan, if you have one, with strong expected taxpayer value). The problem today is that we just don’t know if any major bank is well capitalized; there are too many black boxes that may contain toxic assets. At best, this is a brake on the positive effects that should come from the fiscal stimulus. At worst, we still have a major system issue on our hands.
And there is no reason to think that $350bn is enough to handle this problem. The original $700bn was obviously an arbitrarily chosen number, and the money has been spent so far in a rather unplanned manner. What we do next should not be constrained by the fact that there is a check for $350bn waiting to be picked up. We should design a systematic recapitalization program, figure out what it will cost, and get on with it. My working assumption, based on the published analysis of the IMF regarding losses relative to private capital raising, is that $1trn – properly deployed – should do the trick.
Then we should get to work on housing (yes, this needs more money).
Update: Ben Bernanke seems to be thinking aloud along similar lines.
The Baseline Scenario 
Are we not nearing the point where it would be cheaper and more effective to simply capitalize new banks?
Simon,
Investments in broadband and the electric grid strike me as two good ideas I’ve heard. What do you think? (I’m not in private practice and I’m not representing anyone seeking gov’t $$$).
I’m not Simon, but my problem with that stuff is cost-benefit analysis. If it’s not cost-effective, then I have a hard time believing that it’s a good idea, regardless. And if it IS cost effective, then we should do it–regardless of the economics.
Think about it in terms of ethanol. Investing in ethanol SEEMS like a good idea–it’s supposed to be green, and it’s supposed to free us from overseas oil dependence. If it works. But there’s the rub. Because ethanol isn’t actually greener than normal fuel once production emissions are taken into account, and it’s extremely doubtful that it could ever free anyone from any type of dependence because a) it takes a lot of energy to produce ethanol, and b) ethanol has less energy per unit than regular gasoline. So then, ethanol really only works as a corn subsidy. Which is fine… unless you just lost your job, and you need to buy corn. In which case, I bet you wished that the price hadn’t been driven up by laws that force the production of ethanol.
I’m against neither green energy nor infrastructure investment, but I’m against “green” energy that doesn’t really help the environment, and I’m also against infrastructure investment that won’t eventually provide a positive return.
When you say $1 trillion dollars should do the trick (of properly recapitalizing the banks), I presume (and I hope) you mean $1 trillion dollars total. Not $1 trillion dollars in addition to what has already been invested in banks, or $1 trillion dollars (heaven forbid) in addition to the $700 billion dollars of TARP.
Whatever is needed, I would agree with you. Let’s bite the bullet and properly capitalize the banks NOW so that they can start lending and we can get over this crisis of confidence in the financial sector.
Here’s an idea:
Why should the Treasury do all the investing in banks?
The Federal Government should create bonds which pay an interest of 8% (fairly sizable in these times of low inflation). Funds accumulated from the sale of the bonds would go into a pool which would be used by the Treasury to recapitalize banks (much as with the TARP funds).
With tax payment time just ahead, the IRS could promote these bonds and allow tax payers to declare on their tax forms how much of their tax return they wished to use to purchase the bonds. People who had to pay in taxes could pay extra to receive bonds.
The whole thing would be promoted as an INVEST IN AMERICA’S ECONOMIC RECOVERY effort.
If interest earned was tax free for most people (all except the very wealthy), there might be great interest in participating and the pool might be quite large (maybe even big enough to save CitiGroup).
If people are willing to pay money for war bonds, why shouldn’t they be willing to pay money for bonds to save America’s financial system and the economy which depends on it?