Accountability Time

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.

Back in September, Simon and I wrote an op-ed in the Washington Post that focused on the incentive problems in the initial TARP proposal and cynically predicted:

It is most likely that “governance” over the fund will be provided by periodic hearings of the relevant Senate and House committees during which the Treasury secretary and the fund managers will be asked why they overpaid for banks’ securities and will answer that there was no choice if the financial system was to be saved.

(Recall that the proposal at that point was for Treasury to buy toxic assets from financial institutions, most likely overpaying the process.) However, the governance measures were strengthened in the eventual legislation, and it does seem that Elizabeth Warren and most of her committee (Jeb Hensarling, R-Texas, did not endorse the report) are committed to keeping Treasury under tight scrutiny, which is all good.

I’d like to differentiate between two different types of oversight. Simon and I were immediately concerned with the most basic oversight function: making sure there was no fraud, corruption, or pure waste in TARP. This was especially important when Treasury was talking about buying illiquid assets at necessarily higher-than-market prices, which seemed like a recipe for giving taxpayer money to Wall Street. However, it’s still important to ask whether the programs established under TARP, such as the Capital Purchase Program (the main one used to recapitalize banks) represent appropriate uses of taxpayer money or sweetheart deals for recipients. On this issue, the Warren Panel is rightly asking about the investment terms under their fifth question, “Is the Public Receiving a Fair Deal?” Under this heading, it’s also appropriate to ask, “What Is Treasury’s Strategy?” (the first question).

The second, broader type of oversight is figuring out if TARP is working and what all that TARP money is doing. I think it’s good to ask these questions, but the ground we are on is considerably more slippery. The key problem is that Treasury and the Warren Panel don’t seem to agree on what the goals of TARP were in the first place – which, of course, is largely Treasury’s fault for failing to communicate those goals. 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. The goal of the investment (and the contemporaneous loan guarantee program) was, as Treasury says, to increase confidence in banks, so that other institutions would lend to them, and the immediate way to increase confidence is to put the money in your vault. And last I checked, money was fungible. After my company raised our second round of funding several years ago, we put it in the same big cardboard box as the rest of our money, and there’s no way I could have told you what happened to those $100 bills as opposed to the $100 bills we already had. (OK, in reality we had a bank account.)

On the other hand, I would have been able to tell you, at a high level, what the company was doing that we could not have done without that second round of funding. So that seems like a reasonable question that any intelligent CEO should be able to answer in about five minutes.

On the third hand, my main frustration is this: If you want to control what the banks are doing, just nationalize them already! I mean, the consensus among Democratic as well as Republican economists seems to be that government majority control of banks is something to be avoided, and therefore TARP was designed to avoid it; a few people criticized it at the time for not nationalizing banks, but they were pretty rare. However, the consensus (shared by Congress and most of the public that cares) is that banks should be left in private hands, and that they should do what the public wants (lend more). If we really aren’t happy with how the banks are behaving, we should get majority control in exchange for our investments and control them the old-fashioned way: through the board of directors.

OK, now that I’ve gotten that off my chest, I can say that I think the Warren Panel is asking a lot of good questions. They called out Treasury for not explaining its actions well (“The question is how the infusion of billions of dollars to an insurance conglomerate or a credit card company advances both the goal of financial stability and the well-being of taxpayers”), not doing anything about foreclosures (which was a requirement of EESA), and performing sleight of hand with the “healthy bank” designation (Citigroup was a healthy bank?). If only everyone could agree on what the goals are, then maybe we could figure out whether TARP is working or not.

3 thoughts on “Accountability Time

  1. completely agree. oversight needed but holding on to some cash till they see just where it is they will be able to lend profitably is legitimate behavior.

    making loans willy-nilly when consumption is dropping rapidly is not smart. after capital injection some of the larger banks did start re-working mortgages and citi just agreed to let motgages become part of bankruptcy. both smart.

    tarp started with working on the bank balance sheets and should move to consumer balance sheets. it helps put a floor in for consumption.

    once we can see the floor (or about where it might be)the lending and risk taking can start in earnest again.

  2. Few dare to talk about nationalizing the banks because is considered “socialism”, and people in this country are still fearful of anything associated with that word (and it can be used politically) and would be considered an extreme measure, which might lead to a further erosion of confidence

  3. The following offers a different perspective. It may sound strange. Fresh ideas do.

    Different goals, you note, complicate oversight. Were the goals to: stabilize financial markets and reduce systemic risk; support the housing market by avoiding preventable foreclosures and supporting mortgage finance; and, protect taxpayers? Alternatively, were they to increase lending and revive the economy?
    Not all the above, you suggest, because “you can’t get everything for only $350 billion when you’re dealing with a $14 trillion economy”.

    Yet, $350 billion is a one-time intervention. The US economy may be $14 trillion a year but the global economy is at least $30 trillion, and this is a global economic crisis. If $350 billion, or even President-elect Obama’s $1 trillion, are more than a drop in the US bucket, they are little more in the global context.

    I get the sense from your recent posts that economists are beginning to realize the futility of these actions (backlash, indeed!). If you cannot solve these problems by throwing money at them (because you have not enough) what can you do?

    The first step is to accept that the global economy is a complex adaptive system with a life of its own and the ability to learn, adapt, grow and change. The natural equilibrium of such systems (“homeostasis”, in the jargon of complexity science) means that actions top-down and from the centre (like TARP) are almost certainly doomed to fail and more than likely to have unintended and harmful consequences.

    This is a tough one for macroeconomists and politicians because it seems, at first, to put them out of a job. We have to control complex adaptive systems indirectly. Management is about seduction not coercion, pulling not pushing. In the end, we have to place the problem back in the community by putting it in touch with itself, raising the “collective mindfulness”.

    The first step in managing relationships this complex is to transform the messy network of connections, with some parties talking to too many others and other parties inadequately engaged, into a “small-world network” of interfaces, tightly connected within the interfaces and loosely connected between interfaces.

    The next step is to clarify the aims (goals) of each interface by embracing the unknowns (such as, obviously, the dynamics of the global economy) and challenging the knowns (the unfounded certainties of traditional accounting, economics and finance, for example).

    Different interfaces will certainly formulate different goals.

    When physical and financial assets have lost their value, the only way forward – for all of us – is to improve the quality of the discourse. Such actions help.

Comments are closed.