COP on the Beat
As we see today the life insurance industry set to get in on the bailout act and receive TARP money, the Congressional Oversight Panel, charged with actually overseeing the Treasury Department's TARP strategy, has released their latest report, which is unsparing. Elizabeth Warren, the chair of the COP, delivers a video introduction.
The report looks back at how these types of financial crises have been traditionally handled over time. Warren offers three choices to policymakers: liquidation (essentially what we did in S&L crisis), receivership (the Swedish option), and subsidization (what we're doing to keep zombie banks alive, like in Japan). As you can see above, Warren handles each of these options expertly, and finds four crucial actions needed to successfully resolve banking crises:
• Transparency. Swift action to ensure the integrity of bank accounting, particularly with respect to the ability of regulators and investors to ascertain the value of bank assets and hence assess bank solvency
• Assertiveness. Willingness to take aggressive action to address failing financial institutions by (1) taking early aggressive action to improve capital ratios of banks that can be rescued, and (2) shutting down those banks that are irreparably insolvent.
• Accountability. Willingness to hold management accountable by replacing – and, in cases of criminal conduct, prosecuting – failed managers.
• Clarity. Transparency in the government response with forthright measurement and reporting of all forms of assistance being provided and clearly explained criteria for the use of public sector funds.
Warren concludes that the TARP bailouts failed to provide transparency, accountability or clarity. The Geithner Treasury Department plans, including PPIP and increased transparency, still fall short. "Bottom line: Treasury's efforts to date could be enough, but we will continue to press Treasury about these four tests." Essentially, Warren gives a mixed review, and she thinks that the Treasury efforts are based on the idea that the problems are temporary and not systemic.
One key assumption that underlies Treasury’s approach is its belief that the system-wide deleveraging resulting from the decline in asset values, leading to an accompanying drop in net wealth across the country, is in large part the product of temporary liquidity constraints resulting from nonfunctioning markets for troubled assets. The debate turns on whether current prices, particularly for mortgage-related assets, reflect fundamental values or whether prices are artificially depressed by a liquidity discount due to frozen markets – or some combination of the two.
If its assumptions are correct, Treasury’s current approach may prove a reasonable response to the current crisis. Current prices may, in fact, prove not to be explainable without the liquidity factor. Even in areas of the country where home prices have declined precipitously, the collateral behind mortgage-related assets still retains substantial value. In a liquid market, even under-collateralized assets should not be trading at pennies on the dollar. Prices are being partially subjected to a downward self-reinforcing cycle. It is this notion of a liquidity discount that supports the potential of future gain for taxpayers and makes transactions under the CAP and the PPIP viable mechanisms for recovery of asset values while recouping a gain for taxpayers. On the other hand, 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 actions undertaken by Treasury, the Federal Reserve Board and the FDIC are unprecedented. But 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.
I think Warren is being overly polite, but she's saying all the right things. And I think she's informing some of Congress' moves in this area. The House Oversight Committee is examining the "special purpose vehicles" allegedly used to skirt executive pay restrictions, which contain elements of accountability and clarity. Geithner and the Treasury Department are clearly acting assertively, but to what end? I think Warren's report is spot-on, and needs a wide audience.