WASHINGTON — The Treasury Department's changing goals and shifting rationales for new programs is undermining the market confidence it is trying to restore, observers said Wednesday.
The asset-purchase-turned-capital-injection plan was a case in point. In the last week alone it has had at least three stated goals: shoring up balance sheets, enabling fresh lending, and encouraging deals between healthy and weak institutions.
These goals are not mutually exclusive, but the shifting has produced confusion over whom the government is really trying to help and how.
"Throwing out different purposes of the program confuses people and undermines confidence, which undermines the program itself," said Don Mullineaux, a banking professor at the University of Kentucky. "If you keep changing the rationale … you undercut … the program you are trying to create."
Laurence Platt, a partner with K&L Gates LLP, said the Treasury keeps shifting its focus because new and more significant problems are arising.
"It's the game whack-a-mole; they keep seeing new little moles pop up and then they try to hammer it back down with a mallet," he said.
The Treasury would not comment for this story, but retracing regulators' remarks on the plan to inject $250 billion of capital into banks illustrates the issue.
Treasury Secretary Henry Paulson said Oct. 14 that the capital program was designed to bolster lending, and that banks should use the extra money to offer more credit. A day later Comptroller of the Currency John Dugan said the added capital would be used as a cushion to protect banks against losses in an uncertain future.
By Tuesday, Mr. Paulson was saying the money was a resource for institutions to acquire weaker ones — thus preventing more failures.
"To the extent that Treasury has shifting explanations of its use of congressional bailout funds and shifting explanations of the point of capital infusions, it does undermine confidence in the system that they know what they are doing," said Michael Barr, a former Treasury official in the Clinton administration. "In terms of investors waiting on the sideline, I think that's also a risk."
William Longbrake, a former vice chairman of Washington Mutual Inc. and now a director of First Financial Northwest Inc. in Renton, Wash., said, "It creates confusion at the very least."
The Bush administration's efforts over the last several weeks have been "reactive," said Mr. Longbrake, who is also a consultant for the Financial Services Roundtable.
Karen Shaw Petrou, managing director of Federal Financial Analytics Inc., said the Treasury's confusion about the reason for the capital injection makes it difficult to figure out who should get the money. If there were clear criteria, "then you would have to have a clear policy on what you want the capital to do."
The capital injection plan itself was forged in a change of position. As Congress debated the massive rescue bill, Mr. Paulson was asked several times whether it would be better to recapitalize banks directly instead of buying troubled assets. Mr. Paulson said he did not favor directly injecting capital into banks.
But within days of the bill's passage on Oct. 3, the Treasury switched gears. While it continued to put together its plan to buy illiquid assets, it embraced buying equity stakes in banks.
Though the program was announced more than a week ago, it is still unclear exactly which banks the Treasury is trying to help. It has said the capital is designed to bolster healthy institutions, but it has left the definition of that unclear.
Government officials said Camels ratings should be a factor in granting the capital, but sources said regulators already disagree on where to draw the line. They agree that institutions with poor ratings of 4 and 5 generally should not receive funds, but they are still debating whether those with a rating of 3 should be eligible.
"I've heard there's disagreement on their selection process, which is certainly what you have when you don't have stated criteria," said L. Richard Fisher, a partner at Morrison & Foerster LLP.
Wayne Abernathy, senior vice president for financial institutions at the American Bankers Association, said the Treasury should put to rest speculation and second guessing about the criteria being used by releasing key parameters.
"There needs to be more public disclosure at least about what the general criteria are for evaluating troubled institutions," he said. "There's value in setting out that these are the four, five, six, or seven key areas that we are looking at as we evaluate this issue."
It was also unclear whether the Treasury would overrule the recommendations of the banking regulators. On Monday, Mr. Paulson said his department would give "great weight" to recommendations from the regulators about whether a bank or thrift deserved added capital, but he left the door open to overriding their decision.
"You do run the risk that each agency has its own interpretation and its own spin to the extent you don't develop a common set of criteria that they are all working with," Mr. Abernathy said.
As for how banks would use the money, most observers argue they would horde it — a prospect already worrying some in Congress.
Mr. Longbrake said banks have no reason to use the extra money to lend.
"The anxiety level is extraordinarily high right now, so without having any reassurance on the risk, banks are likely to sit on the capital and wait," he said. "There's no incentive for banks to lend the money out right now, and there's no requirement for the banks to do so."
Mr. Barr also said he doubts capital would be used to further lending.
"That requires certain heroic assumptions," he said. "The capital infusion, I think, is appropriately seen as cushion for financial institutions. It's unlikely to get them to lend in any significant way on its own."
Bob Clarke, former comptroller and a senior partner at Bracewell & Giuliani LLP, agreed there were no incentives to use the capital for lending.
"I don't understand how they get banks to lend," he said.
That has already caused some lawmakers to call for Treasury to attach more strings to any equity stake it takes in banks. On the eve of a Senate Banking Committee hearing on the financial crisis, Senate Banking Committee members Charles Schumer, Jack Reed, and Robert Menendez released a press release demanding the added capital be used to restore lending activities. "This plan will only be effective if these funds are used to increase lending by banks, and it is Treasury's obligation to ensure that," said Sen. Schumer. "The last thing these banks should be doing is stuffing this money under the proverbial mattress."
Sen. Menendez said "banks must understand that these funds aren't a gift."
He said Treasury must ensure that banks use the money to "free up lending, prevent foreclosures and stimulate the economy."