Under pressure to take action to resolve the banking crisis, the Treasury Department has revealed a plan to facilitate the cleansing of bank balance sheets through the auctioning of toxic assets to the private sector.
As described, the plan is likely to attract the private investment critical to execution. However, a closer inspection of the limited detail exposes severe flaws from a monetary and fiscal perspective.
The key elements described at this point are auctioning "toxic" or illiquid assets to the private sector, expanding the asset classes that can participate in the Term Asset-Backed Securities Loan Facility to include legacy (2005-2007 vintage) residential and commercial mortgage securities, attractive pricing to drive investor interest, profit sharing and aggressive financing through the Treasury or the Federal Reserve Board.
Most of the elements, which are subject to greater clarification, are critical to restoring confidence and transparency to the global banking sector. Treasury Secretary Timothy Geithner is on target by focusing on leveraging private-sector resources as a means to that end. Similarly, expanding the Talf focus to deal with legacy assets is right on point. You simply cannot stimulate widespread participation in new securitization programs without handling the dirty laundry of the past.
The strategy takes a wrong turn when aggressive nonrecourse financing is thrown into the mix.
One only has to observe the historic highs for credit default swaps on Treasuries to realize that there is worldwide fear in the continuation of a monetary policy that is becoming increasingly reliant on the printing of money to finance a rapidly expanding menu of crisis remediation and stimulus activities.
Individually, these activities may intuitively make sense. However, in the absence of a comprehensive plan that accounts for all the moving parts and provides an exit strategy that is comprehensive and understandable to the American taxpayer and foreign investors in our debt, fear and uncertainty will continue to be a dominant force driving the markets.
From a monetary perspective, the financing of these assets at high leverage levels will further crowd the field of Treasury financings otherwise needed to support a yet-to-be-formulated comprehensive plan with an exit strategy. As it stands, the trend towards unbridled deficit spending is perceived as a path that can only move the country from one economic crisis to another and pass the problems on to future generations.
From a fiscal point of view, bloating the federal balance sheet to support aggressive financing terms defeats the very principles of transparency that has been preached by the administration almost daily.
It promotes the deferral of accountability for the costs (potential losses) of the economic recovery until such time as the performance on the leverage can be determined.
Should the assets underperform, the high leverage and nonrecourse attributes virtually guarantee that the taxpayer will continue to bear the true risks.
Finally, a review of the criteria for private-sector participation in the Public-Private Investment Program for legacy securities requires eligibility standards that will limit the program to five institutions.
These stringent requirements create the perception of a club rather than a public/private collaboration and virtually assures a noncompetitive bidding environment. There are certainly many smaller firms with considerable expertise and the operational capacity to meet the program objectives and allow for broader private-sector participation.
Leveraging the private sector to cleanse the balance sheets of our largest institutions makes sense. So does providing attractive enhancements (even perhaps a conservative level of financing) to facilitate the expedient execution of the strategy. But providing aggressive nonrecourse financing is not the answer.
