Shocker: Addressing toxic assets instills market confidence

The financial crisis occurred because of the collapse of the housing bubble, which left trillions of dollars in assets tied to bad mortgages on the balance sheets of banks, lenders, and financial institutions.  We knew this in September, which is why Congress originally allocated $700 billion to Treasury to start purchasing the mortgage-backed securities and provide a valuation floor in order to stabilize financial institutions.  Instead, Henry Paulson and then Tim Geithner started throwing money at private companies, ignoring the root cause of the problem.  Markets tanked as investors lost confidence in both the Bush and Obama administrations’ ability to comprehend and respond to the real crisis.

Today, Tim Geithner finally rolled out a plan to deal with the underlying problem of toxic assets — and to no one’s surprise, the markets responded with new confidence:

Financial stocks led a market surge Monday after the government explained in greater detail its plans to take bad credit bets off of banks’ hands.

At 11:00 a.m., the Dow Jones Industrial Average was up 300 points, climbing above 7500 as all 30 of its components rose. American Express, Alcoa, Bank of America, Citigroup and J.P. Morgan Chase saw double-digit percentage gains. General Electric and Caterpillar each rose 7%.

The Treasury Department said Monday that a new public-private partnership could purchase $1 trillion in soured assets from banks, which would allow them to renew lending. Taxpayers will stand to reap gains — alongside investors such as hedge funds and private-equity firms — if the investments prove profitable.

Investors have been eager to hear details on the Obama administration’s plans. There was widespread frustration on Wall Street last month that the Treasury didn’t unveil a plan sooner, but investors were comforted by statements from executives at several bellwether banks that their firms have been profitable in recent months. Last week, the market hailed new steps by the Federal Reserve to bolster the credit markets.

The Fed jumped into the toxic-asset market because of the vacuum of leadership at Obama’s Treasury.  Instead of coordinating with Geithner, who has kicked the can down the road more than once on his own plans, the Federal Reserve announced plans to buy up to $750 billion in mortgage-backed securities.  The move helped stabilize the markets last week as investors can finally look for a rational valuation of assets and improvements in capitalization ratios.

Jim Geraghty notices a fly in Treasury’s MBS ointment, though:

Under the Paulson plan that I was a tentative supporter of, the government was supposed to buy these toxic assets. Under this plan, government loans private traders 95 percent of the money to make the purchase. If the assets turn out to be more valuable, the firm makes a profit. If they aren’t, the taxpayer’s left holding the bag.

Under the original TARP plan, taxpayers held both the risk and the reward.  Had we moved forward with that rather than just write blank checks to Treasury, we’d probably already have started to see a rebound in the investment.  Now any rebound will profit the partners rather than the taxpayers.  We’ll benefit indirectly from the financial recovery, but only if there’s a recovery.

Why didn’t we move forward with TARP in the first place?  We can’t blame that on Obama, or at least not all of it.  The Bush administration bailed out on TARP in favor of direct bailouts to companies deemed “too big to fail”.  We wasted three months during the Bush administration, but Obama promised to hit the ground running — in fact, that’s why he insisted on getting Geithner despite his tax-evasion problems.  Instead, Obama and Geithner dithered while the markets withered, preferring to focus on Porkulus and the leftover omnibus spending bill (and its 8000 earmarks) rather than address the central problem.

But why?  I’d guess that the purchase of the government-mandated, Freddie Mac/Fannie Mae MBSs makes it look as though the CRA-inspired government intervention in the lending markets created the financial crisis — which it did.  Without the Freddie/Fannie-fired boom in lending to unqualified borrowers touched off by the Congressionally mandated MBSs, we wouldn’t have had them infecting the financial system in the first place and housing valuation would have remained linked to inflation, as it has for the past 100 years.  I’d say that the Obama administration doesn’t want people to take that lesson from the crisis, because they plan to conduct the same intervention at a later date under a new name.  Otherwise, the real TARP should have been Treasury’s Job One.

And Jim Geraghty finds the proof for that, too:

KING: Mr. Liddy said he is going to break up AIG. Do we need to break up Fannie and Freddie?

ROMER: I think that is certainly going to be an issue going forward. I think it should be part of the overall financial regulatory reform, to figure out what is the best way.

Again, you know, anytime we have now got taxpayer money on the line, what we have an obligation to do is do it in a way that protects the American taxpayer. What is going to be the way that gets these institutions safe, gets them doing what we need them to do, which is lend like crazy, and just basically functioning again for the economy.

In other words, we’ve learned nothing from this collapse.  I wonder if we’ll learn anything from the one that follows.

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