Another Naked Capitalism gem.

More Bogus Bailout Reporting: “As Big Banks Repay Bailout Money, U.S. Sees a Profit”

Congress has a congressional panel to watchdog the use of taxpayer money funding the Troubled Asset Repurchase Program (TARP).  The panel’s chair is Harvard Professor Elizabeth Warren, who is proving to be a refreshingly frank and non political public servant.

The panel has issued a new report and makes a number of recommendations about TARP funds.  The headline recommendation is that Treasury do another big bank “stress test” right now, primarily because the worst case scenario now appears to be too mild.  As an example, the stress test projected an 8.5% unemployment rate as worst case whereas the current unemployment rate is 9.4% and is likely to rise even more in the coming months.

Also, Warren keeps pushing for more transparency, more information about the stress test data, from Treasury.

The nicest thing about Warren is that she doesn’t hector or bully.  But she doesn’t obfuscate either.  She is crystal clear about what she thinks Treasury should do.

Speaking on CNBC this morning,  Warren gave Treasury a “gold star” for transparency pointing out that under Secy. Tim Geithner the department has provided more information “than any Treasury in history.”  She then immediately pushed for more specific information on the stress test (which Warren said used a very good model and gave Treasury kudos there too) so that outsiders could apply their own modeling with confidence. 

Warren presents what can be good about government if the right people are in place.  She deserves attention, not only because she’s doing her job well, but she’s doing so with the right people foremost in her mind: Citizens.

Here’s a prediction.  One way or the other, the taxpayer is going to own one or possibly several major banks within the next few months.  Treasury Secretary Tim Geithner’s real job is to devise a takeover that doesn’t seem to be one.  Beezer wishes him good luck, but no matter what he proposes the real goal has to be de facto nationalization.

In effect he has to put in place a bankruptcy procedure that technically avoids bankruptcy.

The truth of the situation was discussed quite openly Thursday at Sen. Christopher Dodd’s Senate Banking Committee hearing with Professor Elizabeth Warren, who chairs the congressional oversight panel of the $700 billion Troubled Asset Relief Program (TARP).  It’s instructive to know that Prof. Warren’s specialty is bankruptcy law.

The true, fundamental issue, was broached directly by Sen. Bob Cocker (R-Tenn).  Cocker said the major banks that have taken the most money from TARP aren’t lending mainly because they need to keep the cash on their balance sheets because they need the cash to cushion as much as possible coming writedowns. Writedowns that add up to several trillion dollars.

Prof. Warren agreed with Senator Cocker.  After noting the obvious, that most if not all of these TARP recipients are insolvent with a huge difference between their assets and their obligations, she said that “we have to acknowledge what that gap is,” and then decide who’s going to fill in that gap.  Just kicking the can down the road, however, is not a path Prof. Warren recommends.  “There’s enormous risk and enormous cost at doing this slowly.” 

Congress is upset with TARP because the original concept was to use the money to buy troubled assets at banks and thus keep the banks solvent and lending.  What happened was quite different.  Former Treasury Secy. Hank Paulson put the first $350 billion in cash onto bank balance sheets and apparently bought little or no toxic assets. 

He did this because the credit markets were about to freeze solid, and buying enough toxic assets to actually make the large banks solvent would run into the trillions of dollars.  His only option was to inject cash to the banks as a cushion against expected writedowns.   And according to Prof. Warren Thursday, her initial auditing indicated Treasury paid out about $250 billion of the first $350 billion to buy assets valued at  $172 billion.  Treasury overpaid by $78 billion, according to Prof. Warren, but that would indicate it was trying to inject capital first and foremost as opposed to actually removing toxic assets..

The fact is that Treasury’s actions worked, to a degree.  Secretary Paulson was put in the position of trying to stop a global financial disaster (or at least postpone it).  And he did it, or at least postponed it.  In the current environment he’s not going to get credit for preventing the immediate seizure of credit markets.  You don’t get credit for avoiding castastrophe, because if you’re successful the catastrophe doesn’t happen.

That said, however, Prof. Warren commented that “skepticism” is warranted about the objectives Treasury had in using the first half of the TARP funds.  Ominously, she said her initial research indicated there were “multiple objectives,” not all of which looked to be aimed at simply injecting capital into troubled bank balance sheets. 

Although Congress gave Treasury unprecedented power with the $700 billion in TARP, they did restrict it to $350 initially, with Treasury coming back to Congress for the second half of the commitment.  Hence Sen. Dodd’s banking committee hearing Thursday.

Committee members spent a lot of the hearing complaining about what happened, or didn’t happen, with the first $350 billion.  They want more transparency, more accountability, about what Treasury is doing.  And President Barack Obama has promised much more of both from his administration.

Be careful what you ask for.  The dilemma is that a transparent discussion of the facts will show that either the taxpayer takes over insolvent banks, or by law the banks go into bankruptcy.  Taxpayer takeover will create an additional $2-$3 trillion funding commitment. 

This is why, suddenly, the call for modifying ”mark to market” accounting has resurfaced.  This accounting rule forces the banks to price their loans as though they were liquid, which many aren’t.  This rule makes the banks’ problems much worse.  Many of these loans are 20-30 year mortgage loans, and a large majority of these loans are current and will likely stay current.  But in a recession the accounting rule forces banks to write down the value of these loans, as if the mortgages were being sold into the market–an obvious fiction that distorts reality.

If “mark to market” were eliminated or modified, it would reduce the writedown totals.  So far, however, this action has not been pushed by the Obama administration and Secy. Geithner.

Banks know the writedowns are coming.  Congress knows the writedown are coming.  The President and Secy. Geithner know the writedowns are coming.  The markets know the writedowns are coming.  The public at large does not, and most particularly has no idea of the amount of their money that will be committed.

Again, Prof. Warren’s overall take is instructive.  “There are still some very healthy banks out there…I am a strong believer in supporting those who took the prudent steps…for the others they have to pay the price.”