TARP at six months

The Troubled Asset Relief Program just hit the six month mark, and the watchdog panel that's keeping an eye on the rescue has issued a progress report. The panel's still asking the question, "What is the Treasury's strategy?" and still not sure whether it will work.

You can read through the report here, but to boil it down:

The panel, led by Harvard professor Elizabeth Warren, says the Treasury's strategy seems to hinge upon one key issue -- do the current prices of "toxic" assets reflect their fundamental values? Or are those values artificially depressed because of a lack of liquidity in the frozen credit markets? From the "Warren" report:

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...

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.

In fact, professors at Harvard and Princeton have just argued that the government is indeed wrong - the assets are correctly priced now.

So maybe it's time to talk about "very different actions," like nationalization or letting big banks fail. The Warren panel says based on historical precedent, there are three basic options for dealing with failed banks -- subsidization, liquidation and receivership. So far, the Treasury has leaned heavily on taxpayers subsidizing banks to keep them afloat. The time may be fast approaching for options b. and c. to come more into play. On liquidating banks:

While the total cost of the various options is open to doubt, liquidation provides clarity
relatively quickly. In that sense, allowing institutions to fail in a structured manner supervised by appropriate regulators offers a clearer exit strategy than allowing those institutions to drift into government control piecemeal...

Liquidation is also the option least likely to sap the patience of taxpayers. It is
noteworthy how little controversy has been associated with the FDIC's windup of numerous banks and thrifts over the last year.

On the difficulty of receivership (nationalization):

The prospect of conservatorships at large U.S. banks raises issues of government capacity to manage such processes at one or more systemically significant financial institutions. Although the FDIC has shown skill and professionalism in dealing with failed banks in the past, it has never seized an institution as complex as a systemically significant banking institution would necessarily be... The government's capacity to dispose of bad assets could be overwhelmed by the amount and complexity of the assets held by those institutions.

The government's strategy is clear in some ways, not so clear in others. What is AIG? Is that a creeping nationalization or a forthcoming liquidation or a life support system?

Finally, the panel says the government must explain its plan honestly to the public. And be assertive, "take aggressive action to address failing financial institutions," shut down "those banks that are irreparably insolvent." Be accountable, "hold management accountable by replacing - and, in cases of criminal conduct, prosecuting - failed managers."

Be frank, be assertive, make the tough choices. That's what we've been asking for all along.

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