Why Did TARP Change Course?

The twists and turns of TARP have confused and dismayed. From financing “bad” assets to direct capital injections to the myriad applications of its vast resources, TARP is now hardly recognizable from its original incarnation. The question is: Why? Why was the acquisition of troubled assets abandoned? Why was an open checkbook given to banks interested in receiving TARP funds, causing a rush of investment banks, finance companies and insurance companies to either convert to Bank Holding Companies (“BHC”) or acquire banks to become BHCs? Why are common shareholders of seemingly bankrupt institutions (AIG, Citigroup, etc.) being bailed out, all with U.S. taxpayer dollars? These are some of the more pressing questions on my mind over the past three months.

I have long thought that the issue was political, that Mr. Paulson and those in Congress lacked the political will to wipe out common shareholders and restructure both broken balance sheets and the banking industry. But perhaps the issue is logistical as well: do we have the data necessary to restructure broken CDO pools, and if we lack the data, then the will necessary to acquire the data in order that fundamental change can be achieved? And while I’ve written extensively about the need for transparency, published prices and dynamic collateral management, how we get from here to there is a matter for discussion.

I recently met with Hernando de Soto, a leading thinker, writer and activist in the areas of individual property rights and documentation of ownership as catalysts for social progress. We fixated on the role of the mortgage-backed securities markets in the current financial crisis, and explored the structure of securitized mortgage asset pools as a reason for why Mr. Paulson’s original “buy troubled assets” approach was discarded. Having a granular understanding of the composition of these pools – loan by loan, with the ability to analyze and separate the good, the bad and the salvagable – would seemingly have three critical benefits:

1. Gaining a better understanding of the asset quality of large holders of these CDO assets, in order that the markets can incorporate this information into business and investment decisions
2. Being able to identify which mortages should be restructured, as a vehicle for stemming the tide of foreclosures and the spiraling decline in property values; and
3. Reinforcing the necessity of transparency, a concept that has sorely been missed in the asset-backet security explosion of the past 25 years.

Further, this information would better enable Treasury, the FDIC and Congress to determine precisely which banks are insolvent, the magnitude of the insolvency, and to fuel a rational and data-driven purchase of troubled assets and recapitalization of damaged institutions. This, together with providing a basis for restructuring and writing off trillions of ill-conceived mortgage obligations would likely result in a much more efficient and impactful expenditure of U.S. taxpayer dollars.

With all of these benefits at hand, why hasn’t this path been pursued? Is it the difficultly in specifically identifying elements of these pools that are ultimately broken up and broadly distributed, such that the data doesn’t exist? Is it the dirty and laborious work necessary to obtain this data by building a bureaucracy necessary to obtain it? Or is that on some level our Government leaders don’t really want to know the truth, the magnitude of the idiocy has driven us to toss trillions at problems in the absence of hard data? How we, as taxpayer-investors, can be forced to spend these sums without data and without a plan is troubling. It is as if someone came up to me seeking funding for a start-up and initiatied the following conversation:

Start-up guy: “I’ve got this start-up. I’d like $10 million to get it going.”

Investor: “$10 million for a start-up? That’s a lot of money. Can you tell me about it?”

Start-up guy: “No.”

(Amused) Investor: “Do you have a business plan?”

Start-up guy: “No.”

(Less amused) Investor: “Do you know think there is a market for your product?”

Start-up guy: “I have no idea.”

(Irked) Investor: “Then why do you think you know enough to succeed?”

Start-up guy: “I don’t.”

(Irate) Investor: “Do you really think I’ll fund you?”

Start-up guy: “Yes.”

(Incredulous) Investor: “How could you possibly think that?”

Start-up guy: “Because you already have. Check your bank account.”

(Apoplectic) Investor: “#$%@&*>@#”

I am still trying to figure out the answers, because the way the bailout has unfolded just doesn’t compute. And I’m guessing that many taxpayers out there feel exactly the same way.