T.A.R.P. R.I.P.: Illiquency Watch

TARP's third incarnation as a consumer lending catalyst goes straight to my pet crisis peeve.  I am endlessly flummoxed at the authorities' insistence on throwing liquidity at a solvency problem -- with TARP I, AIG, and now, the consumers.

I have ranted elsewhere about the perils of drawing a sharp line between illiquidity and insolvency in a financial and macroeconomic crisis.  While the bankruptcy world has moved beyond the distinction in important ways, it still dominates the crisis policy response.

With the liquidity-solvency prism as their guide, policy makers invariably define the crisis as one of pure illiquidity/temporary confidence shock long past the point of credulity; the alternative is admitting failure with few tools to fix it.  We have ready medicine for illiquidity:  the Lender of Last Resort lends freely for a short term, preferably at high interest rates and against good collateral, to tie us over until the panic subsides.  This describes old and new Fed lending, for which we have standing authority, as well as key features of all three AIG packages, and TARP to date:  unlike the RTC, which took over failed S&L, TARP is either a money tap or a vehicle for parking "temporarily illiquid" assets in a government parking lot.

In contrast, the medicine for systemic insolvency is large-scale debt reduction and restructuring, which may require legislation and is fraught with political risk, since it entails unpopular decisions about loss distribution.  Where the liquidity-solvency judgment is wrong or fudged (and it always is), debt relief is delayed, while losses are masked and maldistributed.  Unsustainable debt compounds, and with it, the fiscal cost of the ultimate fix.  Revisiting Japan's experience in the 1990s makes for uncomfortable reading.  I am becoming increasingly convinced that doing away with the liquidity-solvency prism and requiring restructuring sooner, in conjunction with liquidity support, makes good policy sense.

On the bright side, this piece on the birth of the RTC feels oddly cheerful -- a reminder that we did not invent sausage-making in crisis.

Comments

[fresno dan]

I agree entirely about the situation. However, I do not see us escaping the "Japan" experience. The S&L "crisis" is a mere fraction of what has happened today. The US simply has no stomach for the sacrifices and pain that facing insolvency would entail. Better to issue treasuries and inflate our way out of debt. I predict a comeback for disco and stagflation (O, it will take a couple of years to get to staglation, and we will hear a lot of chatter about deflation, which is really about mistaking disinflation for deflation. When your used to 5% annual price increases, going down to 1% feels like deflation)

[David Merkel]

Bra-VO. There are few saying this, and it needs to be said. We need RTC-style solutions to reduce indebtedness, not throwing cash at financial institutions.

[Tai Nguyen]

I think that BB/HP know that these institutions are technically insolvent. By all measures, housing (and pretty much any asset) is overpriced relative to wages using any conceivable metric. Force the banks to mark their assets to market value? Then the entire system is insolvent, and then? What they are afraid is for the solvency of any one institution to cascade throughout the entire global financial system the way that Lehman did. Banks, insurance companies, pension funds, pretty much any player in the fixed-income market. So the "solution" is to provide enough liquidity to offset the deflationary aspects of debt destruction, thereby keeping assets from cliff-diving. So far, the Central Banks and other global investors have been playing along, but for how long?

[Ron Danielson]

With asset values falling off a cliff, I wonder at what point do we reach the point of national insolvency? When that happens, so much for the US Treasury AAA rating.

[tew]

I love how the deep moral and ethical issues are completely ignored while saying "loss distribution" is "fraught with political risk".

People that say things like this look forward to "solutions" that are immoral. They would like to take private debt and socialize it. They would like to tax the future wages of everyone in order to pay for past luxuries of a few. They would like to degrade the savings of many in order not to disrupt the asset holdings of others.

This is not just about "political risk". It's also about cultural risk. "Moral hazard" isn't some abstract economic concept. If and when we decide to perform wholesale transfers of debt from private parties to the public, you will permanently hobble feelings of civic virtue.

Perhaps the best term to do long term - really long term, like multiple decades or multiple generations - is to suffer longer, deeper consequences now in order to create the conditions for a JUST redistribution of assets that is based on just principles rather than government mandates.

[Joe S.]

tew should step back, take a v-e-r-y d-e-e-p breath, and set his browser to:

http://examinedlife.typepad.com/johnbelle/2003/11/dead_right.html

The rest of us only need the Cliff Notes on the Greatest Blog Post Ever, by John Holbo. Nickel version: There is a certain kind of conservative who is basically an aesthete of human suffering. Or as Holbo elaborates:

In short, Frum actually thinks that conservatism means forcing the poor and middle-class to sacrifice government programs whose existence is, or may be, in their economic interest. And why? Near as I can figure, for the sake of making over the poor and middle-class into more agreeable objects of aesthetic contemplation for (wealthy) conservatives, whose tastes run to: Donner party-like look-alike doughty leatherstocking hard-bitten frontier-type workers (respectful hats in hand.) And the word for this aesthetic transformation is: making people free. And somehow the economy is going to be OK.

It fits tew's post to a "t."

[dac]

Ever since Paulson implimented his Fast Action Response Team (FART) to impliment the Troubled Asset Rescue Plan (TARP), the stench from the Washigton Banksterocracy has become fumigating. Initally, taxpayers were to get troubled assets at a steep discount, and perhaps a profit down the road. Then came the switcharoo, and Paulso let one rip, and did what he had intended to do all along, he bought preferred stock in his bankster buddies operations, where the taxpayer took a subordinated interest. That's right!, we didn't get s superveneing interest as rescuing lenders usually get, we got an interest where the previos interests must be made whole before we can be. The Taxpayer is now politically trapped into whatever scheme will raise asset prices without regard to its consequences.

Except there is a problem. There really is a natural law of economics, and there really is a calculable inherent value of assets. The root of the problem is from policies that temporarily escalated the price of assets beyond their inherent value, encouraging increased debt, based upon unsound collateral, collateral that could not possibly remain inflated according to known metaphysical / economic natural laws. Now that assets are in retreat, the remaining debt cannot be supported, it must be eliminated by insolvency, or by currency devaluation, or in this case by both.

FART is busily trying to rescue assets from their natural inherent value, by stealing from people who did not participate in the foolishness, to bail out those who did. As good values are punished, and unsound values rewarded, we will come to live in a nation of fools. The primary function of a money system and its laws is to encourage the economic contingencies of reinforcment necessary to maintain production. Paulson's FART approach to the economy destroys the natural purging function wherein fools are allowed to go bust, and rational people are allowed to prosper. In his panic to bail out his billionaire Bankster Buddies, including himself, he is selling out our most treasured asset, the knowledge that man's written code must conform to the natural law, or liberty is lost. Paulson is riviting shackles around the necks of people who did not enter into the fraudulent and foolish contracts, including around the necks of young people who could not resist, but will be harvested so that his crony bankster buddies can keep their loot. FART.