Recent Commerce Department figures showed retail sales fell only modestly in
July 2009, which some analysts interpret the data optimistically as a tentative
sign that spending could be stabilizing after a very weak 2008. But with huge
amounts of wealth destroyed, massive debt still not extinguished, credit
conditions still tight, unemployment continuing to rise, wages remaining
stagnant, and households looking to pay down debt to survive, consumer spending
is not likely to return to the levels seen during the bubble boom years any
time soon. And until consumer spending picks up, no recovery can come.
Fed data also showed that the rate of growth in borrowing by businesses slowed
to 1.7% from a 4.1% rate in the third quarter
2008. The biggest jump in borrowing came from the federal government, coming in
at a 37% rate in the fourth quarter 2008. At the end of 2008, domestic
non-financial debt outstanding totaled $33.5 trillion, with households
accounting for $13.8 trillion, non-financial businesses $11.1 trillion and
government debt of $8.6 trillion.
Public-Private Investment Partnership
US Treasury Secretary Timothy Geithner announced on March 23, 2009, a
Public-Private Investment Partnership (PPIP) to buy toxic assets from bank
balance sheets. The major stock market indexes in the US rallied on the day of
the announcement, rising by more than 6% with the shares of bank stocks leading
PPIP has two primary programs. The first is a legacy loans program to buy
residential loans from bank balance sheets. The Federal Deposit Insurance
Corporation will provide non-recourse loan guarantees for up to 85% of the
purchase price of legacy loans. Private sector asset managers and the Treasury
will provide the remaining assets.
The second program is the legacy securities program, which will buy residential
mortgage-backed securities that were originally rated AAA and commercial
mortgage-backed securities and asset-backed securities (ABS) which are still
The troubling TARP
The funds will come mostly in equal parts from the US Treasury's Troubled Asset
Relief Program (TARP) monies, private investors, and from loans from the
Federal Reserve's Term Asset-Backed Securities Facility (TALF). The initial
size of the PPIP is projected to be $500 billion.
Nobel laureate economist Paul Krugman had been critical of TARP, arguing that
non-recourse loans lead to a hidden subsidy to asset managers, bank
shareholders and creditors.
Banking analyst Meredith Whitney, who first gained credibility in the market by
exposing the weakness of Citigroup in October 2007, argues that banks will not
sell bad assets at fair but depressed market values because they would be
forced to take asset writedowns. Removing toxic assets would also reduce the
upward volatility of bank stock prices. Because stock is essentially a call
option on a firm's assets, this lost volatility will hurt the stock price of
distressed banks. Therefore, such banks will only sell toxic assets at above
market prices. Thus toxic assets by definition cannot find buyers beyond the
The Troubled Asset Relief Program was introduced on September 20, 2008, five
weeks before the presidential election, by outgoing George W Bush
administration Treasury secretary Henry Paulson as a government crisis response
measure to purchase assets and equity from distressed financial institutions to
stabilize a financial system on the verge of collapse. It is the largest
component of the government's measures adopted in 2008 to address the global
impact of the subprime mortgage crisis.
A day later, on September 21, Paulson announced that the original proposal,
which would have excluded foreign banks, had been revised to include foreign
financial institutions with a presence in the United States. The Bush
administration pressured other countries to set up similar bailout plans. It
was a sign that the program had not been thoroughly thought out. Paulson was
charting his course on an undrawn map as his sailed towards a global financial
On September 23, the plan was presented by Paulson and Fed chairman Ben
Bernanke to the Senate Banking Committee, chaired by Republican Richard Selby
of Alabama, which rejected it as unnecessary government intervention. On
September 24, president Bush addressed the nation on prime-time television,
describing how serious the financial crisis could become if action was not
taken promptly by Congress. The public was held hostage as a life-saver for the
Ultimately, there was really only one question that Paulson and Bernanke needed
to answer to Senate Banking Committee members in their testimony: Cui bono?
Who actually benefits? But members of the Senate Banking Committee failed to
ask the key question to protect those who elected them as representatives. Is
the answer the primary benefit will be to first ensure the survival of those
who had brought about this crisis? The key question is not whether the American
economy must be saved; it is whether the American economy needs to be saved by
first saving those who destroyed it in the first place. But the question was
never asked by those charged with the responsibility of asking it.
On the same day, Republican presidential candidate John McCain and Democratic
candidate Barack Obama issued a joint statement describing their shared view
that "The effort to protect the American economy must not fail." The most
fundamental political question was rendered nonpolitical only weeks before
voters were asked to select the next president.
On October 3, 2008, Congress authorized the Treasury to spend $700 billion of
future tax money to stabilize the US economy without a clear understanding on
how the money would be spent and why. Congress created the Office of Financial
Stabilization (OFS) within the Treasury to implement TARP. At the same time,
Congress created a Congressional Oversight Panel (COP) to "review the current
state of financial markets and the regulatory system."
TARP authorized the Treasury to purchase or insure up to $700 billion of
"troubled assets", defined as "(A) residential or commercial mortgages and any
securities, obligations, or other instruments that are based on or related to
such mortgages, that in each case was originated or issued on or before March
14, 2008, the purchase of which the secretary determines promotes financial
market stability; and (B) any other financial instrument that the Secretary,
after consultation with the Chairman of the Board of Governors of the Federal
Reserve System, determines the purchase of which is necessary to promote
financial market stability, but only upon transmittal of such determination, in
writing, to the appropriate committees of Congress."
In practice, TARP allows the Treasury with the help of the Fed to purchase
illiquid, difficult-to-value assets such as collateralized debt obligations
(CDO) from banks and other financial institutions. Tim Geithner, now Obama's
Treasury Secretary, then as president of the New York Fed, participated in the
formulation of the program under the supervision of Bernanke, in support of
In an open letter sent to Congress on September 24, over 100 academic
economists expressed "great concern for the plan proposed by Treasury Secretary
Paulson". The letter, endorsed by a total of 231 economic professors at US
universities within a few days and described as "the emerging consensus from
academic economists", criticized TARP on grounds of fairness because "it
amounts to a subsidy to investors at the expense of all taxpayers"; on grounds
of ambiguity because neither the mission of the new agency nor its oversight
were clear; and on long-term impact grounds because the ill effects of the plan
will linger for a generation, generally understood to be three decades.
Nobel laureate economist Joseph Stiglitz strongly criticized the bill in an
article written for The Nation. Many others also criticized TARP for similar
and related reasons. (See
Killer touch for market capitalism, Asia Times Online, October 30,
The key time line of the Fed's bailout actions is as follows: September 18, 2007 - Cuts Fed Funds rate for the first time in
the crisis by 50% points. December 12, 2007 - Creates Term Auction Facility to auction
loans to banks and first intern central bank currency swaps to provide more
January 22, 2008 - Cuts rate 75 basis points at the Federal
Reserve Open Market Committee emergency meeting. March 24, 2008 -
Invokes emergency authority under Section 13.3 of the Federal Reserve Act to
back the rescue takeover of Bear Stearns with a $29 billion loan.
September 15, 2008 Fed denies rescue that would prevent Lehman
Brothers bankruptcy. September 16, 2008 - Bails out AIG with up to $85 billion. October 7, 2008- Starts buying commercial paper. November 25, 2008 - Starts buying Fannie Mae and Freddie Mac
securities and creates TALF to finance investors in asset-backed securities. December 16, 2008 - Cuts interest rates to virtual zero.
March 18, 2009 - Starts buying Treasuries. May 7, 2009
- Banks stress test results announced.
The Congressional Oversight Panel (COP), chaired by highly respected Harvard
Law Professor Elizabeth Warren, in its August 2009 oversight report "The
Continued Risk of Troubled Assets", examines the economic implications of
troubled assets and assesses the Treasury's strategy of removing these assets
from bank balance sheets. The panel found that the future performance of the
economy and the performance of the underlying loans, as well as the method of
valuation of the assets, are critical to the continued operation of the banks.
Yet none of these critical conditions are guaranteed by TARP.
The report traces the evolution of TARP: As increasing numbers of subprime
mortgage-holders defaulted on their loans in the autumn of 2008, the financial
markets for these assets effectively ceased to function. In response to the
crisis, the Treasury proposed the Troubled Asset Relief Program to transfer
hundreds of billions of dollars in troubled assets off the banks' books. But by
the time TARP was signed into law in early October, the Treasury had decided to
use TARP funds to pursue a different strategy: providing banks with a capital
buffer to write down many of their troubled assets and to build reserves for