The Great Financial Flip-Flop

With a new administration only a few days away from taking over the very troubled Troubled Asset Relief Program (time to call it TTARP?), perhaps it's time to pause and reflect on just how we ended up here, $350 billion poorer with nary a solution to the credit crisis in sight. When Treasury Secretary Henry Paulson begged Congress for the $700 billion back in September, the intention was to use the bulk of the money to buy illiquid assets from the struggling banks, thereby freeing up their balance sheets to start issuing new loans again. Paulson, you may recall, was opposed to the idea of recapitalizing the banks by injecting capital directly into the banks, despite the very vocal proponents of that idea.The most notable proponents were across the pond. At the same time Congress was weighing the bailout package, Paulson's U.K. counterpart, Alistair Darling, was hatching a plan to invest billions in that country's largest banks. The billionaire investor George Soros also expressed sharp criticism of the U.S. plan to buy toxic assets. "Instead of just purchasing troubled assets the bulk of the funds ought to be used to recapitalize the banking system," he wrote in the Financial Times on October 2.  "Funds injected at the equity level are more high-powered than funds used at the balance sheet level by a minimal factor of twelve." displayPromoModule ('{"moduleType":{"value" : "featuresModule", "index" : "1"},"mediaType1":{"value" : "article", "index" : "0"},"mediaType2":{"value" : "article", "index" : "0"},"mediaType3":{"value" : "article", "index" : "0"},"mediaType4":{"value" : "article", "index" : "0"},"url1":"/executives/features/2009/01/07/Goldman-Sachs-Alumni-in-Finance","url2":"/views/blogs/market-movers/2009/01/14/geithner-taxed","url3":"/executives/features/2009/01/07/Barney-Franks-Power-in-Congress","url4":"","teaser1":"The Goldman Sachs “conspiracy” to take over the U.S. financial system.","teaser2":"Why the tax scandal won't keep Tim Geithner from the Treasury.","teaser3":"Meet the sharp-tongued congressman at the heart of the financial bailout.","teaser4":"","headline1":"The Usual Suspects","headline2":"Geithner, Taxed","headline3":"Barney Frank Has Got Your Number","headline4":"","title":"Also on Portfolio.com" }'); Lo and behold, the critics were heard. By October 10, just a week after Paulson won Congress over, the Treasury Secretary reversed course. During a press conference, he suggested the funds would be injected directly into banks after all. Three days later, he announced plans to infuse $250 billion into nine big banks. A subsequent replay of those days and weeks in the New York Times suggested that Federal Reserve chairman Ben Bernanke actually favored that idea all along.And now that most of the initial $350 billion of the TARP money has been spent, where are we? The government has stakes in nearly 200 financial institutions, and some of those shares have gained since the initial investment. But while there may be a small paper gain for taxpayers, the plan has done little to unlock the frozen credit markets. True, last week was one of the most active for the debt markets in months, but the persistent, nagging view that banks need even more capital to survive continues to dash hopes that the credit crunch is over.So, what next? For Treasury officials in the U.S., it's back to square one: let's buy those toxic assets after all. Bernanke, it seems, voted for that idea before he voted against it and then voted for it again. And now, according to the British paper the Telegraph, finance officials there are considering the very same thing. The paper reported on Tuesday that the U.K. treasury has asked Credit Suisse to draw up a detailed plan for how it might create a so-called "bad bank" for the banking sector's most troubled assets. The government is considering either buying these toxic assets itself, or else guaranteeing them but leaving them on the firms' balance sheets.But the problem with these plans is the very same one that original critics of the first TARP plan voiced. These assets are still impossible to price. Determining what price to buy them is one obstacle, and then deciding when to sell them and for how much is yet another. Moreover, what are the indications that such a plan will be anymore effective in jumpstarting lending than the capital injections were? Clearly investors are worried about the government placing conditions on banks that take any additional bailout money based, but taxpayers, and many members of Congress, are fed up with the lack of accountability in the first TARP tranche.As tough as it may be to determine how the government should intervene, it appears clear that relying on market forces to navigate this crisis isn't a more favorable option. After Citigroup announced plans to combine its brokerage with Morgan Stanley's and narrow its overall focus considerably, the stock fell by 23 percent yesterday. Not exactly a vote of confidence. The TARP may not be a success yet, but it's still too early for the free market ideologues to gloat.  Related LinksDefending TARPWorst of TimesSign of a Bottom?