Last week the Bush Administration tried to find ways to use the
funds available in the Troubled Assets Relief Program (TARP) to
bail out the Detroit automobile companies. That decision is just
the latest of weekly, and sometimes daily, Administration
reinterpretations of the TARP program's purposes. And no doubt the
incoming Administration will continue this creativity and TARP will
increasingly become a White House fund for politically sensitive
With $15 billion of TARP funds still immediately available, and
another $350 billion available if congressional action does not
block access to the money, it is time to end this program by
canceling further Treasury authority to allocate funds. To the
extent that new financial crises materialize, recent experience
suggests that the Federal Reserve Board is best able to handle them
and would do so while resisting political pressure. If additional
steps are needed in the future, the White House should request new
congressional programs or authority with far greater clarity and
restrictions on the uses of money. It is time to end the continued
use and abuse of TARP funds.
Why TARP Should Be Ended
The original TARP program could be justified as appropriate
action by government to avoid a catastrophic failure of financial
markets. As a cardinal principle, the federal
government should not intervene to save firms from the consequences
of bad business decisions, which is why the proposed congressional
Detroit bailout was so unwise.
But in rare cases a second principle comes into play: When the
basic functioning of a market is breaking down, with potentially
disastrous consequences for the entire economy, there can be a case
for government to act to help restore a functioning market. The
accelerating turmoil in the financial markets in the early fall,
with the prospect of the entire credit system seizing up and a
spiraling economic collapse, provided an urgent case of the need to
apply the second principle.
At that time, it appeared that the critical step was for the
Treasury to purchase "toxic assets" (consisting of mortgage-backed
securities of uncertain value) so that credit markets could
function smoothly again. TARP was created to address this
necessity. While Congress explicitly limited Treasury action to
assisting financial institutions to remain functional, the
legislative language apparently gave the Treasury too many ways of
using funds for additional purposes.
The problem now is that the Treasury has concluded that the
purchase of toxic assets is no longer practical and has embarked on
a troubling pattern of potentially harmful ad hoc policymaking and
mission creep. A major example of this was Treasury Secretary Henry
Paulson's announcement on November 12 to suspend the original
purpose of TARP and to use flexibility granted under the law to
explore a wide range of alternative uses of the funds, from
guaranteeing securities backed by student loans and credit card
debt to using TARP to refinance problem mortgages. This step
confused markets, reintroduced uncertainty into the pricing of
mortgage-backed securities, and triggered a lobbying frenzy for
ever-more "flexible" uses of the TARP funds.
The Bush Administration's decision to consider responding with
TARP funds to Congress's refusal to bail out the Detroit automobile
companies underscores how far the Treasury has reinterpreted the
mission of TARP. The only way to prevent further misuse of the
program is to end it.
Huge Dangers Remain in Financial
The financial market dangers that led to the TARP program,
however, are far from over and may yet require additional
governmental action. U.S. and international credit markets are
undergoing a wrenching restructuring and repricing of financial
assets as markets adapt to the ending of excessive and risky
borrowing. The worry is that another short-term crisis could
destabilize that restructuring and once again cause financial
markets to seize up.
One especially worrying trend is the widening gap between highly
rated instruments (such as Treasury bonds and AAA commercial paper)
and financial instruments of quite modest underlying risk. The
one-month Treasury rate is now negative--meaning savers and
investors are paying the government to keep their money. Meanwhile,
borrowers with moderate business risk are facing historically high
rates--which have increased quite sharply since late September.
Moreover, banks and other financial institutions will have to
restate the value of their assets as of December 31. While the
Securities and Exchange Commission and the Financial Accounting
Standards Board have made improvements in the use of
"mark-to-market" accounting rules, the rules are still imperfect.
The shock of a large restatement of the balance sheets of major
financial institutions at the beginning of the year could trigger
yet another run on banks and a financial crisis that could gravely
disrupt normal business activity throughout the economy.
TARP Is Not the Cure for Future
The first institutional line of defense against these dangers,
however, should be the Federal Reserve Board under its wide,
existing powers, not the Treasury using TARP funds in ways not
intended by Congress. While many of the Fed's actions in recent
weeks have been disconcerting, the Fed is still the appropriate
institution to address short-term dislocation in the financial
system. Moreover, it is insulated from the political and lobbying
pressures that necessarily ensnare the Treasury and the White
House. If steps turn out to be needed beyond appropriate action by
the Fed, Congress should rapidly consider what action is needed--as
it did with TARP. And if in the future Congress needs to give the
Treasury new powers to deal with another potentially catastrophic
breakdown in financial markets, it should include much tighter
limits on Treasury's discretionary authority than it did when it
What to Do Next
- Say no to any request to use the second half of TARP funds.
Only $15 billion of the first half of the TARP funds ($350 billion)
remain uncommitted. If Secretary Paulson or the incoming Treasury
secretary wishes to use the second $350 billion, the Administration
must give notice to Congress, which then has 15 calendar days to
pass a joint resolution of disapproval to deny use of the money. If
such a request is presented, it should be denied.
- Repeal the TARP program. If this Congress reconvenes, and
certainly when the next Congress begins its work, it should end the
TARP program. Specifically, the authority to spend the second $350
billion of TARP funds, and any remaining uncommitted funds from the
program's first $350 billion, should be revoked.
- Get to the bottom of the financial crisis. There is still no
consensus on the essential causes of the financial crisis or the
strategic actions needed to prevent similar crises in the future.
It is time for an independent commission to investigate the matter
and propose structural reforms in the nation's financial regulatory
system, including the laws governing mortgage lending and other
requirements on financial institutions that appear to have
exacerbated today's problems. The incoming Congress should
establish such a commission consisting of respected independent
experts, and Congress should agree to conduct hearings and take
action on its recommendations.
The commission should:
- Explore the origins of the crisis and the activities of such
private entities as credit rating agencies, the drop in
underwriting standards by private housing lenders, and the role of
unregulated mortgage originators.
- Examine the operations of the major government institutions
involved and make recommendations for changes in their roles. These
should include the Federal Reserve Board, the Treasury, and the
Securities and Exchange Commission. The commission should also
review the charter and operations of the private-public
government-sponsored housing enterprises such as Fannie Mae,
Freddie Mac, and the Federal Home Loan Banks.
- Review specific statutes and programs that might have
contributed to the crisis (such as the Community Reinvestment Act
and low-income housing programs) and examine both the apparent
breakdown of congressional oversight and the links between campaign
contributions and the actions of key lawmakers.
Stuart M. Butler, Ph.D.,
is Vice President for Domestic and Economic Policy Studies at The