Treasury bailout program likely to shift course

John W. Schoen Senior producer • Profile • E-mail

With the changing of the guard in Washington, Congress is taking up a $350 billion question. Who will get the rest of the money left in the controversial $700 billion bailout fund?

The public is waiting for an accounting of the $300 billion cash infusion supposedly restoring lost equity in financial institutions. Is this new equity, new debt, a gift or something else?
— David P., Middleton, Wis.

Congress is also asking how well the money was spent. At this writing, there is growing pressure to revamp the so-called Troubled Asset Relief Program before releasing the second half of the $700 billion fund. But you can find a pretty good accounting of just what the Treasury did with the first $350 billion here.

When originally enacted in a whirlwind of negotiations amid last fall’s financial panic, the TARP funds were supposed to be used to buy “toxic” assets from banks to get them lending again. Most of these assets were backed by bad mortgage loans and of uncertain or dubious value. The hope was that if government cleaned up the mess, the financial system would get back on its feet in short order.

Congress also included provisions calling for direct help to borrowers who were in danger of losing their homes. But given the urgency and complexity of the crisis, the Treasury was given a lot of leeway in deciding how the program would be managed.

In hindsight, that may have been a mistake. Treasury shifted directions several times and ultimately invested most of the first $350 billion directly into the banking industry.

It did so by buying preferred stock, which is a little like equity and a little like debt. Preferred shares earn dividends like common stock but can be redeemed at the full issue price like a bond at maturity. The government also bought warrants, which give the holder the right to buy common stock at a fixed price at a later date. If the value of the common stock goes up, so do the warrants.

Treasury officials argued that without the fresh capital, the banking system would have begun to sustain major, long-term damage. Without a sound banking system, you can’t have a solid economic recovery.

The good news is that it looks like those investments are paying off dividends after all; one estimate last week pegged the gain at something like $8 billion in the last three months.

Some critics note that private investors who came to the aid of big financial firms, like Warren Buffett, negotiated much better deals during the crisis than the Treasury. To that extent, you might call it a sweet deal. But it’s not a gift.

If those dividends keep rolling in, the TARP won’t end up being a drain on the budget.

But the investment so far has done little to get the economy back on track. If anything, the contraction seems to be gaining momentum. And the TARP has offered no relief to homeowners facing foreclosure.

That’s all but certain to change when Congress gets around to releasing the remaining $350 billion.

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