By William Isaac, Published by The Chicago Tribune
Former Treasury Secretary Henry Paulson rushed to Capitol Hill last fall to request $700 billion in emergency funding to purchase “toxic” assets (e.g., mortgage-backed securities) from banks. He got his $700 billion, no questions asked, but then decided to invest most of the money in bank capital instead of bad loans. That midcourse correction was one of the best decisions made during the past six months.
Many people, inside and outside government, continue to be obsessed with the notion of taxpayers buying up toxic assets. They contend it is necessary to get bad loans out of the banks before they will resume lending.
That view represents a serious misdiagnosis of the problem. Purchasing hundreds of billions of assets from the banks will not cause them to resume consumer lending to any material degree. The banks do not have the capital or risk appetite to add materially to their consumer loan portfolios — they will make new consumer loans only if they can securitize and sell them.
Our focus needs to be on getting securitizations going again. We can buy up bad loans (at enormous cost to taxpayers) or we can use our precious dollars to promote new lending. The choice between those two options is a no-brainer. Among other things, reopening the credit markets for new loans will ultimately allow many of the existing loans to be restructured and refinanced.
Three things are needed to energize the credit markets and the economy.
First, we need to build bank capital by continuing to invest in the banks. Thus far, taxpayer investments in bank capital have replaced less than half of the capital the Securities and Exchange Commission’s ill-conceived mark-to-market accounting rules have destroyed. Banks seeking taxpayer capital should be required to submit business plans for prudently increasing their lending over a reasonable period.
Second, we need to issue, for a fee, government guarantees (insurance) to enhance the credit-worthiness of securitizations of new consumer loans. This requires no deficit financing, does not involve the government in managing and collecting a bunch of bad loans, and, if structured properly, should entail reasonable costs to taxpayers.