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May 11, 2011


Arshad M Khan

More than two years after the Troubled Assets Relief Program (TARP) was
introduced, the U.S. economy continues to sputter.  Why?  And what does the
future hold?

Let's start with a brief recap:  First, we had the internet bubble.  The Fed's  
response was liquidity.  The banks awash in cash looked for the next arena
and hit upon real estate.   Guess who saw it coming.  Warren Buffet.  His
favored stock divulged to a contest winner before becoming public
knowledge was a REIT (Real Estate Investment Trust).

There was a time when a local bank (or savings and loan) would vet
prospective home buyers carefully because it would be carrying the
mortgage on its books.  No more.  With the new freedoms following the
repeal of Glass-Steagall, the big money center banks could securitize
mortgages, slice and dice them, and no matter how risky (and cheap) to start
with, they would end up smelling like roses with a AAA blessing from the
rating agencies.

Buying cheap and selling high was a license to mint money and make money
they did.  Of course, it couldn't last -- not many families can pay a half and
more of their  income on a mortgage forever -- and it didn't.  A slight
slowdown in the economy and the defaults became a cascade.

The bankers used to say "keep the government off our backs", now they
were screaming, "help us, it is our hurricane Katrina, nobody could have
seen it coming."  Unfortunately, the TARP response treated them as disaster
survivors:  get them on their feet again and the economy will return to
normal.  They got all the money ... with no conditions.  They said they were
"too big to fail"  and governments and legislatures with ears tuned to the
happy music of campaign contributions -- listened to them.

Others had a different view:  Paul Volcker, a former Fed Chairman, said, 'if
they were to big to fail, they were to big to manage'; the Governor of the
Bank of England (their Fed) quipped, 'if they were too big to fail, they were to
big to be'.  Their views and those of like commentators fell on deaf ears.

Now, the banks are again awash with money, and they haven't given up on
the securitization model.  Trading brings faster profits than investment
through lending to job producing businesses, and they need the money.  To
help them further, accounting rules were changed so that instead of marking
securities to market, they were allowed to carry their worthless
mortgage-backed paper at cost. Thus the balance sheet offered no evidence
of bankruptcy inducing losses.  So, another reason they are not lending is
their profits are going towards shoring up these losses.

One way to have moved the economy would have been to rid us of the
sludge in the system; that is, let the banks take the losses.  A recapitalization
with the government also buying their stock (which could later have been
sold at a profit) would have set the banks on their feet again.

The real job producers in our economy are the multitude of small and
medium-sized businesses. Who lends to them?  The small and medium-sized
banks serving local communities.  TARP ignored them.  Caught in the same
whirlwind, they go bankrupt and restructure weekly.  They are unable to lend
because of a shortage of funds.

Quite clearly then, the current financial system is broken.  If we are to
compete with rising economic powers like China, it has to be repaired. That
effort must constitute some sort of incentives and restrictions that impel the
big banks to focus on investment lending instead of securities trading.  
Otherwise, we will sputter along with high unemployment and low growth and
join Japan, which was also unable to deal with its big banks after its real
estate bubble in the late eighties, in the doldrums.  For a glimpse into our
future, one only needs to look at Japan's last two decades.