Of meltdowns, freezes, bailouts and TARP

One year and myriad programs later, the Troubled Asset Relief Program’s impact, and intention, is still up for debate.

Politicians are calling for an end to the program when it expires on Dec. 31. At the same time, government agencies are trying to sort out how to wind down programs and whether to distribute the unspent funds.

On Oct. 1, 2008, a group of local experts convened at the offices of the Business Report to discuss the causes of the financial meltdown and the solutions that were then being proposed. Roundtable participants included:

• John Clinebell, professor of finance at the University of Northern Colorado;
• John W. Green, regional economist and editor of the quarterly Northern Colorado Economic Report (see column on page 21);
• Mark Kross, president of Larimer Bank of Commerce;
• Ronnie Phillips, professor of economics at Colorado State University;
• Julie Piepho, executive vice president of Cornerstone Mortgage and past chair of the Colorado Mortgage Lenders Association.

The conversation focused largely on the housing market and the government and industry mechanisms that contributed to its meltdown. TARP was still a couple of days in the future, but plans for a bailout of some sort had been floating for weeks. The panel shared ideas on the problem of enforcement of existing regulations, an industry flooded with new products not fully understood, and the psychological impact of a few key events that threw the world’s economy into a tailspin.

TARP’s psychological impact

A year later, Clinebell pointed out that TARP quickly made an impact.

“In some ways, it served the psychological purpose it needed to serve,” he said. “But it didn’t do what it was initially supposed to do by buying up the toxic assets. Those are still causing problems for banks.”

Clinebell feels that the government had to step in to stabilize the credit markets, especially since some of their policies contributed to the mess. The program, in general, could have been executed better, but it did serve its purpose of curtailing the out-of-control panic that had markets frozen worldwide.

“What’s happened since then has been problematic, at best,” Clinebell said.

He feels the first $300 billion spent, along with monetary policy put in place by the Federal Reserve, served to buoy liquidity through the initial crisis. However, use of federal dollars to prop up the auto industry were far beyond the scope of purpose for TARP.

“We really could have stopped at the first $300 billion,” he said. “I think we might have been better off.”

Clinebell pointed to the much-discussed downsides of enormous national debt and the potential for inflation, as well as too much government control. The long-term effects are as unpredictable as the crisis itself.

“If you remove risk from our economy, you tend to eliminate the potential upside,” he said.

Bank recovery hampered

Kross agreed with Clinebell that TARP served its original purpose. He believes that many more banks would have failed if the markets were allowed to remain frozen.

For Kross and others in the banking industry, the regulatory environment is hampering recovery perhaps more so than the economy at large. The message put out by the government by TARP and many programs is that banks need to be and should be lending.

“On the other side, you have regulators that are clamping down on banks,” Kross said. “There are very contradictory messages, which is frustrating and a little challenging.”

The mixed message is impacting local credit markets in a negative way, as community banks are feeling regulatory pressure to keep cash on hand, not lent out. Kross said that he is not aware of how the environment is impacting large banks, which received a bulk of the TARP funds, but as a community banker, he has heard from his peers about their difficulties.

Mortgage industry reeling under regs

Perhaps more so than the banking industry, the mortgage industry is reeling because of new regulatory requirements and new legislation.

“I’m really surprised by the amount of focus on financial regulation in Congress,” Piepho said.

Piepho clarified that it’s not whether more or different regulations are needed but that she didn’t anticipate the amount and depth of legislation enacted rather than letting the market correct itself.

In recent months, the mortgage industry has seen several new and far-reaching laws put into effect or approved for action in the near future. Many of the new laws are rightly aimed at protecting consumers. However, Piepho said that the unintended consequences of these laws — many requiring more paperwork and professionals — will be to make mortgages more expensive and harder to get.

Additionally, many of the general provisions of the new laws meant to ensure consumers don’t get into a loan they can’t afford are already being enforced by the industry.

“I can’t believe I’m spending this much time on government regulations and that they keep coming out with more,” she said. “The subprime mess is done. The industry has regulated itself. It did that right away.”

Piepho said that despite the new rules, she is optimistic about the health of the industry.

“I see the mortgage industry and housing industry becoming more robust,” she said. “It’s been one of our better years. There is plenty of money to lend for creditworthy borrowers.”

Losing opportunity for reform

While lawmakers are focused on transaction level changes to the financial industry, the bigger picture issues might be getting swept to the side.

“In general, I’m afraid we’re losing the opportunity to reform the system,” Phillips said. “We need to make some fundamental changes.”

Phillips explained that the lasting impact of the last year on the U.S. economy is that the government has set a precedent for bailing out big financial institutions. The result is a hybrid private-public system in which the profits are private and the risk is public.

“It seems to me that the only way to avoid that is to not allow big institutions,” he said. “I don’t see any alternative but to break them up.”

A better system, in Phillips’ opinion, would be one with fewer branch managers and more bank presidents — more small community banks. He also feels that regulatory reform should include a separation of powers, with a single regulator made from a merger of the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Office of Thrift Supervision and limiting the Federal Reserve’s influence to monetary policy only. The problem with allowing the Federal Reserve the power to regulate institutions and deal with solvency issues is that the Fed can easily cover a solvency issue for a short time, causing larger problems down the road.

As for the TARP program, Phillips feels that it served its purpose but not in a very efficient way.

“Throwing billions (of dollars) at something is going to help,” he said. “I don’t think any of the programs have been cost-effective.”

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