TALF FAIL, and the Looming PPIP FAIL

The Term Asset Lending Facility, or TALF, hasn’t attracted that much attention. The idea was to lend money to private actors in the form of non-recourse loans that could be used to buy highly rated consumer or business asset-backed securities. The idea here was that by offering people a sweetheart deal wherein the government owned the bulk of the downside, you could get investors into this market, bring spreads back to a more normal level, and boost the availability of credit. To detractors, this was a massive secret giveaway. To proponents, the actual downside risk was extremely small and the markets merely seized by an irrational pessimism, thus TALF was a key measure to restore the flow of credit.

Ezra Klein observes that it’s instead falling into an under-considered third option — very little TALFing is actually happening. “Officials envisioned TALF supporting tens of billions of dollars a month in new lending, saying it could eventually total $1 trillion,” Neil Irwin explains, “But in March, when it was launched, it backed only $4.7 billion in auto loans and credit cards. For April, it logged only $1.7 billion.”

The reason, basically, is that most private actors are afraid that if they leap into this in a big way there may be a huge public backlash and then along come the executive pay restrictions and all the rest. Ezra observes that the PPIP concept is similarly structured and may fall afoul of the same issue.

This, it seems to me, is how you wind up with a Japanese-style banking sector and an L-shaped recession. The financial system, to be restored to health, needs hundreds of billions of dollars in additional funds. But not only is congress reluctant to appropriate such funds, the banks themselves no longer want to receive bailout funds because going on the government dole is bad for the parochial interests of bank managers. But would managers of insolvent institutions really prefer to see their bank sink than to accept a bailout that comes with the mere risk of congressional pay restrictions? Well, no, they wouldn’t. But they know, and investors know, that in a post-Lehman world the government isn’t going to let a big bank fail. And this implicit government guarantee is really the most valuable bailout of all. But it comes with no strings attached because the government can’t credibly threaten to withdraw it.

All of which gets me back to where I was five or six months ago. The only way to clean this up on a tractable time frame is to take insolvent banks into receivership, explicitly pay off enough outstanding bank obligations to get things in decent shape, break up and reprivatize new healthy institutions, and manage “legacy assets” for the long-run.

But basically nobody wants to do this. Obama and congressional liberals want to focus on their core agenda — health care, energy, labor law, education. Republicans don’t want to appropriate money. And bank managers want to continue to take advantage of implicit government guarantees and recapitalize themselves out of operating profits while paying themselves multi-million dollar strategies. Given enough time, that should work. But it could easily take years and give us a prolonged period of sluggish growth.