Obama Reinterprets the TARP. Don't Be Fooled.

Yesterday, Obama asked President Bush to formally request Congress to approve the second $350 billion tranche of the TARP fund. Bush complied, and sent his letter to Congress last night.

This little dance is necessary because Congress split up the $700 billion TARP fund into two halves. The first $350 billion has all been committed or spent now, with the last of it serving as a downpayment on the coming, still-indeterminate Detroit Three bailout.

The two-step process was a fig-leaf added to the original TARP back in October, so that Congress could claim they were overseeing the program in the uniquely tough, objective, fair-minded and knowledgeable way that we’ve come to expect from them. Now that the President has requested the second tranche, Congress has fifteen days in which to grandstand, cluck over how poorly the money has been spent, haul Paulson et al in for a tongue-lashing, and wring their hands over how much the American people hate the idea. Their work of oversight done, they will then approve and release the second tranche.

Partly this is nice for Obama because Congress can have their media circus before he takes office. And partly he can start the 15-day clock now, so the rest of the TARP fund is available sooner.

But Obama made several statements in his remarks that indicate a very big problem we need to be concerned with. He’s rewriting the objectives of the TARP in an evil way. And he’s getting away with it because most people who aren’t finance experts don’t really understand what TARP was intended to achieve in the first place.

In remarks in Washington quoted by news services, Obama said that the TARP funds have been managed badly by the Bush Treasury Department. That’s a cheap political score, but fair enough.

He also said that he’s been disappointed with the “failure to take bold action with respect to areas like housing, consumer credit.” Obama cat’s-paw Barney Frank also said, arguing for approval of the second tranche of TARP funds, that we shouldn’t let our disappointment prevent Obama from using the funds in “more appropriate ways.”

We know from many past statements that Frank has long wanted to put Federal money directly into the hands of distressed mortgageholders. Obama’s statement indicates a similar turn of mind.

In a letter to Congress, Obama adviser Larry Summers said that Obama wants to be handing TARP money out to community banks, small businesses, consumers unable to borrow money, and people in danger of being foreclosed on their mortgages.

In short, these people are looking at the TARP as a big welfare program. That’s not what it was supposed to be.

Where the TARP Came From

The TARP was a break-glass-in-case-of-fire program, originally conceived as a last-ditch response to an extreme emergency. That emergency materialized in mid-September as the institutional money markets crumbled in the wake of the Lehman Brothers bankruptcy.

TARP proponents Hank Paulson and Ben Bernanke initially proposed TARP to Congress in closed sessions that scared Hell out of everyone who heard them. Since time was of the essence, no thought whatsoever was given to explaining the program to the public, much less selling it.

This was a PR failure of gargantuan proportions, right up there with the worst ever. Almost instantly, the people were told by the news media that Wall Street was looking for a $700 billion handout from taxpayers to ensure that the best-paid people on earth would get their multi-million dollar bonuses this year, even though they were losing money. And that, for some unexplained reason, the world would end if we didn’t give them what they wanted.

To this day, many people think that’s what the TARP plan is all about.

On balance, I was in favor of the original TARP plan, even though it created tremendous moral hazard by permitting certain companies to stay in business after making terrible mistakes. The true goal was to keep the global banking system from collapsing, as one trillion dollars in losses nearly wiped out the industry’s entire capital.

If we had allowed that to happen, we might today be looking out at a world in which quite a few of the largest banks in the world were out of business and simply gone. Barack Obama’s stimulus plan would have been a nonstarter because there wouldn’t have been anyone to even give the stimulus money to. Things really were potentially that bad.

It’s true that the implementation of the TARP plan was improvised. But for all Obama’s cheap criticism, there’s no way he could have done any better. In the end, the plan of forcing large banks to give issues of preferred stock to the Treasury in return for TARP cash was a fairly reasonable way to assure market participants that these banks would not fail.

But keep in mind how the TARP funds are being used. They’re not being used to fund spending, consumption or pork-barrel projects. Those monies have been added to the balance sheets of financial institutions. They represent senior claims on the assets of the institutions. Yes, there is the potential for losses on these capital positions, but it’s not the same as ordinary spending.

Think about if you had $500 and you blew it on dinner, movies, and presents for some girl you’re trying to impress. That’s one kind of spending. The other way you could spend it is to buy stock in a business corporation.

Whatever you expect to get out of blowing your money on fun and games, you certainly don’t expect to get your money back. When you invest in stock, you DO expect to get your money back.

That’s the fundamental difference between the disposition of TARP funds, which Obama professes to be so disappointed in, and ordinary spending. It’s also why Paulson steadfastly refused all the non-bank people who stuck their hands out for TARP funds, including the Detroit automakers.

The TARP plan is not “spending” in the ordinary sense of the term. It’s a stabilization fund. The worst-case estimates I’ve seen suggest that total taxpayer exposure created by the TARP will probably amount to $50 billion, maybe $100 billion. It’s just as likely that the liability will be zero or negative, suggesting a positive return on the taxpayer investment.

But that’s not how Obama understands the TARP. Remember, this man is all about fiscal stimulus. He wants to spend as much borrowed money as he possibly can, as fast as he can, to buy whatever he can think of, because he’s become convinced that somehow that’s a good idea.

Obama is trying to blow as much as a trillion dollars on dinner, movies, and presents for favored governors and other politicians. He’s disappointed because Paulson chose to use the TARP narrowly and efficiently, for financial stabilization.

What Obama is trying to do is to add the remaining $350 billion in TARP funds to his New New Deal program. He doesn’t want to invest it. He wants to spend it.

Don’t be fooled.