Back when the current disaster was getting started, our 74th Treasury Secretary Hank Paulson had the idea of buying toxic waste from banks. This was his plan to save the world from financial Armageddon and he got Congress to allocate what then sounded like quite a bit of money -- $750 billion -- for something he inelegantly called TARP. Within weeks, Paulson trashed that toxic-waste buying idea because he couldn't price the toxic waste.
Now that Paulson is gone, our 75th Treasury Secretary has an idea to fix the problem: buy toxic waste. Is he aware that the idea did not work for his predecessor? Yes, that's why he's doing it again, but with a twist. He's going to use government money to lend to the very top of the financial hierarchy -- hedge funds and private equity firms -- so they can solve the problem of pricing the toxic waste. And because he'll do this with so-called non-recourse financing, the best the taxpayer can hope for is to get that loan back -- and we'll cover those hedge funds' losses too.
But first, the U.S. is going to spend $200 billion on another horrible acronym -- the Term Asset-Backed Securities Loan Facility (TALF). TALF will lend $200 billion to hedge funds and private equity firms so they can buy new securities which consist of bundles of consumer loans for education, autos, small businesses and credit cards. To understand just how bad this idea is, consider the odds that a student, consumer, or small business will be able to repay those loans given the plunging job market and the collapsing economy.
Why does the U.S. think that propping up a terrible idea -- securitization -- which got us into this financial catastrophe is the right approach? Does the U.S. not realize it might be a bad idea to lend $200 billion in taxpayer money to the very hedge funds and private equity firms that enriched themselves on too much borrowing while trashing the global financial system?
This TALF program reinforces the very incentive system that got us here. It puts all the risk of loss on the taxpayer and gives all the profits to the hedge funds and private equity firms. Instead of the banks giving out the loans as they did until 2008, now the government is stepping in. Meanwhile, the TALF program will push money onto consumers and small businesses who can't repay it in a collapsing economy where job losses are rapidly mounting.
And to think that this same model will work for pricing toxic waste when firms like Blackstone Group (NYSE: BX) admit that they have no experience pricing it, suggests the kind of blind faith in the private sector's ability to solve all problems that got us into this mess in the first place.
A much better idea would be to use my colleague's plan to let the FDIC buy up the 15% of defaulted mortgages from the mortgage-backed securites (MBS) bundles. It would cost $80 billion and would free the MBSs to trade since the remaining 85% of the mortgages would be current. The FDIC could then restructure the notes and keep more houses from flooding the market.
Stop the bailout madness!
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing. He has no financial interest in the securities mentioned