Comment: The $700 billion man


Clive Horwood
Published on:

“This is the least costly path,” US Treasury secretary Hank Paulson told Sunday morning talk-show viewers when he was out selling his $700 billion bail-out package at the end of September. At the time, details of his plans for the US Treasury to buy impaired residential and commercial mortgage assets from banks were scant and concerns about the so-called Troubled Asset Relief Program’s (Tarp) wider impact were great.

On its own the formation of such a fund is by no means a panacea. Many in the markets have pointed to the problems the Treasury could have agreeing on a price for assets – most of which will be tough to value in the first place. If a price can be agreed, the next worry is whether once banks offload these assets their balance sheets will be in sufficiently good shape to resume lending. In some cases, banks might go under anyway as the prices at which they can sell assets leave them with little left over or the clean-up might reveal even more problems.

As the Bank of England and European Central Bank’s special liquidity schemes have shown, government and central bank intervention does not necessarily mean that banks will lend money. Both central banks have extended their liquidity schemes but frustration persists because banks seem to be using them for funding rather than liquidity.

What is clear is that the Tarp is going to cost the US taxpayer dear. Alongside Paulson’s $700 billion solution, Congress received a request to raise the government’s debt limit to $11.3 trillion from $10.6 trillion. Some estimate that with the toxic assets fund the total cost of the sub-prime mortgage bailout will reach $1.8 trillion – a whopping $15,000 for each household.

Tarp is certainly risky, but it is not a completely new idea. Similar approaches were used by Finland, Norway and Sweden in the 1990s when the Nordic region economy stumbled badly on the back of the Soviet Union’s collapse.

Finland, for one, established a bad bank and that, alongside risk sharing with some of the financial institutions involved and other economic measures, helped pull the country back from the brink. US treasury officials are said to be studying the Nordic programmes and one hopes they will glean some wisdom from lessons learnt by them. Otherwise the $700 billion man will wish he’d taken a different path.