Four-letter government words

Milt Friedman once declared, "Given our monstrous, overgrown government structure, any three letters chosen at random would probably designate an agency or part of a department that could be profitably abolished" (cited in this Wall Street Journal obituary written about him the day after his death on November 16, 2006).

To the "three-letter" agencies of that quotation, we can now add a few "four-letter" government programs, notably TARP, TALF, PPIP, and the ARRA of 2009.

Scholars will debate for decades to come whether or not the bailouts enacted at the height of the market panic during the end of 2008 were necessary to save the financial system. What is clear at this point in time, however, is that continuing bailouts are no longer necessary.

In fact, as the video clip above indicates, banks are rushing to give the TARP money back, in order to escape the onerous interference that comes along with having the federal government as a part-owner of your business. In that video, First Niagara Bank CEO John Koelmel says that his bank is doing the same thing that Goldman Sachs is doing -- raising capital on their own and giving back the capital from the Treasury.*

We would argue that at this point, further extensions of TARP are not necessary, especially now that the boot of mark-to-market accounting has been removed from the throats of financial institutions. We would say the same about TALF (the "Term Asset-backed securities Loan Facility") plan, which established a credit facility by which the Federal Reserve Bank of New York would lend to financial institutions in order to support student loan activity, small business loan activity, car loan activity, and credit card loan activity, at a time when the disruption of markets for securities backed by such loans threatened to bring such lending to a halt.

Nevertheless, there are some who want to keep right on extending TARP's reach, including expanding it to include troubled insurance companies. Larry Kudlow disagrees in this well-argued recent post from his blog, and we are with Larry on this issue.

We would argue that the best thing the government could do now would be to eliminate further expenditure of tax dollars through TARP, as well as the more recent PPIP (the Public-Private Investment Program, designed to help banks by buying up their "toxic assets" or "legacy assets" using a consortium of selected private buyers partnering with the government). It should be clear at this point from the video above, for instance that PPIP is not necessary.

The testimony that former FDIC chair William Isaac gave before the House Subcommittee on Capital Markets, Insurance, and GSEs on March 12 presents a masterful case illustrating that these so-called "toxic assets" were being made toxic by the misguided 2007 accounting rule that forced them to be valued at well below their actual cash-flow value.

Using an anonymous example from an actual US bank, he illustrates in the graph above on a billion dollars in securitized mortgages. The purple bar on the far left, totaling $1.8 million so far, shows the actual losses that the portfolio has sustained, while the blue bar in the middle is the estimate of the maximum losses over the lifetime of all the mortgages in the portfolio, at $100 million. The green bar on the right shows the losses required to be marked against the portfolio of loans by the accounting rule in effect before the change: $913 million or over 90% of the value of an asset currently receiving payments on 98.2% of its assets.

In other words, it is quite clear that the reason those assets were so "toxic" to banks was because of the poisonous accounting rule. We have explained this problem several times, and have included links to Bill Isaac explaining this problem before, such as in this post from November. We would advise all investors to read his entire Congressional testimony linked above.

Particularly on the day that Americans remit their taxes to the government, it is appropriate to examine the case against continuing further "emergency" measures. The government has already taken significant steps to end the causes of the emergency, by addressing mark-to-market and the uptick rule and by flooding the economy with money.

We have argued that the problem was a financial panic, not a "depression," and because of this maintain that continued stimulus beyond addressing the technical factors at the heart of the panic is not necessary. In fact, we have given several reasons why government "stimulus" is harmful, rather than helpful.

While it is not likely to happen, Congress should realize that the technical factors at the heart of the panic have been addressed, and draft legislation to stop the "stimulus" spending in the American Recovery and Reinvestment Act of 2009 that has not yet taken place, and instead allow the massive monetary stimulus that the Fed has unleashed to do its job.

The remainder of ARRA, TARP, TALF and PPIP are "four-letter" government activities that, in the words of the late Professor Friedman, could be "profitably abolished."

* The principals of Taylor Frigon Capital Management do not own securities issued by First Niagara Bank (FNFG) or Goldman Sachs (GS).

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For later posts on this same subject, see also:


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