Wednesday, January 14, 2009

Politicizing the TARP

The deafening grumbling emanating from congressional Democrats regarding the use of TARP funds demonstrates that they are out of touch with the economic realities and wish to morph what was a financial market stabilization tool into a personal slush fund for kickbacks to special interest groups. Rather than focusing on stabilizing the financial system as a foundation for future recovery, many in Congress are intent on dictating the behavior and decision making of the people through financial incentives (bribery in the form of tax cuts, “economic stimulus”, etc) or even outright coercion.

While many financial institutions that have received government funds are guilty of reckless speculation and lending, government officials determined that allowing another institution the size of Lehman Brothers to fail would destabilize the entire financial system due to the complex web of counterparty risk and financial agreements. Since the capital infusions have occurred, politicians have demanded that banks use these funds for new lending. It seems that they quickly forget that government lending mandates played a significant role in creating the subprime market and low down payment requirements that contributed to our current dilemma. Banks obviously are continuing to lend to credit worthy borrowers. In an efficient lending environment, each incremental loan would be granted to a slightly less credit worthy borrower. Given the levels of toxic debt that saddle many of these financial institutions, it is perfectly rational for them to conserve capital and improve their balance sheet while reducing credit availability to marginal borrowers. The politicians are intent on artificially inflating lending activity by forcing banks to provide credit to less than worthy borrowers. How quickly they forget the long run result of such reckless behavior.

The onerous terms being proposed for taking TARP money will cause financially sound institutions to balk at government funds. These institutions, the most capable of expanding credit and leveraging government capital infusions, realize that if government dictates their lending guidelines they will surely be doomed to failure. Alternatively, the bailout being proposed for “homeowners” that have borrowed beyond their means will ultimately be little more than a band-aid on a gaping wound. Individuals and banks alike must reduce their debt burden and reevaluate how they will employ their precious financial resources. If government continues to dictate the terms of business and distorts the economic incentives that balance risk and reward, then we will surely be condemned to a long term recession that ensnares innocent bystanders in its grasp.