Put away the aspirin. You need a tourniquet

February 2nd, 2009 at 11:01am Annette LaCross

Published Jan. 25:

This week’s news flash:
The $700 billion bailout plan isn’t working. In fact, it was doomed to fail from the start. And everyone knew it.
Alas, what you have no doubt already suspected is true — the billions of dollars that have been pumped into dozens of financial institutions in the past four months aren’t going to work because they don’t address the cancer eating away at the economy.
TARP, in essence, is like taking an aspirin after being shot — it might ease the pain a little, but it won’t stop the hemorrhaging. And in the end, the pain won’t kill you. The hemorrhaging will.

The original Troubled Asset Relief Program, as envisioned by former Treasury Secretary Hank Paulson, was going to use the money to buy the bad assets breaking the backs of U.S. financial institutions.

The idea was scrapped because there is no easy way to do it and the banks needed the money yesterday. So the hastily contrived and implemented TARP settled for writing blank checks (“loan” money no one has bothered to track so far) and crossing our fingers.

But as it turns out, the banks’ problem was never really about illiquidity. It was about outright insolvency.

Put simply, an illiquid business is out of cash. An insolvent one has so much debt that even if it sold — or made liquid — every asset it owned, it couldn’t cover the spread.

The banks needed the cash, certainly. Trillions of dollars of potential bad debt were piling up. At some point, the piper was going to come calling, and they’d need to pony up to cover those debts.

Had it been a simple liquidity problem, TARP should have solved it — or at least put a dent in it.

It didn’t because it couldn’t. The culprit is the same knotty dilemma that foiled Paulson when he thought to buy up those bad assets: Nobody knows how much the bad debt is worth.

Some of it is the same debt that brought the banks to their knees last year. But more and more of it may have to be written off as foreclosures, joblessness and consumer inactivity continue to swell.

And there is no market value for bad debt.

Which brings us to TARP2, the new multi-billion-dollar bailout problem being debated by President Barack Obama’s administration — the most popular one calling for the formation of a “bad” bank. The government would buy all those poisonous assets still on the banks’ books and hide them all in their bank. It could then rewrite the mortgage securities to prevent foreclosures. And when the market stabilizes, it would unload all that debt, hopefully at a profit.

But if the government sets the price for those bad assets too high, taxpayers end up paying through the nose for a bag of rotten debt. If the price is too low, the banks would be in the same bind they’re in now.

As loath as I am to support it — to tell the banks they’re off the hook for getting us in the middle of this — I don’t think the economy has any chance of meaningful recovery until that bad debt is off the books.

Bring on the bad bank, I say.

Look at it this way: Bank of America posted a net loss of $1.8 billion in the fourth quarter, blaming its ill-conceived and last-minute acquisition of Merrill-Lynch, which posted “unexpectedly strong” losses.

John Thain, who was fired as CEO of Merrill a week or so ago, has managed — since Jan. 1, when the deal was finalized — to rack up more scandals than former Illinois Gov. Rod Blagojevich.
Thain demanded a $10 million bonus last quarter even though the company’s very future was in doubt. He rushed, in the final days of December, to pay billions in bonuses to Merrill employees — right before the feds pumped another $20 billion into Bank of America. He was subpoenaed last week by New York Attorney General Andrew Cuomo, who is also looking closely at Bank of America’s role in all of it.

Keep in mind, though, that this is a “good” bank. You and I will own the bad one.

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