Hank Paulson’s latest response to the financial crisis

More rabbits from the hat

As Hank Paulson buries one attempt to solve the financial crisis, he and regulators unveil two more

ONE of the most humbling features of the financial crisis is its ability to humiliate policymakers who, thinking that they have a bazooka in their closet, soon discover that it is a mere popgun. When Hank Paulson, the treasury secretary, first called for a $700 billion programme to buy troubled mortgage assets (the TARP), markets sensed salvation; when Congress first rejected it, panic ensued.

The programme passed but by then America’s mortgage crisis had become a global panic, dragging down banks and infecting all sorts of debt. No one seemed to care that in a few months the Treasury would be relieving banks of the mortgages that had started all the trouble. So on Wednesday November 12th Mr Paulson unceremoniously buried the idea. Instead he will devote the TARP to recapitalising banks and non-bank financial institutions such as financing arms of America’s big car companies(though not, for now, the carmakers themselves). He also disclosed that the Treasury and the Federal Reserve are exploring the creation of a “liquidity facility” to buy top-rated securities backed by credit-card, car and student loans, and perhaps mortgages. Banks bundle many such loans into asset-backed securities which they then sell in the capital markets. But that market has all but disappeared.

“We are looking at ways to possibly use the TARP to encourage private investors to come back to this troubled market, by providing them access to federal financing while protecting the taxpayers’ investment,” Mr Paulson said. But he also gave warning that this would take weeks to design and longer to get running.

The same morning, America’s four federal bank regulators issued an unusual warning to banks: lend more or else. The regulators are usually preoccupied with keeping banks sound and warning them not to lend too loosely. No more. They issued an “interagency statement” saying it was “imperative” that banking organisations and regulators make sure that borrowers’ needs are met. Bank supervisors have been told to encourage banks to do so.

The guidance carried a veiled threat: supervisors “will take action” if they find a bank is paying dividends that they deem too high for either a bank’s capital or its ability to meet borrowers’ needs. Banks could rightly protest that as long as they are healthy, their dividends are not the regulators’ business, but bank regulation is now simply another weapon in the government’s arsenal against the credit crunch.

Mr Paulson has come under fire for not having sought to use public money to resolve the crisis sooner, and failing to recapitalise financial institutions at the outset, as many Democrats and independent economists urged. He responded on Wednesday by saying that he would not apologise for “changing an approach or a strategy when the facts change.”

The former investment banker has not been indolent: his department has been a factory for acronyms since the crisis began. But most of those initiatives have either failed to get off the drawing board, such as the MLEC, which was aimed at relieving banks of their off-balance-sheet liabilities, or they have fallen short, such as the HOPE NOW Alliance for modifying mortgages.

Critics say that Mr Paulson, because of ideology, has been slow to agree to commit public funds and to push government intervention. There is something to that, but it is not the full story. Mr Paulson is a dealmaker and, foremost, a pragmatist. He held back in deference to what he thinks the industry and Congress can stomach. He did not initially ask for public funds to buy mortgage assets out of fear that Congress would say no, shaking confidence. And he originally did not seek to invest equity in part thinking that banks would refuse the money for fear of looking weak. For the same reason, when he did agree at last to equity investments, he attached few conditions.

With barely two months before Barack Obama becomes president, the actions of Mr Paulson and the Fed show some sign of easing the financial crisis. Libor, the rate charged on dollar loans between banks, has fallen sharply. But the financial crisis has spawned an economic crisis and an entirely new set of demands. The car companies are not “first-round” victims of the credit crunch the way Lehman Brothers and AIG were. They are second-round victims: the credit crunch has left millions of potential customers unable to finance car purchases, crushing sales for an already weakened industry. General Motors is now at risk of running out of cash within months.

Mr Paulson yesterday said that the TARP should not be used for non-financial companies and Democrats in Congress should instead look to the recently enacted $25 billion loan programme for the companies to invest in greener vehicles. His hesitation is understandable; unlike the banks, the car companies were not healthy before the recession hit, are less able to pay the federal government back its money and are less likely to cause contagion if they fail. “Any solution has got to be leading to long-term viability,” he said.

One idea making the rounds is for the companies to file for bankruptcy protection and the federal government to provide them with “debtor in possession” financing to keep operating while they restructure themselves into smaller, leaner companies. But the companies are opposed to a bankruptcy filing, and with their time running out and both Congress and Mr Obama sympathetic to their pleas, Mr Paulson may yet again have to recognise that the facts have changed.

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