One of my law professors, Gareth Jones, taught law at Cambridge, and was a master of the Socratic Method, the question designed to teach. I always thought Socrates was disingenuous, claiming that he had an open mind, but asking questions that led inexorably to the conclusions he wanted. Not so with Professor Jones, whose facile mind could follow any answer as far as he wanted to, and make the entire thing seem perfectly reasonable, and not so with Professor Warren, the chair of the Congressional Oversight Panel created by TARP.
Each month, Warren’s group produces a detailed report on one aspect of TARP, and a summary of other information about other aspects of the program. This month’s report is here, and the executive summary is here. It is a discussion of the Temporary Asset-Backed Securities Loan Facility:
1. Is the TALF program well-designed to help market participants meet the credit needs of households and small businesses?
2. Even if the program is well-designed, is it likely to have a significant impact on access to credit?
Professor Jones would have loved these questions, and Socrates would have too. The report begins with a complete description of the process of securitization of debt instruments (p. 30; this is an excellent introduction for those not familiar with securitization, say, like most congress critters). The report focuses on the way small business loans and consumer credit card debt, auto loans and student loans, are pooled and sold to investors. This process returns cash to the original lender, making it possible for the lender to make more loans, while continuing to earn fees for administering the pools.
Warren concludes that securitization has never been a significant source for funding small business lending, and TALF doesn’t help. She implies that reductions in consumer lending are more likely due to creditworthiness concerns and consumer pull-backs than from availability of funds. She thinks small businesses have similar concerns and face similar pull-backs. Therefore, she concludes it isn’t likely that TALF will help with either problem.
The evidence she cites is frequently very pointed, teaching readers about the problems in the economy. For example, large banks are the primary users of asset-backed securities. But, most lending to small business is done by smaller banks (p.17):
Specifically, the SBA has calculated that, in 2007, banks with $10 billion or less in total assets held 24.42 percent of total domestic bank assets yet provided 52.18 percent of the total value of small business loans made by banks. Larger banks – those with more than $10 billion in total assets – held 75.59 percent of total assets and made 47.81 percent of the total amount of small business loans made by banks.
This led Secretary Geithner to use his leverage to encourage larger TARP lenders to increase their participation in the Small Business Administration programs. That isn’t going to happen: this lending requires a lot of people, and big banks aren’t hiring.
Consistent with her concerns about families (Professor Warren is the author of The Two-Income Trap which explains how the middle class faces increased financial risk), she pays special attention to the problems facing consumers (p. 23-4):
Of the past recessions, only one other was accompanied by a decline in net worth over the course of a year: the recession at the beginning of this decade. During this downturn, household net worth fell by nearly four percent. By contrast, in the current downturn, households have seen their net worth fall by approximately 20 percent, for a loss of nearly $13 trillion in wealth. This loss can damage the creditworthiness of households, affecting their ability to obtain credit – a loss of ability reflected in the decline in household loans over the past few months. And the decline in net wealth may not be over yet, as housing prices continue to fall in some parts of the country while the rolls of the unemployed swell.
Here’s another double-edged piece of evidence. One of the things that makes credit card debt such a good asset for securitizing is the ability of the banks to reprice credit. That’s a euphemism for increasing the interest rate for no apparent reason. It contributed an estimated 30% of the industry’s pre-tax profits in 2008. Repricing is a way of managing risk in this sector. Warren notes (p. 60):
Whether the entire amount of re-pricing is justified by increased risk or is instead an action either to offset other losses or to boost the issuers’ net profits is a matter about which analysts disagree.
What Warren doesn’t tell us is whether she thinks it is a good idea to encourage the return of securitization, part of the shadow banking system. For an introduction to this difficult subject, try this from Tyler Durden at Zero Hedge. I’d just as soon we didn’t do. I’d rather see term investors investing in productive activities, rather than in refinancing of existing debt or supporting new and probably unwanted consumer debt.
On the other hand, Congress doesn’t pay attention to smart people, like Warren; but to their real constituency, bankers.