Last week, the Treasury's Troubled Assets Relief Program was itself in deep trouble, with observers harping on the administrative nightmare it would entail. On Tuesday, Treasury announced its program of direct purchases of bank stock.
The capital-infusion program would be voluntary for the banks wanting to raise new capital this way. This approach was the right way to go. It promised to use federal resources in an effective and relatively market-friendly way.
But we've since learned from press reports, including in this newspaper, that the program was not quite so voluntary for nine of the nation's largest banks. The day before the government announced its new program, the heads of these banks apparently "volunteered" to sign up the way a soldier is "volunteered" for latrine duty. "Yes sir, sergeant, right away, sir."
To my knowledge, there is no statute that permits the U.S. government to require that a corporation sell stock to the government. Is Treasury so panicked by the financial crisis that it is willing to abandon normal democratic processes, such as acting under statutory powers?
The sad thing is that there is no need to strong-arm large banks; indeed, this tactic adds risk to the financial stabilization effort. Treasury's argument, as I understand it, is that it needs to require some participation in the capital-infusion program to avoid stigma. Because participation carries terms objectionable to banks, such as limits on executive compensation, only weak banks will want to participate willingly. If some banks participated and others did not, those who did would be in effect declaring they were weak and scaring away depositors and investors.
The stigma argument does carry some weight. But the way to deal with it is for participating banks to raise private capital as well as Treasury capital -- so that they can demonstrate that they are unquestionably solvent and strong. One way to demonstrate strength would be to hold capital clearly in excess of the regulatory minimum.
One risk posed by Treasury's less-than-voluntary approach: What if a courageous board of directors of one of the nine large banks doesn't agree to sell stock to the Treasury, despite the CEO's promise? After all, a board should be more than a rubber stamp for the CEO. What if a stockholder suit blocks a bank's participation? Then what? Would Treasury apply further turns of the extralegal screw to the recalcitrant bank?
If a bank hangs tough, we have some very rough times immediately ahead. If no bank resists, we have some tough times ahead for the longer run, because, large bank or small, the federal government is now beginning to walk down the path of credit allocation.
Treasury Secretary Hank Paulson was quoted by Bloomberg on Tuesday as saying that "leaving businesses and consumers without access to financing is totally unacceptable." Actually, it is perfectly acceptable to leave certain businesses and consumers without access to credit. Everyone understands that we would be a lot better off today if the market had denied mortgage credit to many subprime borrowers. Can federal direction as to which businesses and which consumers banks must serve be far behind -- even if not from this Treasury Secretary, then from his successor, or from elsewhere in the federal government?
Some banks need more capital not to expand lending, but to shore up the existing balance sheet. It would be a terrible mistake for Treasury to direct banks participating in its capital-infusion program to expand credit in particular directions, or in the aggregate. Exhibit A: Fannie Mae and Freddie Mac, both now wards of the state. Do we need further exhibits? Federal credit allocation will be an unmitigated disaster.
Banks will not want to play this game. Treasury's new program provides that a bank can exit by repurchasing Treasury shares with newly raised private capital. Given the program's distasteful features and future dangers, banks may want to exit as soon as they can to escape potential federal intrusion into their lending practices. Only weak banks, after all, may remain in the program -- a direct consequence of Treasury's strong-arm tactics. Such an outcome would be unfortunate, as many banks do need more capital.
Some will dismiss my comments as reflecting exaggerated concerns. I well remember, though, how those advocating wage-price guideposts in the 1960s dismissed fears of full-blown wage-price controls. But when comprehensive controls became politically convenient for President Richard Nixon, he imposed them in 1971.
We face the same issue with credit controls. Consider the temptation: Congress may now be able to force off-budget assistance to struggling homeowners and others through Treasury's capital-infusion program. Isn't it logical, members could argue, that participating banks, benefiting from taxpayer-provided capital, do their "fair share" of mortgage relief?
In managing the financial crisis, the worst may not happen -- and I hope it does not. But the arm-twisting applied to the nine large banks is a terrible precedent. The danger is that the financial mess will be turned into a larger, even more critical governmental mess as well.