JPMorgan Takes Over WAMU, Congress Continues to Wrangle on $700-Billion Troubled Asset Repurchase Plan (TARP)

The administration and Congress made considerable progress through Thursday in developing more refined legislation on the Troubled Asset Repurchase Plan (TARP). The plan was further elaborated to include a phased-in approach, foreclosure prevention, limits on executive compensation, elements of equity participation, and oversight.

However, a group in Congress is hastily attempting to craft a competing plan whereby banks would be able to purchase insurance for mortgage-based assets. This competing plan has very few details, so it is difficult to say at this point whether or not it has any merit. However, the delay in moving forward on the modified TARP plan is creating a considerable amount of uncertainty in the markets—raising concerns about where leadership is moving on managing the financial crisis.

The main stumbling block with the TARP plan is the manner is which it is being presented to the public. This is not a $700 billion "bailout." The banking system overall will still have to bear some additional costs related to the mortgage assets crisis even if the TARP plan is approved—so the key question is, how much more cost in the form of asset write-downs can the financial system withstand without folding in on itself?

Moreover, the net costs to the taxpayer are likely to be much lower than $700 billion, although it will be difficult to estimate these net costs given the current uncertainty in the economy and the housing market. A conservative estimate of the net costs might be in the range of $100–200 billion.

Any alternative or competing plan ultimately will involve some kind of front-end commitment from the Treasury and the taxpayers, but will suffer the same bottom-line issue—it will be extremely difficult to evaluate net costs to the taxpayers given the extreme level of uncertainty currently prevailing in the financial markets.

It is hard to say at this point whether the competing plan will gain any momentum on Capitol Hill. If more details were available, then it could be evaluated based on its merits.

There is no doubt that further aggressive action by the Federal Reserve and the administration to deal with this crisis is essential. The Fed's recent efforts to provide more liquidity and manage the effective federal funds rate to well below the 2% target are encouraging. However, lowering the fed funds target would be a much more effective method of transmitting relief to the financial system, as that would translate swiftly into lower short-term consumer, mortgage, and business borrowing rates.

The modified TARP program is a reasonable compromise. It goes without saying that more work needs to be done on the fine print of the program. But we cannot see how any major distraction from this exercise would lower prospective costs to the taxpayer or be constructive at this stage of the crisis.