U.S. Treasury Secretary Attempts to Reset Priorities for Troubled Asset Relief Program (TARP)

However, the scope of the TARP program was recently broadened to include non-banks, particularly insurance companies such as AIG that have played a critical role in providing insurance for credit defaults. Indeed, on November 10, the Treasury purchased $40 billion of preferred stock in AIG under the TARP program using a separate $100-billion pool that the Treasury Secretary has at his discretion, and at the same time the Federal Reserve reduced its loan facility from $85 billion to $60 billion, with a substantial reduction in the interest rate charged.

Beyond expanding the scope of the TARP program to include equity infusions in non-banks, the Treasury Secretary is developing a plan to provide support for the asset-backed commercial paper market, particularly securitized auto loans, credit card debt, and student loans. After an initial massive negative shock in the August–November 2007 period, when total asset-backed commercial paper outstanding collapsed by nearly $400 billion, the market has seen steady declines in volumes. However, the Treasury Secretary's speech was extremely light on the details of this new part of the program, including how it would work and the volume of TARP resources that would be deployed to it. Nevertheless, additional funding support for the asset-backed securitization market would provide some relief for the struggling auto finance companies.

While the Treasury Secretary was providing a necessary update on the execution of the TARP program, effectively codifying the action that has been taken in recent weeks, markets are becoming increasingly concerned about how much of the original $700 billion will ultimately be deployed to reduce systemic risk in the financial sector. These concerns were exacerbated by recent statements from Congressional leaders that they intend to deploy TARP resources for supporting the ailing domestic automotive industry, an expansion of the scope TARP program that the Treasury Secretary is staunchly resisting.

Conflicting statements from the Treasury Secretary and Congressional leaders inadvertently spooked the financial markets and touched off a sharp sell-off in financial stocks.

The resetting of the priorities of the TARP program was necessary in view of the crisis situation that pervaded the financial markets in October, and recent actions taken by the Secretary are in harmony with similar action taken in Europe to quickly shore up the financial system there. Unfortunately, the emerging tug-of-war about how to deploy the TARP resources between the Treasury and Congress could unravel much of the progress that has been made since mid-October.

Global Insight takes the view that the $700 billion in available TARP resources needs to be deployed expediently to reduce systemic risk to the financial system, and this approach is congruent with similar major financial commitments made by other G-7 countries in October to reduce systemic risk in their own financial sectors.

The systemic risk problem in the global financial system is still massive, and the risk of any diversion of these TARP resources could be catastrophic. Any action by Congress to apply more resources to the cash-flow problems in the automotive industry ideally should be done under separate legislation.