How to Spend Part II of the TARP

We will be hearing from the new administration numerous plans as to how to spend the $350 billion TARP in the coming days. I have been reading about the various proposals, and thinking about each one. All are problematic in terms of fixing the financial sector, and restoring credit.

The only thing I have been able to imagine that resolves the problem is temporary nationalization, wiping out the banks debts and starting over. Call it a financial mulligan. But as George Soros pointed out yesterday, nationalization remains politically and even culturally unpalatable. Which is a polite way to say our leaders lack the cojones to perform this needed task. Eventually, when it will be much more dire, they may not have a choice. By then, the costs will escalate dramatically.

Barring any plan for nationalization, we will be deciding between a bad bank, an insurance wrap plan, and other ineffectual attempts to prop up insolvent institutions run by the people who made them that way. Same corporate culture, same risk management, same misaligned financial incentives.

Is there any reason to expect a different outcome when the same players, with the same coach calling the same plays, take the field?

I have a different idea for $350 billion TARP II.

The key problems as I see them is we have a vastly undercapitalized financial sector, a contracting economy that is getting worse, a spent-out consumer, lack of credit generally — and more defaults and foreclosures on homes and credit in the future.

My plan is very simple: Take 175 million taxpaying households — the bottom 80% or so of all taxpayers. They each get a Debt Reduction check for $2,000 each from Uncle Sam. The twist is it can only be used to pay a pre-existing debt (February 1, 2009 or older) — Mortgages, auto lease/loans, student loans, and revolving credit (MC, V, AMEX) or any retail credit card (Sears, Macys, etc.). The check must be used within 90 days — or its forfeited.

What will this accomplish? Consider the following:

• These monies will find their way to Banks and finance companies; its not quite recapitalization, but it gets cash to banks in a productive way;

• Banks experience a (temporary) decrease in delinquencies and defaults;

• Households will reduce their indebtedness by a significant amount; The typical family has $8,000 in credit card and other revolving credit debt;

• The consumer will have the ability to spend a little more freely, due to their increased credit position. We do not want them to go on another credit fueled consumption binge, but spend some money now that they are less over extended;

• The taxpayer actually benefits from the use of his own taxpayer dollars — a welcome change.

• It does not reward the misfeasance of the financial sector;

The logistics of this are daunting. Ensuring that only pre-existing debts are paid won’t be easy — perhaps enforcement can be accomplished by requiring all taxpayers to demonstrate on their personal income tax form that the money was used to pay off debt (fail to show that and get tagged for $2000).

Its not that this is such a brilliant idea; to be blunt, its not. Its just that all the other TARP concepts are so terrible — expensive, wasteful, inequitable, filled with moral hazard, and as we have seen, utterly ineffectual.

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Previously:
Why Not Nationalization? (February 4th, 2009)
http://www.ritholtz.com/blog/2009/02/why-not-nationalization/

Nationalize Now (January 26th, 2009)
http://www.ritholtz.com/blog/2009/01/nationalize-now/

The Moral Hazard of the “Bad Bank” (January 29th, 2009)
http://www.ritholtz.com/blog/2009/01/who-is-the-treasury-secretarys-boss/