The Obama administration’s complex plan to deal with toxic assets may have answered Wall Street’s questions about shoring up the balance sheets of financial firms but it is raising other serious ones about the government’s approach to funding and oversight.
The plan, known as the Public-Private Investment Program for Legacy Assets, is the latest initiative on the part of the executive branch to rely on loans and guarantees, as opposed to budgeted funding, and also asks the same government entities running the programs, to essentially oversee them.
"They've been extending their authority for the last year," says Washington-based economist Dean Baker, co-director of the Center for Economic and Policy Research. "This is really a stretch."
In particular, the PPIP will use a small, amount of money from the second round of the TARP ($75 billion to $100 billion) money approved by Congress and use the Federal Reserve’s emergency lending powers to leverage that by as much as a 6-to-1 debt-to-equity ratio.
“This is an end-run around Democracy,” Rep. Brad Sherman (D-Calif.) told CNBC.com. “No one even imagined we would see trillions of dollars shifted from Washington to Wall Street that no member of Congress ever voted for.”
Sherman is referring to the PPIP and other recent Fed lending programs, including the recently launched Term Asset Lending Facility.
Though the Fed’s authorized to use its balance sheet for such lending activity under “unusual and exigent circumstances”, according to section 13.3 of the Federal Reserve Act, lawmakers and analysts alike have become increasingly concerned about the consequences.
Sherman, who voted against the TARP, calls the Fed’s balance sheet “the endless multiplier”, while Baker says the once all-important TARP money (not to mention its original sticker shock) has been reduced to “almost a fig leaf” in the effort to rescue the financial sector.
Moreover, some in Congress say the PPIP, once again, puts the central bank in an awkward position.
"When you see the Fed and Treasury teaming up, putting programs together, the concern becomes, is the central bank still independent?" asks Sen. Bob Corker (R-Tenn), who generally approves of the plan's concept. "There's an erosion process, an erosion of that independence."
Corker says he voted against the release of the second $350 billion in TARP funding because he was concerned about how it could be used.
What’s particularly alarming about the PPIP program, critics say, is that unlike the original TARP concept, which called for a dollar-for dollar investment in troubled firms through a capital-for-equity swap, the PPIP will essentially use government money to back more limited investment capital from the private sector. Based on early analysis of the PPIP fact sheet, some say taxpayers could end up providing more than 90 percent of the funds to buy the troubled assets.
The PPIC is expected to generate some $500 billion in purchasing power but the government says that could reach $1 trillion.
Skeptics say the White House and Treasury Department are aware that Congress is unlikely to approve additional funding for the effort, given the popular outrage over Wall Street compensation.
"Leverage it up. Guarantee the money," is how one industry source put it. "I don't think Congress is in any mood to approve more money right now."
That thinking played out in an interchange during a House hearing Tuesday on the AIG (NYSE: AIG) bonus flap.
“We recognize it will be extraordinarily difficult,” Treasury Secretary Timothy Geithner told the panel.
“There’s not an awful lot of sympathy up here to provide additional funds,” responded Rep. Paul Kanjorski (D-Pa.)
There may be other funding stumbling blocks for the plan.
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One of the program’s two main components—the Legacy Loans Program—calls on the FDIC, which operates the government insurance fund that insures bank deposits, to “provide a guarantee for debt financing...to fund asset purchases.”
Both members of Congress and former regulators call this worrisome.
“I do not like the use of the FDIC funds for this purpose; it is a deposit insurance fund, not a loan guarantee fund,” says former FDIC Chairman William Isaac.
The FDIC’s insurance fund is already under-funded and its resources are expected to be further taxed as the pace of bank failures picks up amid the deepening recession.
“I’m somewhat fearful of the FDIC being called upon to backstop this effort at a time its insurance fund is pressed to its limits,” Rep. Jeb Hensarling (D-Texas) told CNBC.
“I think you're jeopardizing the FDIC,” Rep. Mike Capuano (D-Mass.) snapped at Geithner during the House hearing.
Though the funding structure of the PPIP has raised the most alarms thus far, oversight issues may not be far behind.
The FDIC will participate in the funding of the program and also “provide oversight for the formation, funding and operations” of these funds.
More broadly, the Obama administration appears to have given the Fed, Treasury and FDIC potentially conflicting roles in executing the PPIP.
“It’s a real trade off between complexity and transparency,” says Baker, the economist. “Its not clear who's watching.”
The Treasury’s fact sheet does not address any outside oversight to make sure there is adequate transparency, something Congress forced on the Bush administration with the TARP last October. That law, the Economic Emergency Stabilization Act, created a congressional oversight committee and an inspector general,while also delegating some authority to the Goverment Accoiunting Office.
Given that TARP money is involved, Congress is likely to make the PPIP its business.
"I see no reason why they wouldn’t have oversight over it," said one senior Congressional staffer. "If you are going to be using TARP funds, then that kicks in."
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