TARP Banks Tighten Credit and Shadow Banking System Remains Broken

Posted by Michael A. Kamperman on June 2, 2009

The GM news has dominated the headlines, and rightfully so.  But GM is a symptom of the crisis, not the cause.  The cause of the crisis is the collapse of credit all over the globe.  The shadow banking system is broken because the asset-backed securities market that relies on AAA ratings is broken.  The U.S. economy is dependent upon the commercial banks to increase lending and absorb a portion of the credit market share that belonged to the shadow banking system.  However, recent data that has gone under the media radar indicates all of the banks that received TARP funding from the federal government saw a combined 3% decrease in lending in March.  This follows on a 2% decrease in lending in February from the 19 largest banks in the country that received TARP funding.  Credit remains extremely tight, even today.  Mike Jackson, the CEO of Auto Nation, stated that 65% of buyers coming into the showroom with prime credit are qualifying for a prime auto loan, and only 10% of subprime borrowers are qualifying for anything.  A year ago, 95% of prime borrowers were able to qualify, and 50% of subprime borrowers could obtain an auto loan.  This pattern of tight credit is true for other consumer loans and for commercial loans.

While the TARP prevented a run on the banks, it has been unsuccessful in restoring the availability of credit.  Part of this is because many of the banks have significant potential future losses and are trying to remain solvent.  The problem is the banks that are in a position to lend are not lending the TARP money they received.  These healthier institutions parked the TARP funds and have been waiting for an opportunity to return them to the federal government to avoid unwanted interference in their private businesses.  The Treasury needs a new plan to restore the availability of credit in the economy.

What the Treasury should do with the returned TARP funds is quit using it as a rescue fund and use it as an economic renewal fund.  The Treasury should reignite the asset-backed securities market for auto’s and jumbo mortgages by taking the returned TARP funds and using them as a reserve to guarantee newly issued asset backed securities ala Fannie Mae to support new lending in these markets.  The Treasury should establish down payment and affordability guidelines to ensure the people receiving the loans have a reasonable chance to repay the loans.  And the Treasury should not exclude someone with a subprime credit score if they can make a suitable down payment and afford the monthly payments.  The strategy of not monetizing the debt combined with keep credit markets very tight is a strategy to plummet us to the economic depths experienced in the 1930’s.