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Thursday, April 02, 2009

Former Treasury Assistant Secretary writes: "What was going on?"

by Bill McBride on 4/02/2009 01:08:00 PM

From the WSJ: Paulson Expected Criticism for Changing Course on TARP (ht Belinda)

Phillip Swagel, who was assistant Treasury secretary for economic policy under Henry Paulson ... in a 50-page essay to be presented Friday at the Brookings (Institution) Panel on Economic Activity ... says his former boss "truly meant" to the use the $700 billion that Congress gave him to buy assets from banks, not to buy shares, and knew he would be criticized when he changed course late last year in the face of a deteriorating economy and deepening banking crisis.
And the WSJ Real Time Economics has a few excerpts from the essay: What Was Going on Inside the Paulson Treasury?

Here is a short excerpt from the excerpts:
  • The Treasury predicted in May 2007 that “we were nearing the worst of it in terms of foreclosure starts” and the problem would subside after a peak in 2008. “What we missed is that the regressions didn’t use information on the quality of the underwriting of subprime mortgages in 2005, 2006 and 2007,” Swagel said — Federal Deposit Insurance Corp. staff pointed that out at the time.

  • The ill-fated 2007 Treasury proposal to create a privately funded entity — called MLEC, or Master Liquidity Enhancement Conduit – to buy up toxic assets from the banks was developed by the Treasury’s Office of Domestic Finance and shared with market participants without involvement from other Treasury senior staff. “The MLEC episode looked to the world and to many within Treasury like a basketball player going up in the air to pass without an open teammate in mind — a rough and awkward situation,” he said.

  • Paulson “truly meant” to the use the $700 billion in TARP money to buy assets from the banks, not to buy shares in the banks, because he saw it as “a fundamentally bad idea to have the government involved in the ownership of banks.” He changed is mind when markets deteriorated and “he well understood that directly adding capital to the banking system provided much greater leverage.”
  • This shows three of the key problems with the Paulson Treasury:

    1) Paulson didn't understand the problem until very late:
    Paulson also said the fallout in subprime mortgages is "going to be painful to some lenders, but it is largely contained."
    March 13, 2007

    "All the signs I look at" show "the housing market is at or near the bottom," Paulson said.
    April 20, 2007

    "In terms of looking at housing, most of us believe that it's at or near the bottom," [Paulson] told Reuters. "It's had a significant impact on the economy. No one is forecasting when, with any degree of clarity, that the upturn is going to come other than it's at or near the bottom."
    July 2, 2007
    2) The ill-fated MLEC, and three page initial TARP proposal showed poor planning and coordination.
    “The MLEC episode looked to the world and to many within Treasury like a basketball player going up in the air to pass without an open teammate in mind — a rough and awkward situation.”
    Assistant Treasury secretary Phillip Swagel
    3) Paulson was blinded by ideological concerns. The FDIC effectively takes over failed banks all the time, but somehow Paulson saw this as a "fundamentally bad idea".

    Hopefully the entire essay will be available online.

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