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How much bailout money will taxpayers get back?

kbh — Fri, 26 Jun 2009 18:20:00 +0000

The Congressional Budget Office (CBO) has released their assessment of the Office of Management and Budget’s semiannual TARP report. That assessment estimates how much cash has gone out the door for each part of TARP, and how much CBO expects will ultimately be returned to the Treasury. I have converted CBO’s table (Table 1 on page 2) to a set of graphs. Looking at the Capital Purchase Program (CPP) in the bottom bar, $199 B has gone out the door in outlays, and CBO expects $174 B of that will be paid back. CBO calculates a subsidy rate for each program, which for CPP is 25 ÷ (174 + 25) = 13%. Taxpayers should expect to recoup 87% of the funds that were invested on their behalf in the Capital Purchase Program and lose the other 13%.

You can see from the graph that most of the funds went to capital purchase: CPP + specific firm deals (AIG, Bank of America, and Citigroup). CBO thinks we taxpayers will get most of our money back from Bank of America and Citigroup. We’ll get about half back from AIG, and a little more than a quarter back from the autos and auto finance companies. The Administration’s foreclosure mitigation program is a spending program, not an investment, and thus we expect to get none of those funds back. Footnote (d) on CBO’s table contains a surprise: “The Treasury has not yet disbursed any of the $15 billion allocated as of June 17, 2009, for foreclosure mitigation.” We heard a lot about the President’s efforts on foreclosure mitigation, and yet no cash has flowed.

To answer the question, “How much bailout money will taxpayers get back?” CBO estimates that:

$439 B of the original $700 B has been spent;
$280 B of that will be repaid; and
$159 B will not be repaid and will be a cost to the taxpayer.

CBO provides further detail on the Capital Purchase program by subdividing it into two parts: CPP for the 32 banks that have already paid back the Treasury, and CPP for all the other banks. Here’s the same graph, but with CPP split into those two parts. You can see that the net cost to the taxpayers from the 32 banks that have already paid back Treasury was (only) $1 B. CBO is guessing a much higher loss on the remaining outstanding CPP investments.

We do not have similar estimates for all of the Fed actions, but we do for the FDIC’s actions, and for the bailout of Fannie Mae and Freddie Mac. The picture changes dramatically when we add these non-TARP financial rescue funds. Courtesy of Sen. Judd Gregg’s excellent Senate Budget Committee Republican staff, I’m going to add in orange the estimated taxpayer costs of FDIC’s component of the Citigroup rescue, and CBO’s estimate of the taxpayer cost of bailing out Fannie Mae and Freddie Mac.

CBO estimates that the cost to the taxpayers of the failure of the GSE’s, Fannie Mae and Freddie Mac, will be $384 B. That is 2.4 times larger than all the other TARP and non-TARP costs (shown here, and excluding the Fed) combined. Here’s the Budget Committee Republican staff’s Budget Bulletin:

CBO estimated that the federal government immediately absorbed a loss of $248 billion for the book of business the GSEs had in September 2008. To maintain an active mortgage market, the federal government is continuing to operate the GSEs, whose new commitments entered into after September 2008 would lose an estimated $136 billion over the 2009-2019 period according to CBO.

Thus when we rank the expected cost to the taxpayers of the different TARP and non-TARP programs, we get:

Fannie Mae & Freddie Mac ($384 B)
Foreclosure mitigation ($50 B)
Autos & auto finance ($40 B)
AIG ($35 B)
Outstanding equity investments in banks through the Capital Purchase Program ($24 B)
Citigroup ($15 B)
Bank of America ($2 B)
The direct Treasury cost of the Fed’s liquidity facility ($2 B)
Repaid equity investments in banks through the Capital Purchase Program ($1 B)

That $384 B number is huge.

And updating to include TARP + FDIC + GSEs (but not the Fed facilities), it appears CBO estimates the net cost to the taxpayer of all these non-Fed facilities will be about $553 B.

Thanks to Jim Hearn of Sen. Gregg’s Budget Committee staff for his incredible table and assistance.

Sources:

CBO’s The Troubled Asset Relief Program: Report on Transactions through June 17, 2009
Senate Budget Committee Republican Staff’s Budget Bulletin (June 25, 2009)

If you’re really into budget policy, you should keep your eye on the Budget Bulletin. You can subscribe by emailing their webmaster, whom you can find here.

How much bailout money will taxpayers get back?

© 2010 Keith Hennessey - Your guide to American economic policy

Understanding the GM bankruptcy

kbh — Mon, 01 Jun 2009 23:17:03 +0000

Many of you are new to this blog since I wrote extensively about autos six weeks ago. As background, I coordinated the auto loan process for President Bush last fall as the Director of the White House National Economic Council (the position now held by Dr. Lawrence Summers). I wrote a series of posts on the auto loans beginning when the President made his late-March announcements, and continuing into the spring. For reference, here are those posts:

This morning I posted some basic facts on the General Motors announcement. Now it’s time for some analysis. Like my post Understanding the President’s CAFE announcement, this is a monster post. I hope you find it valuable despite its length.

I want to try to tease apart the various questions that get conflated in the public forum. My primary goal is to give you a structure for thinking about the issue. My secondary goal is to persuade you to agree with my views on each question. I will be satisfied if you give me credit for achieving only the primary goal.

Here is how I tease apart the questions:

What are the arguments for further government intervention?
Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?
Is the pre-packaged bankruptcy likely to succeed?
Is it fair?
Did the government structure the taxpayer financing correctly?
Will the Administration run GM?

Let’s take them one-by-one.

1. What are the arguments for further government intervention?

Today the President explained why he chose to put another $30.1 B of taxpayer funds at risk to prevent GM from liquidating now. Speaking about his decision on March 30th, he said today:

But I also recognized the importance of a viable auto industry to the well-being of families and communities across our industrial Midwest and across the United States. In the midst of a deep recession and financial crisis, the collapse of these companies would have been devastating for countless Americans, and done enormous damage to our economy — beyond the auto industry. It was also clear that if GM and Chrysler remade and retooled themselves for the 21st century, it would be good for American workers, good for American manufacturing, and good for America’s economy.

This is more expansive than what President Bush argued last December:

In the midst of a financial crisis and a recession, allowing the U.S. auto industry to collapse is not a responsible course of action. The question is how we can best give it a chance to succeed. Some argue the wisest path is to allow the auto companies to reorganize through Chapter 11 provisions of our bankruptcy laws — and provide federal loans to keep them operating while they try to restructure under the supervision of a bankruptcy court. But given the current state of the auto industry and the economy, Chapter 11 is unlikely to work for American automakers at this time.

The distinction is important. President Bush’s arguments were time-dependent: (a) we should try to prevent our weak economy from taking another big hit right now, and (b) let’s buy GM and Chrysler time to get ready to restructure. He also argued (c) that it was unfair to dump a liquidating auto industry on his successor (even if his successor might do something different than he would). It was a “too big to fail now” argument.

Today President Obama made it clear that he made the decision to commit additional funds, if his conditions were met, at the end of March. He then added new reasons to those expressed by President Bush: that America needs “a viable auto industry,” and that it would be good for America if GM and Chrysler survived. While he emphasizes what he would not do, “I refused to let these companies become permanent wards of the state,” President Obama defines a national interest in having auto manufacturers headquartered in the U.S. He reinforced that with his closing line, which was surreal:

And when that happens, we can truly say that what is good for General Motors and all who work there is good for the United States of America.

This is a big expansion of the justification for government intervention in the market. Ford is not failing, and Chrysler is emerging from bankruptcy. President Obama is arguing that American taxpayers need to fund the survival of a third (the biggest) U.S.-based auto manufacturer, because it is important “to the well-being of families and communities across our industrial Midwest and across the United States” and because “it would be good for American workers, good for American manufacturing, and good for America’s economy.” This argument could be extended to almost any large U.S. firm, at almost any time.

My view: I am extremely uncomfortable with the President’s expanded argument for further government intervention. Had the President instead argued, “The economy is beginning to recover, and we cannot jeopardize that with another major shock,” I would have been less uncomfortable with today’s commitment of additional taxpayer funds.

2. Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?

The public debate has evolved in the past two months. Earlier this year the question posed was, “Should the Administration bail out GM?” The basic options were “yes,” “no,” and “only if they enter bankruptcy, and if they do they should try to pre-package it.” The President chose the last of these options. The President decided to put $30.1 B of additional taxpayer funding at risk to help prevent GM from liquidating in the near future, and to help them through a restructuring process.

The benefits and costs are similar to what I described in late March. Here’s the updated version:

Benefits

If the firm survives the bankruptcy process intact, it has a higher probability of being viable in the long run (than in a restructuring outside of bankruptcy).
If the firm survives restructuring, the taxpayer has a higher probability of being repaid.
Old equity holders faced the full costs of the firm’s failure (by being wiped out). No additional moral hazard is created.

Costs

There are still significant risks to GM’s survival:
- Will GM and the Administration defeat the objecting unsecured creditors in court? (however unfair that might be)
- Will the bankruptcy process conclude quickly (within 90 days)?
- Will GM continue to lose market share? Can GM make cars and trucks that people want to buy?
- Will the new fuel economy and emissions rules restrict GM’s ability to make attractive vehicles?
This is a big new cash outlay from the taxpayer. This costs the taxpayer, and further constrains available TARP funds.

The President made clear his answer to this question on March 30th. At that time he laid out the conditions under which he would provide additional funding, and those conditions were met. No one should be surprised that he is now putting more taxpayer funding at risk. I am surprised that they only need $30 B.

My view: We crossed this bridge back in late March. It is not a new decision today to put more taxpayer funding at risk. I don’t like it, but I am at least glad that some incentives have been restored: the firm has to go through a bankruptcy process, shareholders are wiped out, and management was fired. I remember arguments from last fall and earlier this year that GM should get more taxpayer dollars outside of a bankruptcy process. That would have been far worse, and today’s actions mitigate some moral hazard.

Given the relative strength of the U.S. economy now compared to last December, I would have preferred an outcome of a pre-packaged bankruptcy + private DIP financing, and not exposing taxpayers to any additional risk. If GM is really as viable as GM and the President claim it now is, then they should have no problem convincing capital markets to provide them with short-term financing. (Judge Richard Posner argues this.) I will guess that this was not actually a viable option, because the pre-packaging could only come together with the direct involvement of the government. I think the real options would have been expose taxpayers to $30B more risk, or allow GM to liquidate. I would go with the latter: if GM can’t find private financing, they’re on their own. I assume this means they would liquidate. This would have been harsh and painful for those affected. I believe the consequences of further intervention now are worse for a larger number of people in the long run.

3. Is the pre-packaged bankruptcy likely to succeed?

There are two components to this question:

Is the bankruptcy process likely to be quick and successful?
Will the resulting company succeed without additional taxpayer aid?

I do not feel well-qualified to comment on the first question. The talking heads all repeat that “GM’s bankruptcy is more complicated than Chrysler’s,” with little detail about why. I would point out that the Administration is one for one in this process. Their use of this part of the bankruptcy code (section 363), and the process where the old GM sells the good stuff to a new GM, and then the remaining parts are liquidated, appears to have worked for Chrysler. From my perspective, the burden of proof now shifts to those who argue this bankruptcy will take more than 90 days. I didn’t like it because of the precedent it set, but I wouldn’t bet against the Administration succeeding again.

Other than the “good for GM is good for America” quote, the biggest surprise in the President’s remarks was how heavily he was betting that a restructured GM will succeed. He could easily have taken the posture, “GM has made some hard decisions, and they have a tough road ahead if they want to survive and succeed.” Instead, he attached his own credibility to GM’s future success and said:

So I’m confident that the steps I’m announcing today will mark the end of an old GM, and the beginning of a new GM; a new GM that can produce the high-quality, safe, and fuel-efficient cars of tomorrow; that can lead America towards an energy independent future; and that is once more a symbol of America’s success.

Even with a cleaned up balance sheet and more taxpayer funding, it is by no means certain that GM will survive for the long run. If GM fails in the next few years, the taxpayers will have lost an additional $30.1 B that the President committed today. In addition, the above quote will come back to haunt the President. I understand wanting to set a positive and optimistic tone. I am confused why he did so at such great political risk to himself.

I found it useful to return to my first post on the autos and review what this new pre-packaged bankruptcy + DIP financing does to the wide range of challenges faced by GM:

Revenues

The economic slowdown means fewer vehicles are being purchased from all auto manufacturers, foreign and domestic.

Even apart from the economic slowdown, U.S. auto manufacturers have been losing market share over time.

This is in part because they made a bet on light trucks versus smaller cars. This product mix doesn’t work when gas prices are high. Think of the proliferation of SUV’s in the past 10 years. (Note that this was in part the fault of U.S. government policies. SUV’s are technically light trucks, and so they qualify for lower fuel economy requirements.)

Costs & productivity

The Detroit 3’s ongoing labor costs are higher than those of foreign-based firms. This is still true when you compare an American worker in a GM plant in Michigan, for instance, with an American worker in a Nissan plant in Mississippi.

Productivity is lower in U.S. plants of U.S. firms than it is in U.S. plants of foreign-based firms. Some of this is because of the UAW contract that mandates certain inefficiencies. Some of it is poor management.

The Detroit 3 have huge dealer networks that are costly to the manufacturers. These dealer franchises are often protected by state laws that make it hard for the manufacturers to make these networks smaller and more efficient.

Auto manufacturers face a burdensome and unpredictable legislative and regulatory environment.

Balance sheets

The Detroit 3 have enormous legacy costs from their retirees. Past UAW contracts provided generous benefits that continue to burden these firms. This drains profits (when they earn them) away from productivity-enhancing investments.

So can GM survive, and for how long? Can they profit and flourish, as the President suggests they will?

The Administration and GM argue that a restructured GM can break even in a national market of only 10m vehicles sold in America each year. (We’re now around 9.5m/year. “Normal” is around 16m/year.) If accurate, this is astonishing. This would appear to address all three of the bullets under revenues. Addressed? I’m skeptical. I need to review the assumptions in GM’s new plan, especially about market share.
I have seen no evidence that GM and UAW have reduced significantly GM’s ongoing labor costs to be competitive with the transplants. Maybe I have missed it. Unaddressed.
Productivity is still lower in U.S. plants of U.S. firms that it is in U.S. plants of foreign-based firms. As a result of high compensation costs per worker and low productivity, it appears that labor cost per vehicle produced will still be uncompetitive with the transplants. Unaddressed.
GM’s dealer network is being dramatically reduced. Addressed.
The CAFE and emissions requirements are even more burdensome than predicted, but now have at least some degree of stability, given the national standards. On net, worse than before.
The balance sheets will be relieved of enormous debt and legacy health and pension obligations. Addressed.

My view: I need to look more at what GM is assuming for market share. The removal of the legacy obligations, combined with a big chunk of taxpayer change, will buy then many months of survival.

The Administration is stressing the balance sheet improvements, and they deserve credit for that. Conservative critics focus on the additional burdens of the fuel economy and emissions rules, and they’re right, too.

I would focus even more on the questions asked by several commenters: “Will people want to buy GM cars and trucks?” Additionally, can GM make a profit with still high labor costs, still low productivity, still burdensome work rules, and still slow product development cycles?

I want to GM to survive and be profitable in the long run. Their chances are now drastically improved, assuming they survive bankruptcy. But I don’t know if that’s an improvement from a 1% chance to a 20% chance, or from a 1% chance to an 80% chance. A lot more needs to change beyond just cleaning up the balance sheet, and many of those needed changes are deep-seated in the culture, structures, and processes of America’s third-largest company.

4. Is the pre-packaged bankruptcy fair?

Absolutely not. But I want to be precise in my criticism.

The easiest thing to do in Washington is to criticize the negotiator. “I could have gotten a better deal,” we say. I should begin my expressing my sympathy and offering my congratulations to Steven Rattner and the Obama team for closing what was undoubtedly a complex and difficult set of negotiations. I’m sure this one was not easy, and theirs was a thankless task.

At the same time, I share the concerns of many that the deal was not even-handed, and that the precedent will damage future business lending. I have grave concerns about how far they were willing to stretch bankruptcy processes and the traditional capital structure to get a deal.

First I need to correct the Administration, as well as some bad reporting today by the Washington Post. In last night’s background briefing for the press, an unnamed Senior Administration Official claimed (emphasis added):

Secondly, as you know, the UAW has reached a new agreement with GM and that agreement has been ratified that involves significant concessions by the UAW — concessions that are in virtually every respect more aggressive than what the previous administration demanded in its loan agreement.

In the term sheet for the December loan we (the Bush Administration) made to General Motors, we set out “targets,” which we took directly from the Corker amendment offered the week prior on the Senate floor:

Reduce outstanding unsecured debt by not less than 2/3 through conversion into equity or other debt;
“Reduce the total amount of compensation, including wages and benefits, paid to their U.S. employees so that, by no later than December 31, 2009, the average of such total amount, per hour and per person, is an amount that is competitive with the average total amount of such compensation, as certified by the Secretary of Labor, paid per hour and per person to employees of Nissan Motor Company, Toyota Motor Corporation, or American Honda Motor Company whose site of employment is in the United States.”
Eliminate the jobs bank.
Apply work rules no later than 12/31/09 “in a manner that is competitive with Nissan … Toyota or Honda in the U.S.”
Not less than half of their VEBA payment should be in the form of stock.

As best I can tell:

They more than accomplished target #1.
They did little to nothing on #2. I have seen no evidence that compensation of current workers has been changed. UAW Chief Ron Gettelfinger claimed in a message to his members, “For our active members these tentative changes mean no loss in your base hourly pay, no reduction in your health care, and no reduction in pensions.” Maybe there’s a distinction between this statement and “total compensation.” If so, it would be great if someone could help me understand this. But it appears GM and UAW did nothing to address target #2.
UAW agreed to #3 in late March.
They made no apparent progress on target #4. I have neither seen nor heard evidence that the work rules have been relaxed. I am happy to be corrected.
They accomplished #5.

It was incorrect for the Senior Administration Official to call these “demands” of the Bush Administration. They were targets, not hard conditions. It is an overstatement to say that they “are in virtually every respect more aggressive than what the previous Administration demanded,” unless “virtually every respect” means “except for compensation and work rules.” (I am happy to be corrected if I have just missed the changes.)

The Washington Post then further flubbed it by writing:

Critics say it is unfair that the restructuring plan gives the union health trust a larger share of the new GM than the bondholders. But administration officials defend the plan, offering several justifications.

First, they note that the terms of the proposed GM restructuring echo the terms laid out by the Bush administration in December, when it extended $13.4 billion in loans to GM.

The Bush administration’s loan agreement required a 50 percent reduction or “haircut” for the union trust, but a 66 percent cut for the bondholders. The Obama deal requires larger cuts for both sides, though more for the bondholders.

The agreement does more than meet three of the five targets laid out by the Administration. It appears to make no progress on the other two targets. Thus the terms do not “echo the terms laid out by the Bush administration in December.”

More importantly, the targets we (Bush team) laid out said nothing about the distribution of equity shares. The criticism is not that the deal doesn’t cut the VEBA enough, or reduce unsecured debt enough. The criticism is that someone lower in the capital structure (UAW’s VEBA) got a much greater equity share than someone higher in the structure (unsecured creditors). It is disingenuous to point to the targets in the Bush Administration’s December loans to justify this inequity.

The deal is unfair to unsecured creditors, because they get a worse deal than someone standing behind them in line (the UAW’s VEBA). It has nothing to do with who those parties are (labor vs. creditors). It is about the importance of maintaining a stable and predictable set of rules to govern the capital structure of a firm, and the value that stability creates for firms’ ability to raise capital. All these arguments boil down to the cardinal rule of waiting in line for the kindergarten bus: it’s not fair to cut in line. If that rule is broken too often, chaos ensues.

The Administration could be arguing, “Sure it’s unfair, but UAW had more leverage on us than the creditors, so we struck the best deal that we could. We needed UAW to sign onto the deal, while we thought we could roll the creditors in court.” This would better justify the disproportionate equity shares than claiming, “This is a fair deal.”

The objecting creditors will now defend their rights in court. If the Chrysler precedent is an example, you should bet against them. It is interesting that the President did not attack them as “speculators” this time, so at least the rhetorical leverage against them is weakened.

My view: I am more concerned with the signals this unfair treatment sends to future investors. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain firms. I wish I knew whether a different prepackaging was possible, one which would have maintained the precedence of the capital structure and did not stretch the bankruptcy process again. Unfortunately, it is impossible to know.

5. Did the government structure the taxpayer financing correctly?

Judge Richard Posner argues the government should have provided a loan rather than taken an equity stake in GM. The President suggested one reason why they preferred an equity stake: a loan would further burden GM with a stream of near-term interest payments to the government.

I think Judge Posner strikes a nerve with his suggestion. It seems that much of the public discomfort comes from the government now being the owner of GM. It’s the 60% number that made me gasp. It highlights a tradeoff between two goals on which conservatives focus: value for the taxpayer, and avoiding government interference and control. There is a tradeoff between the two.

I believe the U.S. government could auction its equity shares late this year and divest itself completely from General Motors. This would solve the government ownership problem. In doing so, I presume that taxpayers would recoup far less than the $30 B of cash provided.

Question for conservatives: How much of a loss are you willing to take on the $30 B to get the U.S. government out of GM quickly?

My view: I assume there is a non-trivial chance that GM may still fail in the next several years. I like the President’s and his team’s strong language today that this $30 B is the last taxpayer aid, but I would like to reinforce that by ending the government’s ongoing involvement in GM as quickly as possible. I am willing to sacrifice a significant portion of the $30 B to achieve that goal. I therefore recommend that, if GM emerges from bankruptcy, the Administration then establish a much more rapid timetable for selling its equity stake, even if that means the taxpayer loses much of the $30 B. Get us out of GM before the end of 2010. This will strengthen the bulwark against providing additional taxpayer funds if GM fails again.

Note:

Under current law, the authority to provide any firm with additional TARP funding expires December 31, 2009. Correction: Secretary Geithner can, after notifying Congress, extend the TARP authorities to October 3, 2010.
The “set a timeline” argument has direct parallels to a certain national security debate…

6. Will the Administration run GM?

Here I give the Administration credit for good intent and good initial execution. I take at face value the President’s statement that he does not want to run or control GM, and I give him points for saying so explicitly. I am sure there are others, including some in his Administration and some on Capitol Hill, that would love to run GM as Government Motors. I will trust the President when he says he is not one of those people.

I further give the Administration credit for the “Principles for Managing Ownership Stake” they released in today’s fact sheet. While they are being released in the specific context of the U.S. government’s new equity stake in GM, the White House writes more generally “(T)he Obama Administration has established four core principles that will guide the government’s management of ownership interests in private firms.”

The government has no desire to own equity stakes in companies any longer than necessary, and will seek to dispose of its ownership interests as soon as practicable. Our goal is to promote strong and viable companies that can quickly be profitable and contribute to economic growth and jobs without government involvement.

In exceptional cases where the U.S. government feels it is necessary to respond to a company’s request for substantial assistance, the government will reserve the right to set upfront conditions to protect taxpayers, promote financial stability and encourage growth. When necessary, these conditions may include restructurings similar to that now underway at GM as well as changes to ensure a strong board of directors that selects management with a sound long-term vision to restore their companies to profitability and to end the need for government support as quickly as is practically feasible.

After any up-front conditions are in place, the government will protect the taxpayers’ investment by managing its ownership stake in a hands-off, commercial manner. The government will not interfere with or exert control over day-to-day company operations. No government employees will serve on the boards or be employed by these companies.

As a common shareholder, the government will only vote on core governance issues, including the selection of a company’s board of directors and major corporate events or transactions. While protecting taxpayer resources, the government intends to be extremely disciplined as to how it intends to use even these limited rights.

Given that I trust the President’s statements on this point, the risks here are unintended consequences, from within his own Administration and from the Congress. They are big risks, and these are dangerous waters. I hope the Administration treads carefully.

My view: Given the undesirable situation of government equity stakes in, and even controlling ownership of, firms like GM and AIG, as well as potentially Citigroup and other banks, these are good principles. They are also easy to monitor. It is interesting and good that the White House fact sheet says, “The [UAW’s] VEBA will have the right to select one independent director and will have no right to vote its shares or other governance rights.” (emphasis added)

I urge the President to:

Enshrine the principles from today’s fact sheet in the term sheets for the taxpayer investments in GM (and other firms). We did this last December in the GM and Chrysler term sheets. Tie yourself to the mast. This will give you an easy excuse later when someone pressures you to vote those shares in a way that conflicts with the taxpayer’s interest.
Set clear rules for Administration contacts with GM – it’s probably best to funnel all contacts through specific Treasury or NEC officials on the autos task force. No freelancing phone calls to the Administration-appointed directors or “informal chats” with them from White House staff, or from DOT, EPA, USTR, DOE, even State. Put a firewall around interactions with GM.
Come out hard and quickly against the first proposal from a Member of Congress to leverage the ownership stake for a non-taxpayer goal. Nip it in the bud, especially if the idea comes from a friend.

It’s easy to criticize a huge decision like the one made by the President today. I strongly disagree with where we are headed, and I am concerned with the precedent that this deal sets for capital investment in American firms. The alternative, however, is that you have to be willing to allow GM to fail. I would be willing to do so, and it is therefore easy for me to express my views. In summary, they are:

I am extremely uncomfortable with the President’s expanded argument for today’s government intervention.
My first choice would have been to push GM to get private DIP financing. Assuming that was infeasible, I would have recommended denying GM the DIP financing, even if that meant they would liquidate. The economy is sufficiently healthier now than it was last December that I would be willing to risk the additional shock. But I agree the President crossed this bridge at the end of March.
I would bet in favor of GM emerging from bankruptcy, and against them surviving as an intact firm for 5 years without additional taxpayer funding.
The pre-packaging deal was unfair to unsecured creditors, to the benefit of UAW retirees. The Administration loses credibility with me by trying to argue this was a fair deal. They would have been more credible if they had argued it was the only deal they could get. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain U.S. firms.
If a loan rather than an equity purchase had been possible, I would have preferred that – I find Judge Posner’s arguments persuasive. Given the equity investment, I urge the Administration to divest as quickly as possible, even if it means a loss to the taxpayer.
Given the undesirable situation of the U.S. government owning GM and other large firms, the Administration’s new “Principles for Managing Ownership Stake” are solid. They need to lock them in, and corral or beat back all those people who work in the Executive Branch and Congress who have other goals in mind for GM and will be tempted to exert some leverage.

I thank you for making it through this extremely long post, and again want to thank all of the fantastic commenters. If you dislike the President’s announcement, I urge you to consider this question: Suppose the deal announced today were the only possible pre-packaged bankruptcy, and your choice was to take it or allow GM to liquidate now. What would you do?

Understanding the GM bankruptcy

© 2010 Keith Hennessey - Your guide to American economic policy

The Administration’s background briefing on GM

kbh — Mon, 01 Jun 2009 15:44:30 +0000

THE WHITE HOUSE

Office of the Press Secretary

_______________________________________________________________________________________

FOR IMMEDIATE RELEASE

June 1, 2009

BACKGROUND BRIEFING

BY SENIOR ADMINISTRATION OFFICIALS

ON THE GENERAL MOTORS RESTRUCTURING

May 31, 2009

Via Conference Call

7:10 P.M. EDT

MS. PSAKI: Thank you, everyone, for joining the call. Just a reminder that the call this evening is on background, and you can attribute quotes to a senior administration official. And the embargo is set for 10:00 p.m. this evening Eastern time. Everyone on this call should also have a fact sheet.

I’m going to turn it over to Robert Gibbs now.

MR. GIBBS: Thanks, everybody, for joining. We’re going to do this basically in two parts. The first part, my colleagues will go through the GM specific parts of the call tonight. And then after that we will go through the government ownership principles, which I know a number of you are interested in as part of this and other transactions.

So with that, I’m going to turn it over to my colleague.

SENIOR ADMINISTRATION OFFICIAL: Thanks, I’ll just try to run through this reasonably quickly and maximize the time for questions. Everyone should have a fact sheet. I know you’ve only had it for a short period of time, so let me run through quickly the main points that we wanted to cover.

Everyone is aware that 60 days ago the President announced that he would give General Motors 60 days in order to design a plan for viability that would achieve lasting and permanent profitability and opportunity for success. And since that time the company has been working diligently in conjunction with the auto task force to implement those principles, including one of the President’s main principles which was the concept of shared sacrifice among all of the stakeholders.

And so we are here tonight to give you a preview of the results of this, including what the President will talk about tomorrow. So I’ll run through that reasonably quickly.

First, within this concept of shared sacrifice there are several things to talk about — first, as I said, the auto task force has worked with GM on an operational restructuring that is designed to reduce General Motors break-even point of about 16 million annual rate of car sales down to 10 million annual car sales environment. As many of you undoubtedly know, we’re running about 9.5 million car sales at the moment. And so we hope that by reducing this break-even point GM will be able to endure a period of difficult car sales before hopefully we will see a recovery, and this will, of course, allow GM to become profitable at a much lower level of car sales than has been the case before.

Secondly, as you know, the UAW has reached a new agreement with GM and that agreement has been ratified that involves significant concessions by the UAW — concessions that are in virtually every respect more aggressive than what the previous administration demanded in its loan agreement. And one of the major aspects of that settlement, of that renegotiation, was changes in terms of the VEBA — employee retirement health care trust in which GM had a $20 billion obligation under its existing — and I’ll talk in a second about what’s going to happen with that.

GM is also announcing more or less as we speak that the steering committee has reported that bondholders represent at least 54 percent of GM’s unsecured bonds, have agreed to tender their portion of the $27 billion of unsecured debt for a pro rata share of 10 percent of the equity of new GM for — inaudible — for an additional 58 percent. And so I think from the standpoint of the U.S. government we are very pleased and gratified to be going into the 363 process that will commence tomorrow with such a strong showing of support from the — inaudible — community.

And then GM is also announcing tonight the specifics of its operational restructuring with respect to its plant operations. And we will leave the details of that to them as it is their decisions and their restructuring.

So we are going through, as I think everyone here is aware, a 363 process that we hope and expect will be similar to Chrysler. We do not expect it to be as speedy as Chrysler’s because GM is a far larger, far more complicated global company, but we do expect it to proceed, broadly speaking, along similar lines to the Chrysler one, which you all know, has made very good progress and is very close to a successful outcome.

So in the context of that 363, a new company, a new GM, if you will, will be formed to purchase the operating assets out of the old General Motors that will become part of this new company. And left behind in the old company will be liabilities and other miscellaneous assets that are no longer needed as part of the new General Motors that we expect to create.

So as part of that several other things will happen. First, the new GM will establish a new VEBA, a new independent trust. And you will recall that I mentioned the $20 billion obligation that the old General Motors had to VEBA. As part of the shared sacrifice that the President has emphasize, that will be replaced by a $2.5 billion note, $6.5 billion of preferred stock, and 17.5 percent of the equity of new GM — thus warrants to purchase an additional 2.5 percent of the company.

As was the case in Chrysler, VEBA will have the right to select one independent director, and as in the case with Chrysler, and will be the case with both companies, neither VEBA nor UAW will have any right to voter’s share or any other government right. So it is with the exception of one independent director, a purely passive interest.

As was the case with Chrysler, the qualified pension plan for both hourly and salaried employees will be carried over to the new GM and will remain intact and benefits will be paid in the normal course.

Thirdly, as I mentioned, the U.S. Treasury is preparing to provide about $30 billion of additional financing through — inaudible — possession process during this Chapter 11 to meet both working capital needs during the bankruptcy process as well as to refinance certain existing obligations, and as well as to be sure that the company has the means to be successful in the future. And I’ll talk a little bit more about that in a second.

The U.S. Treasury does not believe or anticipate that any additional assistance to GM will be required. We intend for this to be a permanent resolution of the GM situation and an abil

ity for the company to go forward and be profitable.

In exchange for the $30.1 billion, the U.S. government will receive about $9 billion of debt and preferred stock in the new GM and approximately 60 percent of the equity in the new company.

Let me emphasize in anticipation of those later discussion and questions that we did not seek or solicit or desire to have this equity position. We came upon it simply as a matter of prudence and out of desire to assure that GM was able to go forward with a flexible, deleverage balance sheet, one that is capable of sustaining itself during — in a very cyclical business in what is obviously a difficult environment. And so we had a choice as guardians of the taxpayer dollars, which was to either take this equity as part of the consideration that we could receive on behalf of the U.S. taxpayers, and hopefully have it result in the taxpayers receiving a greater recovery, or we could have simply left it behind and given it to others and taxpayers would have ended up much shorter in terms of the total outcome. So the equity ownership of the U.S. government is not something we sought or desired; it was simply a necessary outcome of the restructuring process and a desire to have GM with a substantially deleveraged balance sheet and able to be competitive.

We’re also very pleased to say that the governments of Canada and Ontario — similar to the situation with Chrysler, will participate alongside the Treasury by lending about $9.5 billion and they will also receive both debt and preferred stock and about 12 percent of the equity in the new GM, and similar to the case with Chrysler, the right to pick one of the initial directors.

I think at that point I will — I think I’ve covered now the main points on GM, so let me turn it back to Robert.

MR. GIBBS: Thanks. Before we take questions on that — do you want to go through our government ownership principles now? I know it’s a big part of what a lot of folks are interested in.

SENIOR ADMINISTRATION OFFICIAL: Sure, let me take that on and start by saying that while this, of course applies to GM right now, this is part of a much broader effort to articulate principles for the U.S. government investments in a series of other companies as well. So this is more about how we can expect the government to act as a common shareholder in this and other cases.

The first starting point is really to pick up on something you said, which is the government really has no desire to own equity stakes in companies any longer than is absolutely necessary and will actively seek to dispose its ownership interest as soon as it is practical to do that. The goal is to promote strong, viable companies that can become profitable quickly, can contribute to growth and jobs without government involvement. And there is absolute clarity about that.

Of course, in exceptional cases where the U.S. government feels it’s necessary to respond to a company’s request for assistance the government has decided to reserve the right to set upfront conditions that will protect taxpayers and promote the financial stability or encourage growth. And in the sense of — inaudible — conditions, there has been some — as you’ve seen in this restructuring and in some other companies, where necessary, these conditions are precisely the kinds of restructuring that my colleague has talked about and would focus primarily on ensuring a strong board of directors, that focuses on the right kind of management that can deliver a long-term vision, that gets these companies to be profitable, ends the need for government support as quickly as is practical.

Now, after those upfront conditions are in place, the government feels that it can protect taxpayers’ investment by managing its ownership stake as a hands-off in a commercial manner as possible. And so the government will not interfere with or exert control over day-to-day company operations and very much will ensure that no government employees will serve on board or be employed by the company it makes investments in.

As a shareholder, the government will limit what it votes on to core governance issues, particularly the selection of the company’s board of directors; major corporate events or transactions. And in its effort to protect taxpayers’ resources as much as possible, the government intends to be extremely disciplined as to how it uses even these limited rights.

So those, as I said, are the principles that apply here in the upfront restructuring of GM and in the intention of the government going forward, but are consistently being applied where the U.S. finds itself in these kinds of situations.

MS. PSAKI: Thank you so much. I think we’re ready to turn it over to questions at this point.

Q Good evening. Appreciating that this is obviously a bigger company than Chrysler, how quickly do you expect you can get it through, and do you expect that legally it will be more difficult?

SENIOR ADMINISTRATION OFFICIAL: In 60 to 90 days; more complicated and many more moving pieces, but we are hopeful that it will have a similar successful outcome.

Q Can you speak a little bit about the input that you will have on the selection of some of the directors — you’re not naming them directly, but you will have input into who some of the new board members are — what kind of direct or indirect input, and what would you be looking for in the directors?

SENIOR ADMINISTRATION OFFICIAL: Let me say a couple of things about that. First, you’ll recall that at the time the President, on March 30th — announced that a majority of the directors of new General Motors would be new, so by implication, there will be a number of existing General Motors directors that will continue with the new company and there will be identified, based on consultations between the current chairman and his colleagues and ourselves — there has been a process underway since that announcement, led by the General Motors board, to identify additional directors, again in consultation with the U.S. government.

Thirdly, with respect to the kinds of people that are being sought, they are business leaders, CEOs, former CEOS, people from other walks of life with relevant experience and can contribute, regardless of political background, affiliation, or nature. And I would point you to the selection of the term at Chrysler, Bob Kidder, very distinguished former businessman, former CEO of Borden, former CEO of Duracell, his politics are not known to any of us anyway, who has agreed to take this on because of his belief in this industry and belief and desire that Chrysler could succeed. And I think Bob Kidder exemplifies the type o

f individual that will be sought to serve on the new General Motors board.

Q Are we going to see the new board members named tomorrow or is that a longer process?

SENIOR ADMINISTRATION OFFICIAL: I would expect over the 60 to 90 days, by the time the company comes out of bankruptcy 60 or 90 days from now, I would expect you to see substantial additions to the GM board.

SENIOR ADMINISTRATION OFFICIAL: As a technical matter, these directors will actually join the board of New Co., which will be buying the assets out of General Motors.

Q Gentlemen, can you specify how the UAW negotiations altered the restructuring plan and are there still the number of plants being closed as before, even though there is one new assembly plant — also how would the process for — inaudible — dealer count of GM mirror or change from that used by Chrysler in its bankruptcy case?

SENIOR ADMINISTRATION OFFICIAL: We were involved in helping to facilitate the discussions between the UAW and General Motors, but I think those are matters that are best left to the two of them. I think the UAW has spoken about its contracts and what it believes. Obviously the vast majority of its members have ratified it. And General Motors has spoken about the contract. So I think they’re both satisfied with it and we’re satisfied with it, but we don’t see a need to get into the details.

SENIOR ADMINISTRATION OFFICIAL: And with respect to your second question, GM has already embarked on the beginnings of its new — inaudible — program. They have different management in process, so inevitably it thinks about life slightly differently and so it’s a slightly different process that they’re going through, but the goal and the end result is intended to be very similar.

Q Can you talk a little bit about how long it might take to get all this money back over time and what your expectations are as to how much the taxpayer might see back on this?

SENIOR ADMINISTRATION OFFICIAL: I don’t think we’re here today to predict or project. We designed the restructuring to maximize the potential for taxpayer money. The company has done a great job on the operational restructuring — in conjunction with our colleagues in order to facilitate that. And so we certainly intend to maximize taxpayer proceeds, but I would also point you back to what my colleague said, that we intend to also exit as soon as practical.

Q My question is to expand the subsidiary of GM. Australia, for instance, has got a subsidiary of General Motors America. What will happen to those subsidiaries, and will there be any restrictions on the new GM investing in factories overseas, like for instance, the factory in Australia?

SENIOR ADMINISTRATION OFFICIAL: One of the principles that the President established early on that we have very much intimated as part of this is that U.S. taxpayer dollars should stay within the U.S. And that is not intended to sound protectionist — I think it’s a principle that every country follows. And so we do not intend to use U.S. taxpayer dollars to support foreign subsidiaries. Happily, most of GM’s foreign subsidiaries are able to sustain themselves independently or by receiving support from their local governments, as I believe will be the case in Australia. We have had contacts with the Australian government on this matter and I believe they’re intending to support GM Australia.

You’re all aware of the restructuring of Opal — of GM Europe, and that was effected under the same set of principles, and those are the principles that we intend to maintain going forward. I think having a global footprint is certainly an advantage to General Motors, and to the extent that it is financially prudent and within those principles, we’d certainly like to see it continue.

Q Good evening. Could you give us a sense whether any members on the current GM board will be remaining on the board of the new company, and how that will work with the lead executives at GM, as well, please?

SENIOR ADMINISTRATION OFFICIAL: Well, I believe I already answered that question by reminding you that the President, on March 30th, said that the majority of the GM board will become new members, which means a minority will be old members. And so we do expect to have some continuity with respect to those members. Fritz Henderson is the CEO and like all CEOs, serves at the pleasure of the board, and we would expect that that relationship would continue.

Q As GM restructures and the government is now involved in that company, how — or will the government get involved in new jobs, or should I say, fuel-efficient, alternative-fuel sources, starting with that type of training with GM employees?

SENIOR ADMINISTRATION OFFICIAL: As my colleague suggested, there are a number of principles that are going to govern our behavior as a shareholder in this company and others, one of which is no involvement in day-to-day business matters. And that will be a continuing principle for us. Of course the government of the United States has many relationships with the automobile industry as a whole, including foreign companies and including companies that have not been the beneficiaries of financial support from the U.S. government. And those matters, whether they go to regulation for fuel efficiency, or regulation for safety or support, or employment or what have you, will continue, but they will continue on a track entirely separate from and not driven by our role as shareholders.

I might mention the President some time ago appointed Ed Montgomery, the former deputy secretary of labor, to support him in assuring that we were doing everything that we could for communities in Michigan.

Q I was just wondering if you guys are disclosing which plants or factories may close as part of all this restructuring. I know there’s been talk of 14, or is that still up in the air right now or haven’t been determined?

SENIOR ADMINISTRATION OFFICIAL: As I said earlier, General Motors I believe is in the process of releasing that information, and I think, in the context of what my colleague said about us not making plant-by-plant or any other kind of management decisions, we will leave that to them.

Q Thank you. I’ve got a couple of quick things. Are secured bondholders, do they get a hundred percent back? Does the tax lump carry forward, go to the new company? And can you say that there’s no negative impact on Ford from these arrangements that you’ve described? Thank you.

SENIOR ADMINISTRATION OFFICIAL: With respect to the first question, there are no secured bondholders in GM; there are secured banks, and they will receive a full recovery because they are amply secured, as distinct from the banks in Chrysler which were not fully secured.

With respect to your second question, I’m going to let my colleague answer — would you expect the transfer? And what was the third question? Oh, Ford.

SENIOR ADMINISTRATION OFFICIAL: Ford has ample financial resources. Ford has been very successful in maintaining and even growing its market share during this period and is a world-class company, and we do believe completely — and that has been the President’s decision — the belief that this country can support three domestic successful, viable auto companies.

Q Thanks, guys. A number of the principles — the governmental principles you’ve established — members of Congress have asked GM and the administration to keep the company from importing cars made in Chinese plants. Is that an issue that the administration will specifically stay away from, or will it take a position? Have you made a preference known to GM’s management?

SENIOR ADMINISTRATION OFFICIAL: GM has made a commitment in its later agreement with respect to production in North America. But as to any specific thing, no, that would be a kind of specific commercial thing and would not be the object of our negotiation with the company.

Q — any additional money going into GM beyond the $30.1 billion that you’re extending now — is that an expectation, or are you saying, or will the President say that this is it for GM, this is the extent of taxpayer money and they won’t get any additional funding?

SENIOR ADMINISTRATION OFFICIAL: There’s no plan of any kind, intention, contingency plan, anything of any kind for further support beyond this point.

Q But beyond not having as plan are you saying that there’s no way they will get –

SENIOR ADMINISTRATION OFFICIAL: We believe the support being provided within a framework on a conservative economic assumption should allow the company if stakeholders do what they need to do, if its managers are successful in doing what they need to do, to be commercially viable going forward and not require extraordinary support going forward. One never says never with respect to any hypothetical contingency that could arise in the future, but this is it for support for GM, and on a go forward basis, GM’s position will be the same as that of any other company in the United States.

SENIOR ADMINISTRATION OFFICIAL: We are reducing GM’s liability by well over 50 percent and providing it with the financial flexibility that we truly believe — and an enormous amount of work that’s been done here that will allow it to be viable even under today’s difficult economic circumstances.

Q I just wanted to ask what the sort of anticipated future of the whole task force operation that you all have set up is going to be? And maybe this answers that question, but whether there will be, six months from now or a year from now, some part of the U.S. government that will look after the shares that we will have in the two car companies, if only at a distance?

SENIOR ADMINISTRATION OFFICIAL: There are a number of people around the table who are looking at me with interest in how I answer this. On a go forward from here, moving through this bankruptcy where the government has a major role, there is a great deal to be done, and the staff of the task force will continue to be very active. The Cabinet members who comprise the task force will continue to play their role in providing expertise on a range of issues. On a go-forward basis, the government will obviously adjust its staffing to its needs. But for now, there’s plenty to do.

Q As it is now, you guys have folks in Detroit — I’m not sure what numbers there are. Is it anticipated that you’ll continue to have representation on site going forward?

SENIOR ADMINISTRATION OFFICIAL: We don’t have anybody in Detroit on any kind of long-term basis. People obviously go out there in the context of diligence. I think we — in the context of what my colleague said about the government as shareholder, we are shareholders, like a lot of other people who don’t control companies. And in that respect, we expect that the taxpayers will want us to monitor their investment and be sure that we understand what’s going on, but we’re not going to be having people based in Detroit or anything like that.

Q What will the government’s position be in terms of executive compensation issues?

SENIOR ADMINISTRATION OFFICIAL: There are a series of laws and other regulations that exist, and the company will comply with all of them.

Q But will you — you’ll have the ability to name the compensation committee. Will you leave it to the compensation committee? Will there be any government policy — because you have a policy with the banking bailout; I’m wondering if you’re going to have any kind of a policy for this industrial company.

SENIOR ADMINISTRATION OFFICIAL: Again, there are a series of policies; there’s the Dodd amendment, there will be regulations to implement the Dodd amendment in due course, and the company will live with them. We don’t intend to name the compensation committee per se. We intend to, as we said, to work with the company and their initial directors, but the compensation committee will operate on its own. And we assume, just as it has during the period of the loan agreements where there were also compensation restrictions, that it will operate within them.

SENIOR ADMINISTRATION OFFICIAL: And like as in any company, the board will name a compensation committee.

Q Thanks, guys. Just a couple quick questions. Can you talk about the appointment of the chief restructuring officer and about the bad assets that GM will leave behind, even if you’re not going to name the plants or the dealers that might be left behind? And also, is the government planning or encouraging any more management changes at GM?

0; SENIOR ADMINISTRATION OFFICIAL: I think those are all pretty much questions for the company in terms of the naming of the chief restructuring officer is a company decision. The assets that will be left behind will be — are being chosen, have been chosen by the company, and again we would direct you to them to answer those questions. And in terms of management changes, we have nothing further to announce on that at this time. As I said earlier, Fritz Henderson and other management key members serve at the pleasure of the board. It will be up to the existing board until emergence and then the new board to make any decisions about management.

MS. PSAKI: We have time for one more question.

Q I just wanted to go back to the question of the task force. In terms of the longevity of the task force, do you perceive it being needed well beyond the bankruptcy proceeding itself? I mean, do you perceive the task force being in existence in fact until the company is sold?

SENIOR ADMINISTRATION OFFICIAL: The company is not going to be — I mean, I’m not sure what you mean by the company being sold. The company will go through this restructuring period; new GM will emerge as part of the 363 process; and then the company will continue, as we said, as a private company operating in the for-profit commercial role and so forth. And the government, as we indicated, is a reluctant — will be a reluctant shareholder for only as long as is necessary, for as long as — we will be out as soon as is practicable. During that period of time, we imagine that the taxpayers want us to be looking after their money, and so as we indicated, there will be people here watching over that investment, but as I indicated, in the nature of passive shareholders similar to Fidelity or some other large investment firm that has a large stake in a company.

MS. PSAKI: Thank you, everyone, for joining the call. As a reminder, this is embargoed until 10:00 p.m. Eastern time.

END 7:40 P.M. EDT

###

The Administration’s background briefing on GM

© 2010 Keith Hennessey - Your guide to American economic policy

Mixed results on the Chrysler announcement

kbh — Tue, 05 May 2009 21:35:56 +0000

The President’s Chrysler announcement last Thursday produced mixed results.

The agreement among Chrysler, Fiat, UAW, the Administration, and the large banks appears to increase the probability (from almost zero) that Chrysler will survive for the long run, albeit as a part of Fiat. This is clearly a good thing. Is it worth the cost to taxpayers and the broader damage caused by government interference in the economy?

Taxpayers will sustain Chrysler during its restructuring. (Fiat is putting up no cash.) The Administration has committed $8.1 billion of new taxpayer funding for a bankruptcy process that they think will take 60 days, followed by a transition period of unknown duration. I think the final cost will exceed this additional $8 B, in part because I doubt the 60-day timeframe. Since the Administration agreed to forgive about $4 B the taxpayer has already loaned to Chrysler, I am also pessimistic about the taxpayer’s chances of getting back this new $8+ B outlay of funds.

It appears the Administration reached agreement first with UAW and the big bank creditors, and then tried to “jam” the dissident creditors with a tough and possibly unfair take-it-or-leave-it offer. When those creditors rejected the Administration’s offer, the President publicly excoriated them.

The result may be a firm that survives, but there are serious adverse consequences of this process and dangerous precedents for the broader economy:

Industrial policy —
1. Leveraging TARP banks – It appears the Obama team pressured TARP-recipient big banks to forgive much of their loans to Chrysler. If so, they have taken a huge step toward making these banks instruments of public policy rather than private firms. This is a primary fear of “managed capitalism” — political leaders start leveraging one sector to influence another.
2. Bypassing the capital structure and bankruptcy process – There is no such thing as a level playing field when the government negotiates with private parties. The Obama team set themselves up as both the arbiter of the negotiation and a participant in it. It now appears that they are trying an end-run around the Chapter 11 process through a §363 sale. If they are successful, they will have interfered with the rights of others who thought they could rely on the traditional bankruptcy structure to protect their interests. The Obama team is introducing significant political risk into future business loans by undermining the traditional bankruptcy process. This makes future loans more expensive for firms.
3. Leveraging Fiat to meet new and arbitrary fuel efficiency goals — The fuel efficiency goals mandated by CAFE come from legislative bargaining. The new targets for Fiat (e.g., a 40 mpg vehicle made in the US) were created from thin air by the Obama negotiators. Suppose they had said Fiat cannot make blue cars. Would that be OK? When combined with the apparent cross-sector leveraging of TARP banks, this suggests a scary level of micromanagement and political interference.
The deal appears to favor the President’s political allies — UAW is part of the deal, “investment firms and hedge funds” are not. The fuel efficiency crowd is presumably happy with the new requirements imposed on Fiat. The appearance the Administration has created, reinforced by the President’s public bashing of the dissident creditors, is that they used carrots with their friends, threatened the big banks with a stick, and then hit the dissident creditors with that stick when they refused the Administration’s offer. If the reality reflects this appearance, then the Administration has abused its power in structuring the proposed deal.
Demagoguery – The President attacked people for asking to be paid back the money they loaned. These “investment firms and hedge funds” have a legal right and a responsibility to the people whose money they invested.

It is easy to criticize the Administration’s approach and say what they should not have done. It is harder (and more responsible) to say what you would have done instead, and to accept responsibility for the downsides of that choice. If you disagree with what the President did, I challenge you to recommend an alternate path. I will give you five options. To make it hard, please assume the probabilities listed:

Withhold all additional taxpayer funds. (99% chance Chrysler liquidates by July 1)
Tell the negotiating team to set a goal (a viable firm without permanent taxpayer subsidies) and a limit on taxpayer funds, and then stay out of the negotiations among private parties. (70% chance Chrysler liquidates by January 1 because the Chapter 11 process drags on and Chrysler’s sales plummet)
Do what the Obama team did, but don’t use the §363 process to jam creditors and don’t publicly bash those creditors when they dissented. (50% chance Chrysler liquidates by January 1)
Tell the negotiating team to lead/”help” the negotiations, but strictly instruct them not to pursue non-taxpayer goals (like fuel efficiency), and not to favor UAW over creditors. Use the §363 process if necessary to jam an objecting party, but don’t publicly bash them. (30% chance Chrysler liquidates by January 1)
Do what the Obama team did, and be willing to add more funds if necessary to keep Chrysler alive. (15% chance Chrysler liquidates by January 1)

Also, please assume that a Chrysler liquidation increases the chance of a GM liquidation by 10-20% through a chain reaction of parts suppliers failing.

These probabilities are my somewhat-wild guesses. If you find yourself arguing with me in the comments about the probabilities, you are missing the point of the exercise. Please assume these probabilities (even if you disagree with them) and tell us what you would do, not just what you would not do.

I will start the bidding by choosing (B).

Mixed results on the Chrysler announcement

© 2010 Keith Hennessey - Your guide to American economic policy

Intro to TARP — Summary of the series

kbh — Mon, 04 May 2009 21:30:24 +0000

Here are the four Intro to TARP posts:

Intro to TARP — Summary of the series

© 2010 Keith Hennessey - Your guide to American economic policy

Intro to TARP — TARP II: Direct investment

kbh — Thu, 30 Apr 2009 21:02:33 +0000

Tuesday I began with a simple example, which I am calling Large Bank.

Yesterday we looked at TARP I, in which the government would buy troubled/toxic assets from banks.

Today I will describe TARP II, the plan we (the Bush Administration) implemented, in which the government made direct equity investments in banks to help fill their capital holes. We called this the Capital Purchase Program.

As a reminder,we are trying to address two problems:

Large Bank does not have enough capital.
Large Bank has downside risk on its balance sheet due to the uncertain value of these bad loans. That downside risk makes the firm’s value uncertain and scares away investors.

Here is the balance sheet for Large Bank:

Assets			Liabilities and Equity

Good loans	800		Deposits	600

Bad loans	120		Debt	300

			Equity	20

			Preferred	0

Total	920	. . . . . . .	Total	920

Total capital: 20
Leverage: 46:1

TARP I solves problem #2 if you buy all the bad loans, but it is extremely inefficient in addressing problem #1, the capital hole. Spending 120 from the TARP to buy the bad loans would provide no new equity capital. Spending 150 to buy the loans valued at 120 would provide a net 30 of capital for 150 outlayed from the TARP.

The constraint is not the ultimate cost to the taxpayer. It is instead the legislated limit on how much outstanding cash can be invested/spent at any one time from TARP: $700 B.

To fill the capital hole, our first choice would be for the bank to attract private capital. Bank management appears reluctant to do this, because they don’t want to dilute the value of their existing shareholders. In addition, private investors were unwilling (at least last Fall) to invest in banks that had significant downside risk on their balance sheets. So temporary public capital, provided by the taxpayers, was the only option to recapitalize the banking system.

If we take the same 120 from the first TARP I case, but instead use it to buy preferred stock in Large Bank, we end up with this:

Assets		Liabilities and Equity

Good loans	800	Deposits	600

Bad loans	120	Debt	300

Cash	120	Equity	20

		Preferred	120

Total	1,040	Total	1,040

Total capital: 140
Capital added by this transaction: 120
Leverage: 7.4:1
Risk of bad loans: still lies entirely with Large Bank
Taxpayer outlay from TARP: 120
Long-term cost to taxpayer: Zero if the firm remains solvent, up to 120 if the firm goes bankrupt.

Results:

Large Bank has 120 more capital from the government. It is now well capitalized and has a good leverage ratio. (I am for now glossing over the difference between preferred and common stock.)
Large Bank still has all the downside risk associated with the bad loans. This may continue to scare away private capital, depending on estimates of the relative size of the strengthened capital cushion and the downside risk of those bad loans.
The government has spent 120 of the TARP pool.
The taxpayer will get dividends from the preferred stock (which look a lot like interest payments at a fixed interest rate).
The government is now the majority investor in Large Bank and has both an ongoing taxpayer interest in and leverage over how the bank is run.

TARP II gets tremendous bang for each TARP buck in recapitalizing banks. If you are more worried about the capital hole than the downside risk, then TARP II has far better arithmetic.

If you are worried that the capital problem being bigger than you think, then you want to use TARP resources in the most efficient way possible. Remember that you do not have good information about the size of either the capital hole or the downside risk. You know what the banks report about their balance sheet, but especially last fall, we had to be extremely skeptical about the information being reported about the size of both problems. This is one reason why the stress tests are so valuable — regulators and policymakers presumably have much better information now about the absolute and relative sizes of each problem, at least for the 19 largest banks.

Over the past few months we have been experiencing a significant policy downside of direct equity investment, and it is a major difference between TARP I and TARP II. Under TARP I, the government buys the asset and the relationship between the government and the bank ends. Under TARP II, the government has an ongoing relationship with the bank. This creates policy tension among three different governmental roles:

government as rule-setter and regulator;
government as investor on behalf of the taxpayer; and
government as an interested party with other policy (or non-policy) goals.

This tension is playing out in several uncomfortable and unpleasant ways. The government is involved in compensation decisions within the firm. The government is leveraging its investment to pursue other goals, like encouraging the banks to lend and maybe leveraging some of them to write down auto manufacturers’ debt. And the government may trade off other policy goals against the taxpayer’s investment by allowing banks to convert preferred equity to common equity.

Returning to the original two goals, you can see the two extremes in TARP I and TARP II. TARP I was focused on removing downside risk from balance sheets. The danger with TARP I is you might buy $700 B of bad assets, and have only made a medium-sized dent in the downside risk problem, while doing far less to fill the capital holes. TARP II ignores the downside risk problem while getting a huge bang in filling capital holes. TARP II also has other problems derived from the ongoing linkage between Uncle Sam and the banks.

Tomorrow I will describe TARP III, the Geithner approach, and how it tries to address both problems by tapping into non-TARP resources.

As in the rest of this series, I thank Donald Marron for his examples and assistance.

Should bank stress test results be public?

kbh — Fri, 24 Apr 2009 17:48:29 +0000

Today the 19 largest banks are getting the results of their stress tests from their regulators. Should these results be made public?

This is not a simple question.

The big upside is that markets will have more information, and that all market participants will have access to the same information. This can allow investors, counterparties, and customers to evaluate the health and stability of the banks with which they are doing business. I have a default presumption that more information more widely disseminated is a good thing.

Downside 1: Some banks might be just above the bubble but rank low. They may still be healthy enough to survive and eventually succeed, but if they are disclosed to be among the weakest, that disclosure may cause a run of depositors, counterparties, or investors. This could push some marginal banks over the edge and cause them to fail.

This is not a trivial concern. Last September there were reports that investors were “testing” even the clearly healthiest investment banks (JPM Chase, Goldman Sachs) shortly after Lehman’s fail. Senior policymakers remember that vividly, when panic might have destroyed banks that on paper were solid. From the perspective of the policymakers who have the information, it is easy to understand why they may be highly risk averse. From their perspective, not disclosing the information may appear to be the safer course.

There is a response to this downside. Banks that do well in the stress tests have an incentive to let the world know that. It may be hopeless for policymakers to think they can protect the weaker banks by not having the government release the information, because the strong banks will do it implicitly by shouting their good news.

Downside 2: The stress tests might not be well-designed. If they are poorly designed, overly optimistic, or just misinterpreted by the market, then the government could be injecting bad information into the market. Government may not be smart enough to design the tests to provide enough useful information to the markets.

More importantly, any stress test is highly imperfect, and there is a risk that the results would create a sense of false certainty. I read a lot of market commentary while working in the White House, and was amazed at how frequently high-level market commentaries completely misinterpreted or misread data that we released (much less policy statements).

This is a close call, and people whom I respect advise in different directions. I fall back on my default presumption / instinct, which is to release the information. There is a small probability of a really bad outcome (a panic/run), and a much larger probability of a good outcome with no run and somewhat better informed markets. I also think it is easy for policymakers to overestimate the amount of control they have over the situation.

The Wall Street Journal reports the following game plan:

Today the regulators are giving results to the banks privately, and asking them not to disclose them. They are also releasing the test methodology.
10 days from now, the regulators will release results of the stress tests, although “regulators also have not decided how much information will be disclosed May 4.”

On the whole, this game plan makes sense to me. I am not sure they will be able to hold out for 10 days, and my instinct is that they should release more information rather than less. I hope market participants will take the time to understand just how imperfect this information will be.

By the way, I presume that the decision to leak that they expect to release the results was made after they knew the results of the tests. This suggests that the results are generally good. If the stress tests showed that half of the banks would fail, I presume they would not be signaling a future release.

Four unpleasant options for TARP funding

kbh — Mon, 13 Apr 2009 15:15:07 +0000

Despite Secretary Geithner’s statement to the contrary, I still think the Administration is running out of room within the $700 B Troubled Assets Relief Program (TARP). In my last four posts on TARP funding (1 2 3 4), I have stuck to what I think I can demonstrate analytically. I am now going to shift to some educated guessing about what may be going on within the Administration that is contributing to confusion on the outside. The prior posts involved math, while now I am analyzing people, so I am far less certain about what you read here than when I walked through the TARP arithmetic.

I think the senior economic policymakers in the Administration are overconstrained and have several bad options in front of them. This is not an unusual situation, but to a certain extent they put themselves into this box by spending TARP money on every problem that popped up. $50 B on housing, $5 B on auto parts suppliers, $15 B on small business loans, additional unspecified sums for GM and Chrysler, and new as well as old mortgage-backed securities — things add up. I think they’re in a box.

The box has three sides:

They have created expectations among various constituencies for programs announced over the past two months. These expectations would consume most of the remaining $700 B of TARP funds. If their new programs are successful, they will want to expand them to further strengthen financial institutions and markets. If they are unsuccessful, they will need more TARP funds to try something else.
They are justifiably afraid of asking Congress for more TARP funds.
They could create some room for themselves by taking taxpayer funds back from some of the healthy big banks, but they may be worried about the signals that sends about the others.

It appears that they are testing all three sides of this triangular box to figure out which is their least worst option.

Senior Administration policymakers are operating in an ever-changing financial, economic, and legislative environment. When they developed the President’s budget in February, asking Congress for more TARP funds probably seemed difficult but not necessarily impossible. In that circumstance, it was reasonable and responsible for them to put a $250 B placeholder in their budget for a potential future TARP request.

The legislative environment is now much more hostile. It would not surprise me if, for the moment, they have ruled out asking Congress for more TARP funds, and are instead trying to figure out how to create as much room as possible within their existing constraint.

Commenter Wayne Marr asked a good question.

… But the main point is that Obama and team (Larry, Christy, Austan, Geithner, etc) can simply go to [the] well (Congress) since Democrats can pass pretty much what they want. The recovery plan was not named the “Great Bailout:” but the “American Reconstruction and Recovery Plan” or some such nonsense for a reason.

Why not another funding program called “The Better Banking Plan for the 21th Century” to provide more cash for technically insolvent banks? Or those that posed a systemic risk? So does it really matter that we have 30B left of TARP or 100B left for TARP?

While I generally agree that the President has tremendous leverage to get Congress to pass his agenda on a wide range of topics, I seriously doubt that is the case here:

95 of 235 House Democrats voted no the first time on TARP (on September 29, 2008), and 63 House Democrats voted no on the successful vote four days later. Speaker Pelosi now has a significantly larger majority (254), but she would still need Republican votes.
TARP is far more unpopular now than last Fall.
President Obama could undoubtedly get some House D votes who we (the Bush Administration) could not, but not enough to pass such a bill.
I surmise that House Republicans are in no mood to go out of their way to help the majority or the White House, given how aggressively the Speaker and White House have been in passing other legislation without their input. That does not mean that all of them would vote no, merely that the Administration will have a hard sell to make.
Finally, even if she had the votes, I would bet heavily against the Speaker bringing up such a bill if she thought the vote would be partisan, because she would conclude that such a vote would expose her House Democrats to too great of a political risk in the next election. I think that she thinks that she would need bipartisan cover from Republicans as a condition for bringing such a bill to the floor.

As background, the Temporary Asset-Backed Securities Loan Facility (TALF) is what the Fed and Treasury are doing together to keep securitization markets going for things like student loans and car loans. They now want to expand it to include securitizations for new mortgages, and to use it to buy toxic mortgage-backed securities. TALF was created during the Bush Administration. This is the second major expansion since President Obama took office.

PPIP is the Public-Private Investment Partnership, Secretary Geithner’s plan to buy toxic assets from banks. It has two parts, one of which works in conjunction with the Fed, and the other with the FDIC.

Secretary Geithner’s comments that they have $135 B of room left in the TARP is testing side #1 of the triangular box to its maximum possible extent. In an attempt to convince people that they have sufficient room, to reassure both markets and the Congress, I think his staff put together the biggest number they could plausibly say with a straight face. They have not, to my knowledge, explained what $135 B of room would mean for the TALF and buying toxic assets, and I fear that such an answer would tremendously disappoint market participants who are expecting a $1+ trillion TALF and a $100 B PPIP. If the Administration has made policy decisions that lock in $135 B of room, then they have scaled something way back beyond what they had previously said publicly.

The Administration faces a choice: scale back these two programs to be smaller than what they had previously suggested to market participants, or squeeze something else hard to create more room within the $700 B limit.

The other option is to get some TARP funds back from the healthiest big banks. Since the law allows the Administration to recycle returned funds for other purposes, every invested dollar repaid can be spent again.

Certain large banks (e.g., JP Morgan Chase and Goldman Sachs) are publicly signaling that they would like to repay the Treasury. It is hard to blame them, considering the political and legislative environment. Martha MacCallum of Fox News pushed me on this point, correctly pointing out that it seems un-American to dissuade banks from paying back the taxpayer.

The banks are reportedly being told “not yet” by the Administration. I will guess that the Administration is concerned about something that worried some of our experts – if healthy banks return their funds, then investors will conclude that every bank who is not returning their funds must therefore be unhealthy.

This logic becomes strained, however, when those banks find other avenues for signaling to the market that they are healthy, as they are doing now by screaming “WE WANT TO GIVE IT BACK.”

At some point the banking policy concern may be overwhelmed by the near-impossibility of getting more funding from Congress and the policy and political undesirability of scaling back on PPIP, TALF, or the housing commitment. If this happens, then the Administration will happily start accepting funds from banks. The numbers are large enough that this could create room for them to do other things, and as a long-run policy matter, we want the taxpayer to be paid back. These are supposed to be temporary investments in the banks, in which public capital substitutes for private capital that was unwilling to show up last Fall.

There is another outside-the-box possibility that I am sure the White House has considered. Part of their resource constraint arises from having made a $50 B TARP commitment to housing.

They could push this program out of the TARP, and ask Congress for these housing funds anew. It would be much easier for a heavily Democratic Congress to pass $50 B for housing than for them to pass the same amount (or much more) for “Wall Streeet banks.”

I would oppose such a request, because I oppose this housing spending inside or outside of TARP. But I’m sure they could pass it, given their large partisan majorities in both bodies. This option would cause the White House political pain on its left, which pushed hard for these programs, and could cause FDIC Chairman Bair heartburn, given her impassioned support for these housing programs.

Things probably look a little different to the folks sitting inside the West Wing and at Treasury than I have described here, but I would wager heavily that a discussion at least similar to this is ongoing within the senior ranks of the Administration. As long as that decision is unresolved, it will be confusing as we try to interpret statements like Secretary Geithner’s that he has $135 B of room within the $700 B TARP allocation. Those policymakers need to balance the benefits of decision-making flexibility with the costs and repercussions, from markets and/or Congress, of the bad news when it is eventually delivered. They may be waiting for the right time to signal that a previous commitment will be scaled back, or instead for the right time to ask Congress for more funds. I think it is better for market participants and Congress to have early clarity, especially if it’s bad news.

In my experience, it is better to deliver the bad news as soon as you have made the decision. Rip off the band-aid quickly.

I will end with a thought experiment. Suppose my analysis is roughly correct. It is easy to figure out what you don’t want to do. It is much more difficult to decide what you do want to do. If the President asked you for your recommendation, what would it be?

Scale back on PPIP and TALF as necessary to avoid having to ask Congress for more funds.
Ask Congress for more funds. Follow-up: how much more?
Tell banks that you welcome them repaying the Treasury early.
Push housing outside of TARP and make a separate request of Congress for those funds.
Wait and hope.

Let’s not hide $1.4 trillion of IOU’s

kbh — Wed, 08 Apr 2009 14:02:14 +0000

Yesterday on his blog the President’s Budget Director, Peter Orszag, asks himself and then answers the question, “How much does the federal government owe?”

This sounds like a technical question of concern only to “those of us wearing the green eyeshades,” but the Director’s suggested answer has dangerous ramifications, and could mislead or at least confuse taxpayers and financial market participants.

The Director’s answer makes the federal debt appear $1.4 trillion smaller than the way it is traditionally measured. He argues that we should, in effect, ignore 1.4 million million dollars borrowed by the federal government. That is breathtaking.

Let’s look at the Director’s argument and why I think it’s dangerous.

Most budget experts focus on debt held by the public, which Director Orszag accurately describes as “the amount that the federal government owes to others.” I will expand on that a bit with some concrete numbers:

Take the total amount the Federal government will spend this year. Specifically, we’re looking at cash paid by the U.S. government to someone outside the government in 2009. A budget wonk would call these outlays. I’ll use the nonpartisan Congressional Budget Office’s numbers for current law, so I get $3.85 trillion of outlays for 2009. That is way (way) above historic norms, in part due to the financial stabilization efforts, and in part due to the new “stimulus” law.
Now take the amount the Federal government will collect in revenues this year. This is cash coming into the U.S. government from someone outside it. Almost all of this is taxes. CBO says this is $2.186 trillion of revenues for 2009.
If the U.S. government is paying out $3.85 trillion in cash (outlays) this year, but collecting “only” $2.186 trillion in cash, then we need to come up with the difference somewhere. That difference is $1.667 trillion for 2009. This is what CBO says is the federal budget deficit for 2009.
The U.S. government gets this cash by issuing IOU’s to people outside the government, aka Treasury bonds. The government gets cash from anyone who buys Treasury bonds – individuals, firms, and foreign governments.
The debt held by the public is simply the accumulation of these IOU’s. It is the sum of money owed by the U.S. government to others. (Update: See the caveat at the bottom.)

Nothing I have said so far is the slightest bit controversial, but this is where Director Orszag and I part ways. Tuesday he wrote:

As I said at the beginning of this post, I think the most meaningful measure of federal debt is debt held by the public net of financial assets. If I take a $100 loan from my bank and stick that amount into my bank account without spending any of it, my family and I aren’t poorer, because even as I owe $100 to my bank, my bank owes $100 to me. On net, and as long as the new asset is equal in value to the new liability, there’s no change in my overall financial state. There’s a similar effect when the federal government borrows money in order to invest in financial assets.

Suppose I tweak the Director’s metaphor to make it better fit the current situation and illustrate my point. If he takes a $100 loan from his bank and invests it in the business of his deadbeat neighbor Alan I. Gorp, he still owes the bank $100. The bank cannot loan that $100 to anyone else. His (the government’s) borrowing has “crowded out” borrowing by someone else. And who knows how much his $100 investment will be worth next month? We should care not just about his net position, but also about his total liabilities, and especially about how much he (the government) is borrowing from the bank (private sector).

In normal times this would not be a big difference, because the U.S. government in large part stays away from owning financial assets. Now, however, the federal government is buying equity stakes in banks and other large financial firms, and issuing loans to financial and non-financial firms. Director Orszag’s numbers show that the U.S. government owned $506 billion of financial assets last year, and will buy another $915 billion this year. (I’m subtracting “Debt net of financial assets” from “Debt held by the public” on Table S-1 of the President’s budget.) Those are huge numbers, and have a huge effect on what figure you cite for the federal debt.

If you look at the traditional measure of debt held by the public, which you’ll remember is the sum of all IOU’s (Treasury bonds) issued by the Federal government, then under the President’s budget and using OMB numbers, that’s equal to $8.36 trillion. Compared to one year of our entire national output (GDP), that’s almost 59% of GDP.

If, however, you net out OMB’s estimate of the value of the financial assets, then the debt held by the public net of financial assets, is “only” $6.94 trillion, equivalent to almost 49% of GDP. That’s still a big bad number, but it’s $1.4 trillion and 10% of GDP less bad than the debt held by the public numbers. That’s a convenient way to make the problem look much smaller. Director Orszag argues that it is also the “most meaningful measure of current federal debt.”

Here is his key paragraph:

As the federal government has acted to stabilize the financial sector amidst the worst financial crisis since the Great Depression, the federal government has purchased significant financial assets—such as preferred equity stakes in Fannie Mae and Freddie Mac. The federal government will likely take a loss on these purchases, but the assets have value. And just as what my bank owes me should be netted against what I owe the bank in determining the health of my personal finances, the value of these assets should be netted against publicly held debt in determining the health of the government’s finances. … Debt held by the public net of financial assets is the most meaningful measure of current federal debt … (emphasis added)

I disagree with this last statement, but I think I understand why he says it. From his perspective of the federal budget, he’s netting out some of his liabilities with a somewhat liquid asset that he now holds and hopes someday to sell. He concedes the point, however, that he is including some assets and liabilities with his new measure, but excluding others. This makes his new metric suspect.

From the perspective of the U.S. economy, the “netting” comes from different places. The U.S. Treasury has to issue $905 billion of Treasury bonds this year to raise the cash to buy those financial assets. This makes it harder for private firms and individuals to borrow, because they are competing with the government for cash, so they have to pay a higher interest rate. Those funds are then invested in other parts of the economy.

Another way to see why this is a poor metric is to imagine that the U.S. government were to borrow another trillion dollars by issuing even more Treasuries, and then immediately buy one trillion dollars of credit default swaps with the cash raised. According to Director Orszag’s preferred measure, nothing would have changed, because the two transactions would net out. But clearly we would have just had a major impact on the U.S. (and global) financial economies. U.S. government borrowing in these enormous amounts hurts financial markets, no matter what is done with the funds raised.

Director Orszag touches on another problem with his new metric when he writes “The federal government will likely take a loss on these purchases, but the assets have value.” He’s right, but the value of the particular assets being purchased by the government is highly uncertain. How much is he counting as the value of the $19.4 B loaned (so far) to General Motors? I sure hope he is not counting it at face value. What about the $70 B “invested” in AIG, or the $5.5 B in Chrysler? Any private firm valuing these assets would say their values need to be discounted.

The values of these financial assets are highly uncertain and depend heavily on what assumptions OMB uses about the likelihood of them being repaid. For people to trust this metric, they need to understand how it is calculated, which means that OMB should divulge the discounts they are applying to their financial assets. I will guess that he does not want to divulge those assumptions. I wouldn’t if I had his job.

I think the most meaningful measure of current federal debt is still debt held by the public. I think the public policy debate can be further informed by also disclosing the estimated value of the financial assets held by the U.S. government. But policymakers should not net out the two and use that measure instead of the one that most directly measures how much the U.S. government is borrowing from the private sector. This is particularly true when that new measure hides $1.4 trillion of debt borrowed by the U.S. government from the private sector.

Director Orszag, and those measuring his performance, should continue to use debt held by the public as the most meaningful measure of current federal debt. Budget projections will account for that measure to come down over time as the financial assets are sold and funds recouped.

Net measures can hide meaningful information. This is a theme I will return to often. Any time someone in economic policy gives you a net figure, see if you can learn something more by asking about the components that make up the net calculation.

The President’s Budget is titled “A New Era of Responsibility.” In his February 24th Address to the Congress, the President said,

The only way this century will be another American century is if we confront … the mountain of debt they stand to inherit. That is our responsibility.

A new era of responsibility does not begin with hiding $1.4 trillion of that mountain of debt. These IOU’s will not go away just because we ignore them.

Update (12:20 PM Wed): A friend corrects my statement that the debt is simply the accumulation of past deficits. It’s not. The Credit Reform Act measures credit subsidies (like for federal loan or loan guarantee programs) differently than it measures cash flows, and the deficit does not capture “means of financing and cash management, like when Treasury borrows funds and deposits the cash at the Fed.” I stand corrected on these points. I don’t think this changes my logic above about whether to net out the purchase or sale of financial assets.

Is $700 billion enough? Clearing up the confusion (or at least trying to)

kbh — Thu, 02 Apr 2009 16:02:32 +0000

Last Friday I raised the question of how much funding is left in the TARP. This is now a broader discussion involving Secretary Geithner and the Treasury staff, the General Accounting Office, the Wall Street Journal and ABC News. I’d like to review the progression of this topic over the past six days and see if I can clarify what I think is going on. I will be rigorous in this post, and will follow up later today with a more speculative post about what I surmise is going on inside the Administration that is contributing to this confusion.

Last Friday I wrote that I thought the Administration was running out of money in the TARP. I wrote then, “They have $33 B — $58 B before they hit the $700 B barrier.”
That same day I showed that the Administration has been laying the groundwork for another TARP request since February, and using a $250 B number as a placeholder.
Last Sunday, George Stephanopolous asked Secretary Geithner about this. The Secretary replied, “George, we have roughly $135 B left of uncommitted resources. Less is out the door, but in terms of, if you look at what’s not committed yet, it’s roughly, you know, $135 billion.
Monday, Maya Jackson Randall reported in the Wall Street Journal that “The Treasury Department said it has about $134.5 billion left in its financial-rescue fund, giving the Obama administration a cushion as it implements expensive programs aimed at unlocking credit markets and boosting ailing industries.”
Tuesday morning I tried to reconcile this $100 B gap. I tried to show how one could interpret, or maybe reinterpret, the commitments previously made by the Administration over the past two months to justify the Secretary’s figure. I think and hope that I showed a plausible explanation for why the Secretary thinks he could say such a large number.
That same day (Tuesday), GAO came up with the same $32.6 B figure, that I described last Friday. GAO correctly labels that figure, “Maximum announced program funding level.”
Wednesday morning, Mr. Stephanopolous posted about this difference between Secretary Geithner’s Sunday morning number on the ABC News show, and the Tuesday GAO table.
A couple of hours later, Ed Morrissey wrote about this roughly $100 B difference on HotAir.
ABC News has since posted the following update on their website, although without a time stamp: “GAO officials tell ABC’s Charlie Herman that they now believe there are about $109 billion available in TARP. The office accepts Treasury accounting for all but the $25 billion Treasury estimates will come from financial institutions returning TARP money.” Clearly someone at Treasury picked up the phone and worked on GAO.

Let me see if I can clarify what I think is going on.

I think that $32.6 B is the best estimate of the amount of TARP funding available, using the fairest interpretation of the Administration’s public descriptions of a set of programs, made at varying times over the past two months.

I think that $134.5 B represents how much room they would have available, if they were to reinterpret their previous commitments in ways that technically comply with their past statements, but differ significantly from what market participants and the press expect. I think Treasury walked GAO privately through these reinterpretations.

In a way, both figures ($32.6 B and $134.5 B) are right, because (I think) the Administration is changing their policies. They just have not yet told anyone how.

As I wrote Tuesday morning,

So was I wrong last Friday? There are three possibilities:

I was wrong.

Circumstances changed.

While over the past several weeks the Administration has emphasized the size of their new programs, they are now looking for flexibility so they can maximize their chance of avoiding another request of Congress. They know that Congress is in a foul mood about the TARP, and are therefore looking to emphasize this flexibility by stating the largest number they can justify.

I think it’s #3. The Administration needs to balance the needs of the market with what is feasible from the Congress. Given recent AIG coverage, they are now leaning hard in the maximum flexibility direction. If this direction is sustained, I think the cost will fall upon the new programs, the TALF expansion and the PPIP, which would have to be smaller than some market participants may expect.

If you review the record of the past couple of months and interpret the Administration’s public statements at face value, taking the most logical interpretation for each, the numbers add up to $667.4 B, leaving $32.6 of room. This is what I did last Friday, ABC did for the Sunday morning show, and GAO published on Tuesday.

If instead you stretch each commitment to the maximum extent possible to create more funding room, if you assume that certain previous commitments overlap and are therefore non-additive, and if you assume that $25 B of previously injected capital will be returned to Treasury by banks, you can hit the Secretary’s $135 B figure.

So the proper question is no longer, “How much room is left in the TARP, given what we know to be the Administration’s policies?” It is instead, “What are the Administration’s policies, and given those, how much room is left in the TARP?”

Specifically, I believe this confusion could be clarified if Treasury were to answer publicly the following questions. The eaisest thing would be if they would publish a table (like GAO’s, or even my simpler one) that shows the policies and numbers assumed in the $134.5 B figure. Assuming they’re not willing to do this, and if they continue to insist on the $134.5 B figure, then the press, or Congress, or GAO, should ask the following questions of Treasury. I hate to be so lawyerly about this, because I think they’re trying as hard as they can under difficult circumstances, but I believe this confusion should be publicly clarified for the benefit of market participants, Congress, and the public at large.

I think the confusion would be clarified if Treasury were to post written answers to the following questions on their website, so that they are accessible to all. Getting this information filtered through GAO or a news organization is contributing to the confusion. With that, here are the questions to which the answers are now unclear (at least to me).

The Secretary has stated, and Treasury staff have confirmed, that they have $134.5 of uncommitted resources in the TARP.

Q1. How much does this assume is committed from the Capital Purchase Program? (The original commitment was $250 B. The WSJ reported that Treasury was assuming stopping at $218 B.)

Q2. How much does this assume will be repaid by banks, and when? Does Treasury know of specific banks that will return these amounts, and if so, (roughly) when should we expect that to happen? Within days, weeks, or months?

Q3. How much TALF subsidy is assumed within this $134.5 B figure? Please break this down among the following components:

TALF for securitization of consumer credit
TALF for securitization of new mortgages
TALF for securitization of “toxic/legacy” mortgages as part of the new program announced last week?

Q4. How big should we expect the TALF lending capacity to be for each of the components in Q3? (This is a joint Fed/Treasury question that isn’t directly relevant to the amount of TARP commitments. It is, however, essential to markets to understand what to expect.)

Q5. Please list all the components of the “Consumer and Business Lending Initiative” and the TARP commitments for each.

Q6. The Administration has stated a range of $75 B — $100 B for the Public-Private Investment Partnership program. What figure for PPIP is assumed within the $134.5 B figure?

Q7. Is the TALF subsidy for the securitization of toxic/legacy mortgages a subcomponent of the answer to Q6, or is it separate?

Is $700 billion enough? Clearing up the confusion (or at least trying to)

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