Thursday, January 1, 2009

Fundamental Inconsistencies in the Treasury's Report to Congress

Yesterday the U.S. Treasury reported to Congress about its $700 billion bailout program, which it now calls the "Capital Purchase Program."

It claims that the program helped "prevent a financial collapse" (p. 4). At the same time, it admits that “capital [from its CPP] needs to get into the system before it can have the desired effect.” (p. 5)

I find these claims to be fundamentally inconsistent, because (a) most of the CPP money has not yet been received by the banking system and (b) NONE of it had been received as of October 27. How did we survive between September 15 (when Lehman failed and brought on the crescendo of the credit crisis) and October 27? How did businesses make payrolls?

Maybe some credit goes to the Federal Reserve, who (from a different authority) was spending taxpayer dollars throughout September and October. But the whole justification of the $700 billion TREASURY authority reminds me of the supposed WMD in Iraq -- scary but nonexistent. A financial collapse was somehow prevented without the $700 billion.

4 comments:

Milton Recht said...

My sense is most businesses do not need to borrow funds to make payroll. Anecdotally, I checked with a few business owners, bookkeepers, and payroll officers I know at the time and they could not understand the need to borrow for payroll unless the business was failing. Are there statistics on borrowing for payrolls? And in what industry groups?

Brian said...

Some businesses do fund payroll by borrowing. Some businesses are highly cyclical and borrow for all kinds of needs including payroll and then when revenue comes in they pay off all their short term debt. I don't think it's most, but there are businesses that do finance payroll and it's more of a timing issue than a business failing issue.

Ronnie said...

While some business do borrow to make payroll and other extreme short-term financing payments, most viable business do not.

The "bail-out" or fail screed was the biggest farce in recent history. I agree with the WMD analogy 100%.

Linus Wilson said...

Banks may not want to raise capital without government intervention. Shareholders can raise equity values by shifting risk onto creditors. This means bad loans will be funded and good loans will be rejected. My coauthor and I argue that the major problem with the $700 billion bailout at present is that it buys preferred not common stock. Preferred stock is too much like debt to be effective.
Our paper can be accessed at the following link:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1321666