The Fed balance sheet is a precarious thing right now, with assets totalling nearly $2 trillion. Coupled with the increasing pressure to raise interest rates on future inflation concerns, a lot is riding on the next steps the central bank takes. Some indicators in the unemployment data have begun pointing towards the possibility of recovery picking up in the near future. So what should the Fed be doing?
One logical step would be to scale back the emergency facilities set up during the crisis so that banks can begin to wean themselves off the government teat more permanently. Consider the Public-Private Investment Program (not exactly a pure Fed facility, but government nonetheless). This was highly touted by Treasury when it was announced as a way to save the banks. Four months later, not much has happened yet with the program, and even though it is continuing to move forward.
One half of the PPIP plan, or TARP II, has already been shelved. PPIP was going to use a combination of private capital, taxpayer funds, and FDIC guarantees to buy toxic assets—legacy assets—from the banks. This was based on former Secretary Paulson’s original idea for the bailout bank in September 2008. The toxic assets have been tying up bank capital as the financial institutions struggle to meet reserve ratios given the mark down on the debt banks were holding went markets tanked starting in mid-2007.
Interestingly, though, the FASB adjustment of mark-to-market accounting rules in April has reduced the need for this program. Banks have been able to adjust what the declared value of their assets are worth, easing the liquidity pressure. Since banks have shown little interest thus far in divesting their toxic assets right now—because they would have to take a significant loss and at this point are solvent while holding on to them—this part of PPIP was scrapped.
Nevertheless, Treasury is pushing forward with the second half of PPIP, which aims to buy back toxic securities from banks and financial institutions. My question is, why? Why add unnecessary toxic waste to the balance sheets of the government? The original $900 billion program has been scaled back to just $40 billion—is taking on that kind of debt really going to keep banks from breaking down?
The idea of helping the private sector into the purchasing process is good, but the taxpayers are still bearing too much of the risk on these investments. Washington should be taking advantage of this opportunity, when the outlook on Wall Street is starting to strengthen, to let the market begin to stand on its own two legs. All of PPIP should be shut down, and then the Fed can begin to roll back its other facilities as well.