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We need hope, not toxic assets

By William M. Isaac

March 1, 2009

Former Treasury Secretary Henry Paulson rushed to Capitol Hill last fall to request $700 billion in emergency funding to purchase "toxic" assets (e.g., mortgage-backed securities) from banks. He got his $700 billion, no questions asked, but then decided to invest most of the money in bank capital instead of bad loans. That midcourse correction was one of the best decisions made during the past six months.

Many people, inside and outside government, continue to be obsessed with the notion of taxpayers buying up toxic assets. They contend it is necessary to get bad loans out of the banks before they will resume lending.

That view represents a serious misdiagnosis of the problem. Purchasing hundreds of billions of assets from the banks will not cause them to resume consumer lending to any material degree. The banks do not have the capital or risk appetite to add materially to their consumer loan portfolios—they will make new consumer loans only if they can securitize and sell them.

Our focus needs to be on getting securitizations going again. We can buy up bad loans (at enormous cost to taxpayers) or we can use our precious dollars to promote new lending. The choice between those two options is a no-brainer. Among other things, reopening the credit markets for new loans will ultimately allow many of the existing loans to be restructured and refinanced.

Three things are needed to energize the credit markets and the economy.

First, we need to build bank capital by continuing to invest in the banks. Thus far, taxpayer investments in bank capital have replaced less than half of the capital the Securities and Exchange Commission's ill-conceived mark-to-market accounting rules have destroyed. Banks seeking taxpayer capital should be required to submit business plans for prudently increasing their lending over a reasonable period.

Second, we need to issue, for a fee, government guarantees (insurance) to enhance the credit-worthiness of securitizations of new consumer loans. This requires no deficit financing, does not involve the government in managing and collecting a bunch of bad loans, and, if structured properly, should entail reasonable costs to taxpayers.

Third, our leaders need to lower their voices, tone down their rhetoric, and lead. The economy slowed tremendously last October, and I believe it was a direct result of fear-mongering by the leadership of both political parties trying to round up support for the bailout bill. We could almost hear the collective wallets slam shut, as consumers feared we were headed toward financial Armageddon.

President Franklin D. Roosevelt comforted us by extolling that the only thing we had to fear was fear itself. President Ronald Reagan lifted our spirits by telling us it was a new morning in America.

The leaders of both parties have been on the airwaves non-stop for six months frightening us with irresponsible rhetoric about the unmitigated disaster in which we find ourselves—the worst economic disaster since the Great Depression, they say. What have we heard from our leadership during the past six months that would cause us to buy a new car or house or even a washing machine?

While very difficult, our current economic downturn and banking crisis are not as serious to date as what we experienced during the 1980s, when interest rates climbed above 21 percent, unemployment approached 11 percent, and nearly 3,000 banks and thrifts failed, including the largest banks in many states (nine out of the 10 largest banks in Texas, for example).

We need a lot less talk and more action. Instead of announcing that we plan to announce a grand solution and letting the media raise expectations to unachievable heights, we should simply announce new programs as they are developed.

President Barack Obama offered us hope during the campaign, telling us "yes we can" and "change is coming." He excited not only a nation but much of the world. We have heard almost none of that message of hope and optimism since the election, but that is precisely what we need.

I am encouraged by Obama's announcement of his housing initiative. He presented a specific and comprehensive program that appears to have the right elements to make it work. He provided a realistic assessment of where we are and what we need to do, and he offered us hope for the future. He got it precisely right in substance and tone—that's leadership and that's what we crave.

William M. Isaac, chairman of the Federal Deposit Insurance Corp. from 1981 to 1985, is chairman of The Secura Group of LECG, a financial services consulting firm

headquartered in Washington.