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Bad Harbinger for Obama's Lending Plan

By Marc Tracy

We've been deeply concerned about the Obama administration's plans to use $15 billion from the TARP fund in an effort to increase the flow of small-business credit for quite some time. To recap: the plan is to use the money to purchase small-business loans from their current holders, thereby freeing up banks' and holders' balance sheets to make new loans. In theory, this strategy is perfectly sound. In practice, though, it's never really been tried, and indeed early reports from the strikingly similar TALF initiative are not good. The bigger problem, though, is that the plan is wincingly dependent on the cooperation and active participation of private-sector actors. And, in this instance, they are (understandably) not biting: the six largest holders of these loans, who together own 80% of the relevant loans, do not want to participate in the program. And so it remains on hiatus.

Well, last week a similar plan was officially declared D.O.A. for similar reasons, leading us to wonder when the $15 billion initiative's time will be officially up. Last week, the Federal Deposit Insurance Corporation "indefinitely postponed" its Legacy Loans Program, which involves those famous public-private partenerships in which investors would use some of their own capital and lots of government (that is, taxpayer) leverage to buy bad assets off of banks. The program was set to begin later this month, with the targeted purchasing of $1 billion in soured mortgages.

However, the banks won't bite. "Many banks have refused to sell their loans, in part because doing so would force them to mark down the value of those loans and book big losses," the New York Times reports. "Even though the government was prepared to prop up prices by offering cheap financing to investors, the prices that banks were demanding have remained far higher than the prices that investors were willing to pay." Who can blame them? Not us.

Now, let's not lose sight of something. In many ways, this is good news--it means the banks think they can ultimately get a better deal by holding onto these bad assets, collecting payments when they can, and waiting for a day when they can sell them for prices that don't cause them huge writedowns. Were that day ever to come, it would be a wonderful day for the financial industry and the economy generally; and even the fact that the banks think that day will come, and will come before their balance sheets drive them to insolvency, is both a good sign and an amount of optimism that will intrinsically have a buoying effect on the economy and those assets. So in that sense, this is great news!

However, as a harbinger for the administration's plans for small-business credit, it's bad news. These banks' refusals had direct consequences--it killed the government program. That's quite a precedent, and it suggests that the private actors' refusal of the $15 billion initiative might, too, kill that program.

Still, we'll try to view this as an opportunity. We were never gung-ho on the credit initiative anyway, chiefly because we don't think credit is the problem, and that there are probably better, non-credit-related ways to spend that $15B.

So, howsabout this, federales: you admit that your small-business credit initiative is effectively dead, and waste no time finding a better use for that money--something that will provide immediate and significant relief to Main Street small businesses--and, in exchange, we will go easy on you. Deal?

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