With roughly half of the government’s TARP (Toxic Asset Relief Program) funds already disbursed, why is it that we’re still having so many problems with the subprime and ‘packaged’ loans that triggered this downslide in the economy? Wasn’t the idea to get rid of these debts on the bank’s balance sheets and allow them to start making new loans? Shouldn’t the banks be healthier and out there lending money to their customers by now?

Unfortunately, the answer is “No”.

That Was Then

Originally, when the markets started free-falling last November (after the government refused to come to the rescue of Lehman Brothers, and allowed them to go under) a wave of panic selling took off, plunging the stock market up and down like some kind of demented roller-coaster. In an effort to stop or at least curtail some of the market jitters, Fed chairman Bernanke and then-Treasury secretary Paulson went begging to congress for enough funds to “buy up” all the “toxic” debt that was causing the banks so much trouble. Those sub-prime mortgages that had fueled the housing bubble had turned into huge packages of debt that were so intertwined, that it was virtually impossible for banks to deal with individual loans. As a group, these ‘packaged’ loans turned out to be financially lethal, as the bad loans couldn’t be separated from the good, dragging them all down.

Bernanke/Paulson wanted funds to take the subprime loans off the bank’s hands, and manage them centrally, until such a time they could be separated, restructured, and sold back to the public (presumably at either break-even or at a profit).

Statements like “catastrophic depression” and “economic meltdown” were standard phrases used throughout the process of securing this money. Congress was in such a panic to do something that they released the money. The allocated $700 billion in funds to the TARP program, basically handing Paulson a huge blank check, to buy up assets as he saw fit.

This is Now

However, it didn’t go quite that smoothly. Along the way, the strategy shifted from buying up the bad assets (and getting them off the bank’s hands) to buying stakes in the banks themselves. Something along the lines of a quasi-nationalization of the major banks. Tens of billions were distributed to many of the top banks, whether they needed/wanted it or not, in hopes of boosting consumer confidence in the banking system as a whole. The overriding idea being if the banks were sufficiently capitalized, they could immediately start making loans to consumers again and get the market back into play, if nothing else.

Didn’t happen.

The banks that received the funds largely sat on them for an extended period of time. No new loans, no consumer help, no NOTHING. Some of the banks (Bank of America in particular) used the funds to ‘buy up’ other failing banks, and make themselves larger. The net effect was that the credit markets came to a halt, all but stopping consumer lending. In a domino effect, many businesses of all sizes saw their lines of credit reduced or eliminated, causing problems with making payroll and buying supplies. This caused yet more problems with closings and layoffs. And the cycle continued, as banks, seeing the closings and layoffs, tightened lending even further.

So How Do We Get Out of This Mess?

There remains an additional $350 Billion in funds to be disbursed. Pres. Obama has received authorization to disburse the funds, but is waiting to formulate a more effective strategy for getting the money to actually help the market get back on it’s feet.

One idea is to go back to the original intention of moving bad debts out of the banks, to a ‘Bad Bank’ owned/operated by the government (similar the Resolution Trust Corporation of the late ’90s) to be centrally managed. This would give the banks leeway to make loans again, and fulfill the original premise of the bailout. There’s no guarantee that even this would work, as the government can’t “force” the banks to lend money. (Yet, that might be written up as part of the requirements for receiving some of the second-half of the bailout money).

As it stands, with half the funds gone, there’s little or no visible effect on the banking system or in the market. It’s time to try something new.