OK

At least four of the issues gripping the debate over the White House’s Proposal for Treasury Authority to Purchase Mortgage-Related Assets, or TARP, seem certain. Congress is going to recess soon; and Congressional legislation will require bipartisan oversight, caps on executive compensation and some sort of window-dressing to aid to homeowners.

Otherwise the Hill hearings have been political theatre while a deal is hammered out behind the scenes.

The Administration’s strategy for pushing the TARP through Congress is a panic-based warning that, without immediate Government intervention, financial markets will implode and consumers will suffer lost jobs, savings and access to credit to support their businesses. This argument is strikingly analogous to those underpinning trickle-down economics. TARP is premised on the assumption that a wealth transfer of taxpayer dollars to Wall Street will engender market liquidity thereby benefiting the public good; trickle-down economics is premised on the assumption that slashing tax revenues to benefit corporations stimulates economic growth thereby benefiting public good.

I do not dispute that bold action by the Government is called for. The United States has been in a recession for months, a recession only exacerbated by the current financial crisis. However, the TARP bailout provides insufficient protection to taxpayers. It is a one-sided proposal benefiting Wall Street yet offering none other than hope that a Government subsidy to Wall Street of unprecedented magnitude will ever be recovered.

Chairman Bernanke and Secretary Paulson have resisted bailout models other than the TARP during their Congressional testimony. They offer hollow arguments, much as they have in their persistent reassurances until late that the fundamentals of our economic and financial markets were strong. TARP relies on the Treasury to acquire mortgage securities of unknown value using complex, confusing acquisition models. TARP's engineers already are bereft with conflicts of interest. Secretary Paulson, a smart and honest man, placed $800 million of his Goldman Sachs stock in a blind trust before his confirmation. Black Rock, the money management firm hired by Secretary Paulson to manage $30 billion of toxic assets it acquired during its rescue of Bear Stearns, is controlled by Merrill Lynch and PNC Financial Services Group.

Bernanke's testimony did leave a door open for an alternative to TARP. Congress should open it. He testified "I would advise Secretary Paulson to be flexible....there are other ways to use this money that will again purchase assets or purchase capital and support the banking system." I agree. There is a better mousetrap which accomplishes the primary goals of TARP, can be enacted quickly and provides more protection to taxpayers. It will restore confidence in financial markets through the creation of an investor of last resort as opposed to a buyer of last resort.

I used to be an investment banker on Wall Street and advised financial institutions, public and private. Were I advising the White House in the same manner as I would one of my clients seeking to invest in distressed institutions I would immediately turn to a tried-and-true investment model. The first step would be to establish an independent Government entity with its own budget and ability to hire and fire management. That’s akin to what public universities like the University of North Carolina do in forming quasi-independent investment firms like UNC Management Co. to oversee the university’s endowment. This new Government entity would be capitalized by the Treasury with $X billion to make investments in financial institutions mired in the liquidity crisis. The Government entity’s template investment instrument would be a convertible preferred stock paying a dividend and allowing for the conversion of the preferred stock into common stock at a reasonable conversion premium of, say, 20% above the market price.

This better-mousetrap model would arm troubled financial institutions with infusions of fresh capital and leave to them the job of disposing of toxic assets at a time and price they determine. Their financial condition would be no worse than had Treasury acquired those assets outright. Returns realized by the new Government entity would be returned to the Treasury. Most importantly taxpayers would have a senior position to existing shareholders, benefiting from their prosperity and having more security should they fail.

The alternative TARP model is vintage Warren Buffet. It is the conventional standard he has utilized over the past 30 years to invest in firms under duress. He did so Tuesday through a $5 billion investment in newly-issued convertible preferred stock of none other than Goldman Sachs.

Warren Buffet puts the interests of shareholders of Berkshire Hathaway first. The Congress should do likewise by putting the interests of Americans first.

I was a candidate for the US Senate in the 2008 Democratic primary in North Carolina. In my prior life I've worked as an investment banker for Goldman Sachs, Lehman Brothers, Salomon Brothers and Bear Stearns advising public and private financial institutions.

Originally posted to Neals Way on Wed Sep 24, 2008 at 06:21 PM PDT.

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