President-elect Obama requested the second half of TARP funds, $350 billion, from Congress. Bank of America to receive a $20-billion additional capital infusion from TARP I resources, and other official support of troubled assets.
President-elect Obama moved swiftly, and we think wisely, over the past several days to request approval from Congress to have access to the second tranche of TARP funds—$350 billion. The Senate voted on January 15 not to disapprove of the disposition of these funds, and we expect the House to follow suit in the next few days.
While there has been considerable controversy over the effectiveness of the TARP I program, the facts speak for themselves. Bank credit (on balance sheet) to the private sector expanded by $323.7 billion in fourth-quarter 2008, up from only $195.3 billion in third-quarter 2008. Without the disposition of TARP funds, this expansion of bank credit simply would not have happened anywhere near this scale.
The main choke point with credit flows remains in the securitization markets—including mortgage-backed securities, auto loans, and credit card debt. We estimate that securitized credit actually declined in the fourth quarter, possibly by as much as $50 billion, as private investors both in the United States and abroad remained severely risk averse. Clearly, without the TARP capital infusions, the credit crunch in the fourth quarter of 2008 would have been far worse than it was.
While there is an ongoing debate as to how to deploy the second $350 billion of TARP funds, a considerable portion of these funds will likely be used for further capital infusions into the banking system. We estimate that roughly $200–$250 billion in additional capital will be needed to stabilize capital ratios in the banking system over the next several quarters and keep bank credit flowing, in order to support a rebound in the economy.
The U.S. Treasury will invest $20 billion in capital in Bank of America, and the bank will comply with enhanced executive compensation restrictions and implement a mortgage loan modification program. The $20-billion additional capital for Bank of America raises the total capital provided to that institution to $45 billion, close to the $50 billion provided cumulatively to Citigroup. The capital funds will be drawn from remaining TARP I funds that have not yet been disbursed. As a result, some lower priority pending applications for general funds will be deferred to the TARP II program.
In addition, the U.S. Treasury and the Federal Deposit Insurance Corporation will provide insurance protection against the possibility of unusually large losses on an asset pool of approximately $118 billion of troubled assets (primarily by residential and commercial real estate) assumed by Bank of America as a result of its acquisition of Merrill Lynch. In addition, and if necessary, the Federal Reserve stands ready to backstop residual risk in the asset pool through a non-recourse loan.
The bottom line here is that the TARP program is working in terms of forestalling a more severe credit crunch, and it is functioning as a critical tool to break the adverse feedback loop from depleted banking system capital, tighter credit conditions, and a weak economic performance.
The main problem that we are dealing with now is a rapidly deteriorating economic environment that is putting additional downward pressure on bank capital, and access to private sources of capital virtually ground to halt in the summer of 2008.
An aggressive TARP capital infusion program is therefore the only way to combat this banking system capital-depletion problem. Taking this approach will potentially increase the effectiveness of both monetary and fiscal policies in terms of ultimately reviving the economy. The president-elect is on the right track so far in terms of understanding these issues and taking prompt action to secure the second tranche of TARP resources.
