Why Haven't Credit Problems Been Resolved?

The government's Troubled Asset Relief Program — known as TARP — was designed to thaw the frozen credit markets by, among other things, buying up financial firms' "toxic assets." The Treasury Department says it has given $155 billion to eight banks so far, which has helped them increase short-term lending. But the department hasn't yet started to buy up problematic mortgage-backed securities.

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RENEE MONTAGNE, host:

When Congress passed that $700 billion rescue plan, it said it wanted detailed reports on how the money was being spent. The Treasury Department issued its first report to Congress this week, and the report said, it's unclear whether the plan is working NPR's David Kestenbaum has an update. Good morning.

DAVID KESTENBAUM: Good morning.

MONTAGNE: What has the Treasury Department done so far?

KESTENBAUM: The major thing it did was last week, it agreed to wire $125 billion to nine major banks. The government is basically buying shares in these banks. The idea is to get them money to make it easier for the banks to do what banks do, which is lend money out. According to outside analysts, there are actually something like 30 banks that been improved so far.

MONTAGNE: And what has that done for lending from these banks?

KESTENBAUM: Well, the question is lending at what rates and who are they lending to? The Treasury report says that short-term lending is easing up and they're happy about that, but companies are still finding it hard to get money longer term at rates that they're happy with.

MONTAGNE: And why is that the case? Why is it a problem with longer term lending?

KESTENBAUM: Right. Well, they're throwing all this money at the problem, right? So why hasn't it fixed things? And that's sort of a puzzle. I mean, one answer is that maybe it's just too early. I'll give you two other answers from two University of Chicago economists. Luigi Zingales said either the banks were worse off than we thought or, and I know this sounds silly, the banks are scared. Yes, they're banks or institutions, but he says, you know, they're run by people.

Professor LUIGI ZINGALES (Economics, University of Chicago): If you got scared, basically had a bad system in place, you got hit by a major shock, you almost sort of got killed, you got a second chance to live, you're not ready to go back to operation as nothing had happened.

KESTENBAUM: His colleague, John Cochrane, has a slightly different view, he says maybe we should not expect so much from the bailout. Yes, has says, it's stopped, you know, a potential catastrophe of kind of a run on a banks, but - look, we're just in a new reality now where lending is going to be tighter.

Professor JOHN COCHRANE (Economics, University of Chicago): I think we will eventually be lending at somewhat lower rates, but not totally lower rates. I think we all learned a lesson here that if you make risky loans, there's a chance that they could default.

MONTAGNE: So in a sense, there's a reason for them to be scared?

KESTENBAUM: That's the question. Are they being rationally scared or are they being more scared than the situation merits?

MONTAGNE: So, what about the government? How is it deciding which banks get the help and which don't?

KESTENBAUM: We don't know, that's the answer.

(Soundbite of laughter)

KESTENBAUM: They're being very...

MONTAGNE: Why, David? Why do we not know?

KESTENBAUM: They're being secretive and they say that's for good reason. They're doing it for the protection of the banks. So, if a bank applies for the program and gets rejected, that's like a financial scarlet letter. So, the government is not disclosing the names of banks that it turns away and it's not laying out how it's making the decisions, even though these are sort of life or death decisions for some of these banks. Some of what could happen, and you're starting to maybe see this now, is that the stronger banks will use the money to buy up weaker banks. We have something like 8,000 banks out there now and one analyst told me he thought we can end up with half of that. Now, Congressman Barney Frank among others are raising questions about whether this is really what the bailout money should be going for, banks acquiring other banks.

MONTAGNE: Well, that's a question I think a lot of taxpayers might be asking.

KESTENBAUM: Right. So the argument is that, this is actually what needs to happen and this makes the whole systems stronger you get. The banks that are healthy will take over the banks that are having trouble, and that's what they are, - or should happen.

MONTAGNE: Well, lets go back to what a lot of folks thought that the bailout was going to do and the original plan was to buy up the actual toxic assets, what about that plan?

KESTENBAUM: The Treasury says that's still on the table. Remember the basic idea was that, there are bunch of mortgage-backed securities, all these things out there in the system that depend at some level on mortgages, and those things are all in trouble, so that's what we call toxic assets. And the government's solution was originally to just buy those up, take those up everybody's hands and say, OK, it's all right. Don't worry about it. We got them. But the government is now saying that's on the table but Treasury won't say they're definitely going to do it.

MONTAGNE: When the government spends this money, what does it actually do? I mean, I'm thinking it doesn't write a check.

KESTENBAUM: Right. I mean, I do have this image of a guy there with a pen. But it's all electronic. It's actually done through the bank of New York Mellon Corporation, which oddly enough is one of the banks that itself is getting some of the stabilization money. So, I guess technically they're wiring the money to themselves.

MONTAGNE: Thanks for joining us once again.

KESTENBAUM: You're welcome.

MONTAGNE: NPR's David Kestenbaum. And there's plenty more about the financial crisis at our Planet Money podcast and blog. You can find it at npr.org/money.

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