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TARP Not the Answer; Time for Plan B, Duke Expert Says

September 30, 2008

Duke University finance professor Campbell R. Harvey says he is not surprised that the House of Representatives voted against the Troubled Asset Relief Program (TARP), given “the numerous problems” with the proposal.

In a paper  posted on his website Friday, Harvey argued that TARP has at least three major flaws.

 

-- First, “Buying these toxic assets at ‘hold to maturity’ prices is throwing away taxpayer money -- it is tossing good money at bad.” He argues that the assets should be purchased at a much lower price consistent with a three-to five-year holding period and an assumed recovery in market conditions. “At these prices, financial firms would be pleased to sell -- and the taxpayers get to buy at a price where we can make a positive return.”

 

-- Second, the subcontracting of the $700 billion program is a mistake, Harvey says. “There are too many conflicts of interest -- it is best for the Treasury to manage this internally.”

 

-- Third, TARP would not necessarily increase the amount of lending in the economy, Harvey says. “What we really need is for banks to be willing to make loans to small- to medium-sized businesses -- the firms that are having the roughest time getting financing. Small and medium businesses are the key driver-job creation.” An economy-wide investment in the common equity of banks would provide an instant capital injection that would target lending.

 

“The TARP would have taken months to work through,” he adds. “It is a mathematical nightmare just thinking about how to value some of these toxic securities.”

 

Harvey ’s paper argues for a comprehensive approach to dealing with the crisis that directly targets credit availability. “The bottom line is that we need to jump-start the credit process in our economy. So far, we are just putting one fire out after another. We need a comprehensive policy that deals with financial institutions, the credit available to non-financial companies and the consumer who, after all, determines almost 70 percent of GDP.”

 

“It is time for Plan B. The next plan must cast a wider net and deal with all aspects of the problem.”

The latest version of Harvey ’s proposal is available at   http://faculty.fuqua.duke.edu/~charvey/Crisis/Harvey-v3.pdf .