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Opinion: Troubled assets? On second thought, no thanks.

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Looks like the federal government won’t be cornering the market on troubled bank assets after all. At least not this year.

Treasury Secretary Henry M. Paulson Jr. disclosed today that the $700 billion Troubled Asset Relief Program approved by Congress last month at his request won’t buy ... troubled assets. Despite its zeal to sell the rescue plan, it was clear from the start that the administration’s vision for the program was blurry. Some officials wanted to pay a premium for the assets in question (mortgages, mortgage-backed securities and other ‘illiquid’ financial instruments) as a way of recapitalizing struggling banks. Others just wanted to establish market values for those assets to clarify how rich (or poor) the banks that owned them were. The Times’ editorial board liked the latter approach, not the former, because there are far more efficient ways to recapitalize banks than overpaying for defaulting loans. And in fact, that’s what the Treasury Department has been doing with the TARP funds spent thus far (close to $300 billion): making direct investments in banks and other financial institutions (read: American International Group).

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Just because the government isn’t shopping for troubled assets, however, that doesn’t mean the Treasury Department won’t add some to the taxpayers’ portfolio. As part of the AIG bailout, the government is helping AIG buy $70 billion worth of exotic derivatives called collateralized debt obligations that banks issued but AIG insured. (The government and AIG will put up $35 billion for the securities, a price that reflects their current market value.) According to the Wall Street Journal, AIG will have to cover the first $5 billion in losses incurred by the CDOs, which are backed by subprime mortgages and other loans. In addition, Paulson laid out two further objectives for the TARP that could result in the government acquiring or guaranteeing risky bets placed by lenders. One is to provide more credit for consumers by lending money to banks against the collateral of securitized auto and credit-card debt. The other is to avert foreclosures, potentially by backing new loans to some troubled borrowers. Although there’s no specific plan for aiding homeowners yet, FDIC chief Sheila Bair has pushed for the feds to guarantee refinancings for borrowers whose mortgages could be modified to meet a standard measure of affordability.

Meanwhile, the administration is resisting pressure from lawmakers to make more demands on banks that receive federal help. Lawmakers had particularly sought to require those banks to make new loans, rather than hoarding the money or using it to pay dividends, and to avert more foreclosures. In a statement released today, the four top regulatory agencies for the financial industry provided new guidance for all banks and thrifts, gently pushing them to make more loans and fewer foreclosures without setting any specific requirements. In essence, the regulators urged banks to make loans to creditworthy borrowers, to not weaken their cash reserves by paying excessive dividends, to not make foreclosures until they’d considered less costly modifications, and to end any financial incentives that gave executives short-term benefits for making long-term commitments. If banks and thrifts really need to be told such things, that’s a sad commentary on their management as well as the regulators’ past practices.

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