Treasury Secretary Henry M. Paulson's decision to abandon plans to buy troubled bank assets shows that he has come to two conclusions about what was once the chief focus of the government's $700-billion bailout:
The first is that it wouldn't work. The second is that the economists and financial experts who agitated to have capital injected directly into the banking system now appear to have been right all along.
Paulson announced Wednesday that the federal government would formally abandon plans to buy troubled mortgage-backed securities from banks and other big investors to instead focus its efforts on thawing credit markets.
The shift, however, had been in place since last month. A week after the package was passed by Congress on Oct. 3, Paulson began signaling that the thrust had changed and that much of the $700 billion instead would go toward providing capital to banks by investing in their preferred shares.
That action might be compared to replacing a gravely ill patient's slow intravenous drip with a shot of adrenaline into the heart. The stock market rallied, and over the next few weeks the capital injections intensified and talk of the asset purchases ebbed.
"The surprise content of the announcement today is precisely zero," Georgetown University finance professor Sandeep Dahiya said Wednesday. "This is not a change of policy, but a recognition of a policy that's already happened."
At the start of this week, only $60 billion still remained to be spent from Congress' initial $350-billion outlay, and the asset-purchase program still had not been established.
Although Treasury's change of course has aligned the U.S. more closely with Britain and continental Europe, where direct recapitalization of banks has become the standard response to the financial crisis, it has raised new doubts about the U.S. bailout.
These include concerns about Paulson's inconsistent direction. The Treasury secretary originally presented the plan to buy toxic mortgage-based investments under the Troubled Asset Relief Program as the only conceivable solution to bank failures, then vehemently resisted congressional attempts at modification.
"This was a major piece of legislation," observed Campbell R. Harvey, professor of international business at Duke University. "TARP was what people were voting on, and now he announces that TARP is not going to be TARP."
