Several weeks ago I reported how the government Troubled Assets Relief Program (TARP) money was being used to shore up bank balance sheets rather than purchasing troubled assets from those same balance sheets. I explained that the government discovered the TARP bail out money was insufficient to purchase all of the toxic assets (bad mortgages, loans and other paper) from the banks holding those assets, so then Treasury Secretary Paulson implemented a plan to inject capital into the strongest financial institutions in an effort to shore up their balance sheets.

Presumably this would have led to stronger banks that could then begin loaning money to consumers and businesses. Under this original strategy, the banks would continue to carry the toxic assets on their balance sheets, with the hope that the injected capital surplus would work to counteract the inevitable write downs the banks would have to recognize. Eventually, it was reasoned, the banks would either write down or sell the toxic assets as they recovered over time.

In the ensuing weeks and months we all learned this didn’t work out so well. The largest financial institutions like Citibank and Bank of America took the bail out money, continued to spend money unwisely and didn’t open up the lending windows. The toxic assets, in fact, continued to drag down their ability to loan money. The first installment of TARP money, therefore did little to quell the credit crisis. Arguably the institutions who took TARP money look weaker today than they did just a month ago.

So now we’re hearing the idea of an “aggregator bank”. The “aggregator bank” is similar in concept to the Resolution Trust Corporation (RTC) that purchased troubled real estate from savings & loan associations during the 1980s crisis. The RTC then took ownership of the troubled assets and sold them over time.

I asked economist David Jones how the remaining $350 billion TARP funds would be sufficient to purchase $2 – $3 trillion of toxic assets from the bank balance sheets. He explained to me that the Federal Reserve will “leverage” the money with its unlimited balance sheet. In other words, the remaining TARP money is simply a down payment from which the government will use to borrow the balance required to implement the aggregator bank strategy.

I find these concepts troubling on a number of fronts. First, those in Congress comparing the RTC to the aggregator bank are suspect. When the RTC took toxic assets from the savings and loan industry, those assets consisted mostly of commercial real estate (and mortgages thereon) that had a current yield in the form of rental income. The RTC was able to liquidate the real estate over the course of a few years, as investors found opportunity in office buildings and shopping centers earning returns that would only improve over time as the assets recovered.

The aggregator bank, on the other hand, will hold mostly paper that will transform into hard assets only upon the foreclosure on the mortgage notes encumbering those assets. Further, we have learned that most of those assets consist of speculative residential real estate and condominiums. With our rising unemployment rates (particularly in areas where the speculative construction was so rampant) there wouldn’t appear to be a ready market to gulp up residential real estate as there was for the commercial properties the RTC owned twenty five years ago. Moreover, the prevailing political winds indicate the government’s desire is to enable current borrowers to maintain the residences, by either writing down the mortgage notes or by rewriting the terms.

In other words, at the end of the day it would appear that the aggregator bank will be taking gigantic losses and will not have attractive hard assets to sell.

Second, the aggregator bank achieves its objective only through the government printing press. History tells us that when governments try to print their way out of financial crisis runaway inflation results. So long as our economy remains in the doldrums, we hear that inflation is not that much of a worry. But when this money works its way into the system, I wonder how it can’t be devalued. You can almost hear the run on precious metals that will result.

Third, I question whether relieving toxic assets from the banks and financial institutions that did the most damage is not rewarding those that should instead be punished. How do we know that these same institutions won’t continue their bad practices? While many suggest that allowing Lehman Brothers to fail largely exacerbated our current credit crisis because it “was too big to fail” and that allowing a Citigroup or Bank of America to fail would only make matters worse, perhaps a “break up” of these institutions along the lines of AT&T would be appropriate.

So watch the news about the aggregator bank and how the government intends to use the remaining TARP funds. Whether there is a more attractive way out of the current crisis is beyond me. I remain confident that we will come out of this. In any event, it is my hope that our political and business leaders take a hard look at the possible effects of the aggregator bank strategy.

©2009 Craig R. Hersch .Learn more at www.sbshlaw.com