Implementing a plan he had hatched in secret, Treasury Secretary Henry Paulson, Jr. announced a major shift in direction for the $700 billion Troubled Assets Relief Program (TARP). Despite its name, the program will not directly purchase troubled assets. Instead, it will provide capital for a wider array of lenders, including nonbank consumer lenders.

When Congress was debating the Emergency Economic Stabilization Act (EESA), it thought the purchase of distressed mortgages and mortgage-backed securities would be the heart of the rescue program it was creating. Since then, however, Treasury has shifted its emphasis toward capital injections for financial institutions. Congress apparently drafted EESA with enough latitude to allow the shift, although some Congress members are angry that Treasury did not at least consult them before making the Capital Purchase Plan (CPP) the heart of TARP.

Of course, Treasury has been implementing its CPP for some time now. After essentially forcing the industry’s super-giants to participate, the Department has been marketing CPP participation to the rest of the industry. What’s changed is Treasury’s admission it is not going to bother setting up the full mechanism that would be needed to buy, hold, and manage a portfolio of sick assets. Better to provide capital to the private sector and let sick assets stay where they are.

Nonbank Participation

Tellingly, Paulson’s new plan goes beyond promising capital for financial institutions. Apparently believing banks can’t do it all, Paulson is now focusing the CPP on nonbanks as well.

Paulson acknowledged that the CPP has already helped stabilize the financial system to some extent. However, he went on to state that both banks and non-banks may need more capital in light of “their troubled asset holdings, projections for continued high rates of foreclosures, and stagnant U.S. and world economic conditions.”

Because of that, he declared, “The important markets for securitizing credit outside of the banking system also need support.” Approximately 40 percent of U.S. consumer credit is provided through securitization of credit card receivables, auto loans, student loans, and similar products. “This market, which is vital for lending and growth, has for all practical purposes ground to a halt,” Paulson said. “Addressing these two priorities will have powerful impacts on the overall financial system, the strength of our financial institutions and the availability of consumer credit.”

Foreclosures Still A Problem

Even as it shifts priorities, Paulson said, the Treasury would continue to explore ways to reduce the risk of mortgage foreclosures, Congress’s original priority when it enacted the EESA. However, he added, “Our assessment at this time” is that buying up sick securities and troubled mortgages “is not the most effective way to use TARP funds.”

Despite the shift in focus, Paulson promised, the current CPP program will be carried through to completion. Ensuring that the financial system has sufficient capital is essential to getting credit flowing to consumers and businesses, he said, and that is where the bulk of the remaining TARP funds will be deployed. The CPP will remain a major part of that goal.

“We are focused on developing and preparing programs” to meet the goals that Congress set, Paulson declared. He added a promise to brief the president-elect’s transition team on these matters — a reminder that TARP’s direction might change yet again after Inauguration Day.