Annual Report | October 24, 2011 at 5:14 pm

The Bank Bailout in Perspective


Over the past two years, the Bank Bailout saved the American financial system from collapse while turning a profit of $25 billion—enough to fund the Securities and Exchange Commission (SEC) for 20 years. Yet Americans across the political spectrum despised the Troubled Asset Relief Program (TARP), the $700 billion bailout that seemingly epitomized Wall Street’s leverage in Washington.

Last October, a Bloomberg poll found that 43 percent of Americans felt that TARP had weakened the economy, while only 24 percent felt it had strengthened the economy. Despite being conceived by a Republican administration and continued by a Democratic one, TARP is likely one of the most hated programs ever implemented. Nonetheless, TARP undoubtedly averted greater economic catastrophe and ultimately cost far less than expected.

But voters’ instincts are not wrong. For all its achievements, TARP cannot be called a great success; it failed to stem the foreclosure crisis, increase lending, hold bankers accountable, and stop rocketing unemployment. It also sparked a still simmering distrust of policymakers and government.

The Road to TARP

The US housing bubble  collapsed at the height of the financial crisis in 2008, devaluing mortgage-related securities and the banks that held them. The stock market plunged in the wake of major bank liquidity crises and insolvency. Ad-hoc government-brokered sales of Merrill Lynch and Bear Sterns only created more uncertainty.

In September 2008, over an extraordinary 19 days, the US financial system moved toward catastrophe. The Federal Deposit Insurance Corporation (FDIC) moved Washington Mutual through the largest bank failure in US history, Fannie Mae and Freddie Mac were placed in conservatorship, Lehman Brothers suddenly filed for bankruptcy, the Federal Reserve began an $85 billion rescue of the American International Group (AIG), and the Treasury guaranteed $3.7 trillion worth of money market funds. Chairman of the Federal Reserve Ben Bernanke later claimed that the growing crisis was “a cataclysm that could have rivaled or surpassed the Great Depression.”

Convinced that a more comprehensive plan was needed to reassure markets, Bernanke and Secretary of the Treasury Henry Paulson conceived of TARP, an unprecedented $700 billion authorization to allow the Treasury to purchase toxic assets from banks. Congress recoiled at the price amidst growing public outrage, rejecting the first iteration of the bill. But as the markets convulsed, Congress passed a marginally amended version of the bill.

Given the delay, Secretary Paulson decided that purchasing toxic assets was no longer practical and instead elected to spend the first $350 billion by directly injecting capital into banks. The nine largest banks, representing 75 percent of all American banking assets, were given $25 billion each in exchange for stock. This initial round of funding bolstered the banks’ capital reserves, but without any preconditions attached, failed to increase lending.

As President Bush’s term drew to a close, some $17 billion in TARP funds were loaned to General Motors (GM) and Chrysler to avoid bankruptcy. Together, in January 2009, President Bush and President-elect Obama requested that Congress release the remaining $350 billion in TARP as further capital infusions seemed likely. By the end of the month, TARP had disbursed $301 billion in total.

Shortly after, the new Secretary of the Treasury Tim Geithner ordered the TARP banks to undergo stress tests to gauge their financial resilience. Expecting poor results, he further laid out a new rescue plan that would have created a private- public bank to purchase and hold up to $500 billion in toxic assets. This plan, however, was soon abandoned after banks refused to sell their assets at large losses in spite of generous government financing.

Simultaneously, Chrysler and GM, beginning to exhaust their existing federal loans, returned to seek more funds. The President’s auto task force, after guiding both GM and Chrysler through bankruptcy and significant restructuring, granted the automakers $25 billion in TARP loans.

In June, under heavy lobbying and with better-than-expected stress tests, the administration began to allow banks to repay their TARP funds. To date, the Treasury has recouped $313 billion of the $412 billion it dispersed. Both GM and Chrysler paid back their TARP loans several years ahead of schedule. While the bank bailout itself was profitable, the administration estimates that the total cost of TARP, including assistance to insurers like AIG, will be $48 billion.

What Went Right

In the broadest sense, TARP was a success. It halted the collapse of the US banking system and may have prevented a second Great Depression. The Congressional Oversight Panel wrote in its final report that TARP “provided critical support to markets at a moment of profound uncertainty.”

In September 2008, as the market was making three digit swings, TARP not only provided a mechanism for resolving the core of the crisis, but also served as a strong statement that the government would take extraordinary measures to ensure the survival of the financial system. Mark Zandi, chief economist of Moody’s, wrote that “the capital purchase program was ultimately the one key thing that was necessary for stabilizing the financial system and the economy.”

TARP also prevented an even deeper recession. A study done by Zandi and Alan Blinder of Princeton determined that without TARP and the Federal Reserve’s monetary easing, GDP growth would have been 4.7 percentage points lower and unemployment would have been 4.0 percentage points higher in 2010.

And, from a cost standpoint, TARP was a greater accomplishment than anyone had possibly imagined. At its onset, estimates ranged in the hundreds of billions of dollars. The Congressional Budget Office initially determined that the program would cost $356 billion.

This significantly reduced cost stemmed not only from stronger-than-expected bank performance, but also from effective Treasury management. The Congressional Oversight Panel reported that the “Treasury deserves credit for lowering costs through its diligent management of TARP assets and, in particular, its careful restructuring of AIG, Chrysler, and GM.”

TARP, then, also allowed for the orderly bankruptcy of Chrysler and GM. Without the TARP funds, the carmakers would have exhausted their funds and been liquidated to pay creditors. Such a shutdown would have been devastating, wiping out over one million jobs in the motor vehicle industry and likely taking Ford down as well. Today, Chrysler and GM have restructured, paid back their funds ahead of schedule, and appear to be on the road to recovery.

What Went Wrong

In the final analysis, TARP must be faulted for accomplishing less than originally anticipated and for the significant financial and cultural distortions it created. TARP may have prevented the worst of the financial crisis, but it ultimately failed in its other stated goals—preventing the foreclosure crisis and increasing lending.

In fact, part of TARP’s low cost can be attributed to the failure of the Treasury’s foreclosure prevention programs. Expected to cost $50 billion, the TARP-created Home Affordable Modification Program (HAMP) was supposed to restructure mortgages and prevent 3 to 4 million foreclosures. Instead, this goal has been lowered over time, and today only 1.5 million trial modifications and 500,000 permanent modifications have been made. Since TARP’s authorization, 7.1 million homeowners have received foreclosure notices.

HAMP attempted to save mortgages through temporary reductions in interest rates and monthly payments. But even with these lower payments, many homeowners were still underwater at high risk of default. The Congressional Oversight Panel recognized that HAMP was flawed: “moderate, long term payment relief did not provide the deep, short term relief necessary to keep unemployed borrowers temporarily without income in their homes.”

Many of TARP’s greatest costs, however, cannot be strictly measured in dollar amounts. Though TARP rescued large banks and the motor vehicle industry, Americans perceived it as a massive bailout of undeserving bankers, underscoring the nexus between Wall Street and Washington and undermining public confidence in policymakers and regulators.

TARP may have done too well in rescuing banks and too poorly in addressing the broader economy, allowing bankers to rebound and pay bonuses even as unemployment remains high. Felix Salmon of Reuters summed up the sentiment: “The little guy was hurt hard; the fat-cat bankers are smiling, unremorseful, and back to their old ways already.”

This attitude is undoubtedly simplistic, but TARP’s rushed execution and failure to provide accountability is seriously twisted policymaking. Anil Kayshyap, Professor of Finance at the Chicago Booth School of Business, said, “The public’s frustration has led to a general rise in populist political rhetoric and has polluted the policy discussion in many other areas.” The significant backlash has frustrated further government efforts to stabilize the economy and prevent a double-dip recession.

Closing the Book on TARP

TARP was a hastily executed effort of unprecedented size to rescue the US financial system from collapse. In that regard, TARP succeeded; without the immense government intervention, the recession would have been deeper, longer-lasting, and far more serious.

But as TARP comes to a close, it is clear that the program failed in several serious ways. Its foreclosure efforts were poorly designed and will not provide the mortgage relief needed. Toxic assets were not ultimately purchased, and banks did not use TARP funds to restart lending. The program’s greatest claim, then, is also its downfall. TARP saved the economy by saving the banks. And while its creators and promoters had hoped TARP would do far more, it failed to deliver. The American people, facing a 9.1 percent unemployment rate (as of September 2011), have a right to despise it.

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