Tuesday, March 29, 2011

The TARP Scam

Bankers and government officials would have you believe that TARP was a success. Their main two arguments are 1. Without it, we would be in the abyss and 2. TARP was a profitable operation for the U.S. government and thus taxpayers.

I will first present the case in favour of the Troubled Asset Relief Program by reproducing below an article published yesterday by Robert Samuelson (no relations to Paul) who writes often for the Washington Post and others newspapers. I will then lead you to John Taylor's blog to bring you a much more unbiased assessment of the initiative. Taylor is a professor of economics at Stanford and the Taylor rule is named after him. Let me know who you believe!

Here is Why TARP Has Been a Success Story by Robert Samuelson:

"It isn't often that the government launches a major program that achieves its main goals at a tiny fraction of its estimated costs. That's the story of TARP - the Troubled Assets Relief Program. Created in October 2008 at the height of the financial crisis, it helped stabilize the economy, using only $410 billion of its authorized $700 billion. And most of that will be repaid. The Congressional Budget Office, which once projected TARP's ultimate cost at $356 billion, now says $19 billion. This could go lower.

"You would hardly know.

"Almost everyone loves to hate TARP. It's a favorite political sport of liberals, conservatives, Republicans, Democrats - and the public. A Bloomberg poll last October asked how TARP had affected the economy. Forty-three percent of respondents said it weakened the economy; 21 percent said it made no difference; only 24 percent said it helped, with 12 percent unsure one way or another. Commentators in newspapers from the Wall Street Journal to the New York Times disparage TARP.


"One lesson of the financial crisis is this: When the entire financial system succumbs to panic, only the government is powerful enough to prevent a complete collapse. Panics signify the triumph of fear. TARP was part of the process by which fear was overcome. It wasn't the only part, but it was an essential part. Without TARP, we'd be worse off today. No one can say whether unemployment would be 11 percent or 14 percent; it certainly wouldn't be 8.9 percent.

"That benefited all Americans. TARP, says Douglas Elliott of the Brookings Institution, "is the best large federal program to be despised by the public."

"The source of outrage is no secret. Bankers are blamed for the crisis and reviled. The bank bailout - TARP's first and most important purpose - was instantly unpopular. Most Americans, says Elliott, "believe that taxpayers spent $700 billion and got nothing in return."

"What this ignores - aside from being factually incorrect - is that an alternative being promoted at the time was widespread nationalization of banks. The cost would have been many times higher; the practical problems would have been enormous. As it was, TARP invested $245 billion in banks(and about $165 billion into the other programs). The extra capital helped restore trust. Meanwhile, the Federal Reserve increased its lending; the Federal Deposit Insurance Corp. guaranteed $350 billion of bank borrowings. Banks resumed dealing with each other because they regained confidence that commitments would be honored.

"Of the $245 billion invested in banks, the Treasury has already recovered about $244 billion, including interest payments, dividends and cash from sold bank stock warrants. So the bank rescue has roughly broken even. When TARP's remaining bank investments are closed, the Treasury expects an overall profit of about $20 billion.

"Almost all of TARP's activities have been distasteful. This was surely true of the rescue of General Motors and Chrysler. But the automakers' collapse would clearly have worsened already dismal unemployment. Did we really want these companies to shut down, with some plants sold to foreign automakers? Of the $80 billion committed to the auto rescue, the Treasury now expects to recoup about $65 billion. The government still owns about 33 percent of GM and 9 percent of Chrysler. By contrast, the sale of its 92 percent stake in AIG, the insurance giant, might yield a small profit.

"We need to remember that TARP was a desperate program for desperate times. It's had its failures: The Obama administration's forecast that it would provide mortgage relief to 3 million to 4 million homeowners has fallen well short (the current number is about 600,000). But the larger purpose of helping calm financial markets succeeded. Costs have been lower than predicted because aid was extended at the panic's height, when expectations of losses were greatest. As the economy has recovered, the gloomiest predictions proved exaggerated.

"Some TARP critiques reflect desirable oversight by Congress, the Government Accountability Office and a special Treasury inspector general. But some criticisms are broad generalities that, on inspection, are highly suspect. One common allegation is that TARP will encourage more reckless risk-taking because big financial firms know they'll be bailed out if their gambles backfire - a problem economists call "moral hazard." Bankers keep profits but are protected against losses, which are assumed by the public.

"This is a serious issue, but TARP's legacy is actually the opposite. During the crisis, investors in banks and financial institutions suffered huge losses. It wasn't predictable which institutions would survive and which wouldn't - or on what terms. The same would be true in the future. Indeed, TARP's extreme unpopularity compounds uncertainty, because it suggests that politicians will recoil from more bailouts. The moral hazard is more imagined than real."

Now that we read the case for TARP, have a deep look at the following blog entry, Evaluating Tarp, from Economics One, John Taylor's blog. In the text below, I also reproduced the links to the different testimonies to the Congressional Oversight Panel of the House of Representatives as I want to strongly encourage you to click on them to get various opinions from different economists on TARP.

Here is Taylor's March 17th entry about the infamous program:

"Today’s TARP hearing at Senate Banking follows a slew of recent reports. The Congressional Oversight Panel (COP) issued its final report yesterday. Economists Simon Johnson, Allan Meltzer, Joe Stiglitz, and Luigi Zingales submitted testimony to COP two weeks ago. The Special Inspector General for TARP (SIGTARP) issued a comprehensive review in January. Three members of COP published an oped in today’s Wall Street Journal.

"A common theme is the high cost of the TARP. I‘m not talking about whether the government lost or made money, which is not a good measure of effectiveness, but rather the costs to the economy (stability, growth, employment, etc). Since November 2008 I have been writing about the costs of the chaotic rollout of the TARP which in my view worsened the crisis and exacerbated the panic. (Here is my written testimony for today’s hearing.) In his recent book former FDIC chairman Bill Isaac concluded that “any objective analysis would conclude that the TARP legislation did nothing to stabilize the financial system that could not have been done without it. Moreover, the negative aspects of the TARP legislation far outweighed any possible benefit.” In his recent testimony Joe Stiglitz said that “TARP has not only been a dismal failure…but the way the program was managed has, I believe, contributed to the economy’s problems.”

"Of course others are more positive about the stabilizing effect of TARP. Timothy Massad, current acting assistant secretary of Treasury, argues that the TARP prevented a more severe panic, citing as empirical evidence a paper by Alan Blinder and Mark Zandi. However, Blinder and Zandi explain that they don’t do a separate evaluation of the TARP: “We make no attempt to decompose the financial-policy effects into portions attributable to TARP, to the Fed’s quantitative easing policies, etc,” they say, so this is not really empirical evidence. COP is also positive about the short run impact though less positive than the Treasury

"Though some disagree about the net costs of TARP in the short run, few disagree that the longer-run costs are substantial. In January the SIGTARP listed these costs:
  • “damage to Government credibility that has plagued the program,”
  • “failure of programs designed to help Main Street rather than Wall Street,” 
  • “moral hazard and potentially disastrous consequences associated with the continued existence of financial institutions that are ‘too big to fail’” 
The COP final report listed these costs:
  • “continuing distortions in the market”
  • “public anger toward policymakers,”
  • “a lack of full transparency and accountability.”
"At the COP hearing, Stiglitz, Meltzer, Johnson, and Zingales (who rarely all agree) were unanimous in their view that the TARP actions have created an incentive for financial institutions and their creditors to take high risks due to the expectation of being bailed out, favoring big players and leaving the economy vulnerable to financial crisis. They also agreed that the Dodd-Frank legislation did not solve “too big to fail.”

"To these costs I would add that the TARP established an unfortunate precedent of heavy-handed government intervention in the operations of businesses. The government forced some financial institutions to take TARP funds, even those that said they did not want them, by threatening actions from regulators. The government used the TARP for purposes other than originally stated in Congressional hearings, including the bailing out of automobile companies.

"TARP is not popular with most Americans. Economic evaluations now rolling in support their view, but rather than pointing fingers, it is time to absorb the lessons and take actions to remove the legacy costs and try to end government bailouts as we know them."

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