Thursday, October 31, 2013

TARP, Five Years Later

President George W. Bush signed the Troubled Asset Relief Program into law on October 3, 2008. What has happened with it five years later? For me, the main difficulty in thinking about TARP has been keeping track of all the things it ended up doing. The U.S. Treasury has a useful website that runs through the details of TARP. As one might expect, it's slanted toward the position that TARP was a good idea. But that bias doesn't affect the actual numbers of what the government spent and the extent to which it has been paid back.

TARP was authorized to spend $700 billion. What did it actually do? The money went five places: 1) $68 billion to the insurance company AIG; 2) $80 billion to the auto companies; 3) $245 billion to bank investment programs; 4) $27 billion to credit market programs; and 5) $46 billion to housing programs. The other $235 billion in spending authorization was cancelled. Let's unpack these categories and see what happened.

This chart shows Treasury's total commitments under TARP in billions of dollars. $235 billion was cancelled; $68 billion was com

The government justification for investing in AIG looks like this: "At the height of the financial crisis in September 2008, American International Group (AIG) was on the brink of failure. At the time, AIG was the largest provider of conventional insurance in the world. Millions depended on it for their life savings and it had a huge presence in many critical financial markets, including municipal bonds. AIG’s failure would have been devastating to global financial markets and the stability of the broader economy. Therefore, the Federal Reserve and Treasury acted to prevent AIG’s disorderly failure." The Treasury used its $67 billion to buy AIG stock and it has sold off that stock since then, finishing in December 2012. The Treasury ended up making a gain of $5 billion. The Federal Reserve Bank of New York also loaned AIG $112 billion, and has ended up making a gain of $7 billion as that loan has been repaid. These gains end up in the U.S. Treasury.

The auto industry

Treasury reports: "The Automotive Industry Financing Program (AIFP) was created to prevent the collapse of the U.S. auto industry, which would have posed a significant risk to financial market stability,threatened the overall economy, and resulted in the loss of one million U.S. jobs. Treasury invested approximately $80 billion in the auto industry through its Automotive Industry Financing Program. As of September 30, it has recovered $53.3 billion or more than 66% of the funds disbursed through the AIFP program." The Treasury exited its investment in Chrysler in 2011, and the government now owns only about 7% of GM stock, down from 60% at the peak. The website reports that "the auto industry rescue may end up as a net cost to the government." It's useful to remember that the TARP money wasn't all that the government did. As I discuss here, the government also stage-managed an accelerated bankruptcy process that reorganized the ownership of Chrysler, in a way that did much less for the bondholders than a standard bankruptcy process, and more  for the the employees. The firms were also handed created tax breaks not usually available to bankrupt firms worth tens of billions of dollars.

Bank investment programs

This was actually five separate sub-programs; for example, it includes the "stress tests" under which bank regulators re-examined the balance sheets of many banks under a variety of different scenarios, and pushed some of them to raise more outside private capital as a result. But in terms of spending, the biggest element was the Capital Purchase Program that provided investments and loans to about 700 banks. "Treasury has recovered almost $225 billion from CPP through repayments, dividends, interest, and other income – compared to the $204.9 billion initially invested. Treasury has recovered more than 100 percent of that amount through repayments, dividends, interest, and other income. Treasury continues to recover additional funds."

Credit Market Programs

"Three programs were launched: the Public-Private Investment Program (PPIP), the SBA 7(a) Securities Purchase Program, and the Term Asset‐Backed Securities Loan Facility (TALF). Although the specific goals and implementation methods of each program differed, the overall goal of these three programs was the same—to restart the flow of credit to meet the critical needs of small businesses and consumers.​" These three programs are no longer making loans and are in the process of being wound up. They have either repaid the government money invested, or are on their way to doing so.

Housing Programs

There are two main programs here. The Making Home Affordable Program is aimed at assisting households that are faced with foreclosure on their home mortgage. The website reports that 1.2 million households have negotiated lower mortgage payments (usually with some write-down of the principal) and another 200,000 have arranged to sell their homes for less than the mortgage. The Hardest Hit Fund aimed at mortgage borrowers in 18 states where the fall in housing prices was especially severe and/or the unemployment rate was exceptionally high. It allocated funds to state-based programs. As of second quarter 2013, the summary report is that it has spent $1.6 billion to assist about 126,000 households nationally. Here in late 2013, these programs are still taking applicants, which seems misguided to me. They were badly needed during the past few years, when they did relatively little.

Overall, the Treasury reports that TARP is likely to end up costing the federal government about $40 billion. As this review should help to clarify, most of that is for the auto company bailout, and the rest is the housing and credit market programs. The bank investment programs and the AIG investment have ended up making money for the government. This outcome wasn't unexpected. The economic theory behind a lender-of-last-resort program is well-established. In the middle of a financial panic, as in fall 2008, financial markets can lock up. In that setting, having a deep-pockets government agency like the Treasury or the Federal Reserve provide capital can restart the financial markets. Even better, when the government provides financial liquidity during a crisis, it can then often make money when it cashes out its financial stake after the crisis has passed, when the economy has improved.

Of course, the fact that most of the TARP spending has ended up being repaid doesn't settle the issue of whether it was a good idea. Here are some outstanding issues:

1) The bailouts of 2008 raise an issue of whether systemically important financial institutions can reasonably expect future bailouts if they get in trouble. If so, they may engage in overly risky behavior in the future. The government can make many promises that it won't bail out large institutions in the future, but if push comes to shove, will those promises be kept?

2) We don't get to replay history to find out how alternative policies would have worked. What if AIG, the car companies, or some of the banks had been required to reorganize through a normal bankruptcy process?

3) Many firms went broke in the Great Recession. As a matter of fairness, what makes the firms that TARP helped so special?

4) TARP was intertwined with separate but related actions by the Federal Reserve, by bank regulators, with bankruptcy processes for the car companies, various tax law changes, and so on. As a result, it's hard or impossible to evaluate the effect of TARP in a vacuum.

5) When you step in during a crisis, there is some luck involved if your intervention works out well.