This morning, starting at 9:30am, the Congressional Oversight Panel holds a hearing to assess the performance of the Troubled Asset Relief Program (TARP). The hearing will be streamed live and also archived, featuring testimony from: Dean Baker (Center for Economic and Policy Research), Charles Calomiris (Columbia University), Alex Pollock (American Enterprise Institute), Mark Zandi (Moody’s Economy.com), and me.
In late September 2008, Secretary of the Treasury Henry S. Paulson asked Congress for $700 billion to buy toxic assets from banks, as well as unconditional authority and freedom from judicial review. Many economists and commentators suspected that the purpose was to overpay for those assets and thereby take the problem off the banks’ hands – indeed, that is the only way that buying toxic assets would have helped anything. Perhaps because there was no way to make such a blatant subsidy politically acceptable, that approach was shelved.
In any case, after the TARP was passed on October 3, 2008, it was quickly overtaken by events. First the UK announced a bank recapitalization program; then, on October 13, it was joined by every major European country, most of which also announced loan guarantees for their banks. On October 14, the US followed suit by using TARP to fund injections of capital into banks, as well as unlimited deposit insurance (for non-interest-bearing accounts), and guarantees of new senior debt.
The overall US policy response to the crisis did well in terms of preventing spending from collapsing. Monetary policy responded quickly and appropriately. After some initial and unfortunate hesitation on the fiscal front, the stimulus of 2009 helped to keep total domestic spending relatively buoyant, despite the contraction in credit and large increase in unemployment. This was in the face of a massive global financial shock – arguably the largest the world has ever seen – and the consequences, in terms of persistently high unemployment, remain severe. But it could have been much worse.
There is no question that passing the TARP was an essential element in restoring confidence. In some countries, the government has the authority to provide fiscal resources directly to the banking system on a huge scale, but in the United States this requires congressional approval. In other countries, foreign loans can be used to bridge any shortfall in domestic financing for the banking system, but the U.S. is too large to ever contemplate borrowing from the IMF or anyone else.
But if any country provides unlimited government support for its financial system, while not implementing orderly bankruptcy-type procedures for insolvent large institutions, and refusing to take on serious governance reform and downsizing for major troubled banks, it would be castigated by the United States and come under pressure from the IMF.
At the heart of every crisis is a political problem – powerful people, and the firms they control, have gotten out of hand. Unless this is dealt with as part of the stabilization program, all the government has done is provide an unconditional bailout. That may be consistent with a short-term recovery, but it creates major problems for the sustainability of the recovery and for the medium-term. Serious countries do not do this.
Seen in this context, TARP has been badly mismanaged. In its initial implementation, the signals were mixed – particularly as the Bush administration sought to provide support to essentially insolvent banks without taking them over. Standard FDIC-type procedures for failed institutions, which are best practice internationally, were applied to small- and medium-banks, but studiously avoided for large banks. As a result, there was a great deal of confusion in financial markets about what exactly was the Bush/Paulson policy that lay behind various ad hoc deals.
The Obama administration, after some initial hesitation, used “stress tests” to signal unconditional support for the largest financial institutions. By determining officially that these firms did not lack capital – on a forward looking basis – the administration effectively communicated that it was pursuing a strategy of “regulatory forbearance” (much as the US did after the Latin American debt crisis of 1982). The existence of TARP, in that context, made the approach credible – but the availability of unconditional loans from the Federal Reserve remains the bedrock of the strategy.
The downside scenario in the stress tests was overly optimistic, with regard to credit losses in real estate (residential and commercial), credit cards, auto loans, and in terms of the assumed time path for unemployment. As a result, our largest banks remain undercapitalized, given the likely trajectory of the US and global economy. This is a serious impediment to a sustained rebound in the real economy – already reflected in continued tight credit for small- and medium-sized business.
Even more problematic is the underlying incentive to take excessive risk in the financial sector. With downside limited by generous government guarantees of various kinds, the head of financial stability at the Bank of England bluntly characterizes our repeated boom-bailout-bust cycle as a “doom loop.”
The implementation of TARP exacerbated the perception (and the reality) that some financial institutions are “Too Big to Fail.” This lowers their funding costs, enabling them to borrow more and to take more risk. The consequences appear in your tax bill and your job prospects.
By Simon Johnson
An edited version of this post previously appeared on the NYT.com’s Economix blog and is used here with permission. If you would like to reproduce the entire post, please ask the New York Times.
The Baseline Scenario 
FDIC chairman Sheila Bair says TARP caused “..The horrible public outcry — it’s had a terrible, terrible impact on public attitudes towards the financial systems, towards the regulatory community. “
http://blogs.wsj.com/economics/2009/11/13/in-retrospect-bair-says-tarp-investments-in-banks-not-a-good-idea
CNBC this AM roundly criticized Obama’s $750bl stimulus bill as a failure. Curiously they never mentioned Bush’s $700Bl TARP or the FED’s trillions in bailout money for Wall Street.
Is there a class bias here? Just wondering?
Although system has stabilized, waht will be the effect of the coming CRE loan problems that are mainly held by smaller financial institutions?
“Socialism for the rich, capitalism for the poor.”
I’ll tell you what it did. It virtually eliminated any chance of this administration obtaining a second term easily if at all. In addition it has convinced the majority of Americans that they garner no benefits from the economic system unlike those at the APEX of capitalism.
My guess is that in the future any government and/or business proposal to further American competitiveness vis-a-vis the economy will be met with tsunami of disdain from the American public. Why should the public buy into it? They retrieve no benefits when the economy improves but suffer all the consequences when it declines. Might as well scuttle it for everybody. If you are going to the electric chair, you might as well have a CEO sitting on your lap to share the experience.
I wonder if Mr. Johnson and others will urge Congress to restore Glass-Steagall, strong regulation/banning of derivatives, and bankruptcy workout for large financial organzations.
Team Obama has been in office for 10 months. In the public mind, Team Obama now owns TARP. I dared listen to talk radio this morning (depressing), and it’s become obvious that the general public has forgotten that it was Paulson who pushed TARP through under GWB.
But I don’t blame the general public, because they’re right. In every speech (from the Inauguration on), and in every appointment decision (Geithner, Summers, etc…) Team Obama has deliberately thrown its hat into the ring with TARP, declared vociferously its support for the “credit channel hypothesis” as the source of all problems, hired the same people, and failed to respond.
This, in combination with severe tactical errors at every step, has destroyed any chance of implementing the infrastructural transformation the country desperately needs. Team Obama is doing everything within their power to prove their critics correct.
Curiously they never mentioned Bush’s $700Bl TARP
””””””””’
If they would of mentioned it, they would of showed a video of Obama, after he was elected, throwing his full support behind TARP. This isn;t a R vs. D issue, it is simply class warfare
I remain puzzled by all this noise over TARP. TARP has always been chump change; it is engorgement of the Fed balance sheet on God only knows what that remains the real threat to what remains of democracy and what remains of the middle class. There is free money for the banks and no money for anyone else. The Fed has forced every citizen to become a speculator. Of course, this dovetails nicely with the collapse of employment. People now have considerably more free time for digesting Wall Street misinformation.
Incidentally, how do those guarantees of senior bank debt figure in computing TARP spending? I suppose guarantees simply don’t count, right?
It wasn’t ever worth “restoring confidence” in a system which is unsustainable, anti-democratic, and predatory.
And it’s not a matter of “it could have been much worse”. It will be much worse when the next crash comes. That crash will probably be the final one, and at that point our having wasted time we’ll never get back and what little real wealth we as a society had left propping up a handful of criminals instead of recovering and renewing our country, will come back to haunt and harrow us in a vicious multiplier.
As for the so-called “lagging indicators” (such nondescript terms for such massive misery), the whole concept is a fraud since those jobs are NEVER coming back. Not under this system.
The plan is very simple: as Peak Oil and resource depletion restore civilization to its normal technological level, the power elites also want to restore feudal social and political conditions. That’s what they intend to do and that’s what they’re doing. Look at any piece of evidence.
The people would have been much better off to undergo whatever short-term hassles were involved in ridding ourselves of this parasite once and for all. Taleb called it: “blood, sweat, and tears”. And it wouldn’t even be that hard, compared to the travail we’re now in for.
We’re simply an addict who would rather keep shooting up, no matter how horrible it gets, and never mind that one day we shall definitely OD.
We’d rather do that than undergo a few days of withdrawal.
This is spot on. And as you say, perhaps it’s because they “hired the same people.”
Hmmm… Dean Baker of the organization that rides the coattails of engineered credibility of the real CEPR, Charles “Boom Boom” Calomiris from the Columbia Center for Global Rejigger, someone from a telemarketing company, and the number one flack from the company that pumped the hot air into our bubble (and our modern ambassador of the Zand Dynasty?)
Calomiris snippets:
– Prof. of financial institutions
– Prof. at School of Int’l and Public Affairs
– Member, Shadow Financial Regulatory Committee
– Member, Financial Economists Roundtable (keep “Roundtable” in mind for future reference)
– NBER
-Council on Foreign Relations (of course)
– Hoover Institution Task Force on Property Rights (This property rights business is always lurking in the background. Maybe Mr. Kwak can bring us up to speed on what property rights will look like globally in a decade or so?)
– American Enterprise Institute (just like the other guy) Project on Financial Deregulation. This sounds juicy… do get us up to speed on what this is all about)
– CoB of “Greater Atlantic Financial Corporation” of Washington, D.C. (There’s that word “Atlantic” again.) Maybe some enterprising young investigative financial journalist (I’m looking at you, T) can figure out what these guys are up to?
– Int’l Financial Institution Advisory Commission
– Yale, just like James!
– Rec’d support from NSF, World Bank, Japanese Govt, Herbert V. Prochnow Foundation, and Garn Institute of Finance.
– See link for his consulting gigs. Salient: 4 Fed Banks, Fed Board, World Bank, govt’s of Mexico, Argentina, japan, China, El Salvador, Brazil, Colombia. BofA, Goldman Sachs, Lloyds, AIG, UBS, Citicorp, Fidelity, Fleet, Credit Suisse
– Apparently he’s really into emerging markets and financial innovation. He won a prize for his teaching. Taught at World Bank & IMF. Taught business ethics (sure he did).
– Recent speaking engagements at European Central Bank, IMF, Kansas City Fed, Central Bank of Chile, Brazilian Bank Assoc., and “Cayman Business Outlook, among others”
– Was the Paul Montrone professor of something or other. http://www.muckety.com/Paul-M-Montrone/7220.muckety
There’s even a “Paul Montrone Seminar Series on Ethics” “…an intimate series of roundtables which focus on real-life ethical issues and the consequences of decisions.” You can’t make this stuff up.
http://www4.gsb.columbia.edu/leadership/speakerseries/montrone
Montrone is on board of the Metropolitan Opera, just like Ezra Zilkha (friend of the CoFR), Josef Ackermann (junior board), CEO of Deutsche Bank. What a coincidence.
Alex Pollock: Space Ship Enterprise Institute For Publicity Policy In The Lurch. (Got to have our Chicago in the mix… he was CEO of the FHLB of Chicago, is director of the Chicago Mercantile Exchange, etc.)
Simon, this looks worse than when you sat in on that SEC thing with Bernie Madoff!
(You’re not going to tell us what you do all day, are you. Just give us a hint… does it involve David Miliband?)
Looks. Like. We. Need. An. Ethics roundtable seminar quick!
Here it says of Calomiris: “He is Chairman of the Board of Greater Atlantic Financial Corporation, a publicly traded bank based in the Washington D.C. metropolitan area.”
Click to access CalomirisBIO2009.pdf
Why so vague, professor? It’s headquartered in Reston, Virginia.
http://www.gab.com/branch_locations.html
This is called aristocracy or maybe plutocracy.
Oops. Convene another ethics seminar… they forgot to include this in the short (hint: the one people read and the one used most commonly by journalists(?)) bio for Calomiris, at Columbia:
“Senior Research Fellow, Rimini Centre for Economic Analysis, University of Bologna, Italy, 2008-present”
“Member, Federation of American Scientists Committee on Systemic Risk, 1995-96” Classic.
“Consultant, 1989-91; Visiting Economist, 1988, Federal Reserve Bank of Chicago”
“Economist, International Monetary Fund, 1981” (Just like Simon!)
http://www.aei.org/scholar/9
They do note that he is currently the “Henry Kaufman Professor of Financial Institutions,” but sadly they don’t tell us about Henry Kaufman:
“He was on the Board of Directors of the now defunct Lehman Brothers where he served as chairman of the Finance and Risk Committee prior to the firm’s bankruptcy. On March 19, 2009, Kaufman was named as a defendant in a lawsuit launched by New Jersey governor Jon Corzine on behalf of the state of New Jersey alleging fraud and misrepresentation associated with securities offerings undertaken by Lehman Brothers immediately prior to the firm’s bankruptcy. The suit seeks compensatory damages of $118 million in addition to punitive damages.[citation needed]
Dr. Kaufman is a recipient of The International Center in New York’s “Award of Excellence”
http://en.wikipedia.org/wiki/Henry_Kaufman
What will be the catalytic economic or political “spark” to decisively re-set the playing field ?
Haven’t we heard from colamari before? Something fishy about this!
Something akin to Dred Scott.
I resisted that :) But thank you.
Exactly. Which is why calling out CNBC for only showing the Dem side is stupid and simplistic to the story of what’s going on. By framing it as only a Dem issue, they seem to be advocating for the Rep. side for some reason, even though both sides should be called out.
Look at the facts as best we can figure them out as they stood at the beginning of October 2008. First what was the cash flow situation? That is apart from accounting treatments. Valuation reserves themselves are non cash entires. Were the financial institutions bleeding from deposit losses and inability to secure financing to replace non retail debt that was maturing? Too big to fail is an oxymoron under dire cash flow losses in a banking institution.
It was quite obvious to me that fear was causing huge cash flow drains and were not only bringing down those that failed but very likely a large number of other senior finance sector firms as well. In a number of ways we saw a replay of the Panic of 1907. After all, mutual funds are not all that different from the Trust Companies of 1907.
What was required was stabilization investment and TARP provided the funds and impetus to calm the panic.
Everyone wants to be hard nosed but few present a methodology. Here is a nasty one. All the big banks are seized. All withdrawl’s are frozen over an exception amount. The equity holders are entirely out. The non retail lenders lose a heavy part of their loans and get stock in the reorganized institution. The depositors lose a piece too! Both now own the bank. Let’s be even more hard nosed and the recapitalization winds up with a four to one leverage over revalued assets. But none of what I suggest provides funds to cover fleeing lenders to the institution. What happens when the withdrawl freeze ends?
Where would the financial system be had the “right thing” been done. The ” right thing” being doing elective surgery before treating a stroke.
Time and funds were of the extreme essence. Nothing else would work in the time frame under the circumstances.
Remember all the talk about seizing the banks? Rarely was a thought out methodology presented. Besides, the top elites themselves were obviously personally terrified.
A wee correction to my post above. I was referring to money market funds above, of course.
I have lived through a corporate near collapse and was a part of the group that staved off bankruptcy caused by a sudden change. The mental process of being shocked and dismayed separates those that can instantly and absolutely change views and direction from those that are ineffective at adapting to survive. It is this aspect of the financial crisis that has not been explored very much.
In the case of the US financial and political system the lack of procedures to quickly head off a sudden adverse change seem completely lacking from long term ideological infighting of elite factions and the nation as a whole.
We had a very close call. I doubt the system could survive another sudden shock of the magnitude of fall and winter 2009 crisis.
Professor Johnson must really have some insider experiences about the US elite players reaction and conduct during the crisis.
Great point statsguy… Obama guaranteed he’d be the morph of Herbert Hoover by not nationalizing and breaking up the banksters.
No, its economic Feudalism. What TARP has done is required the SERFs (you and me) to pay a FEALTY (our tax dollars) to the new LORDS, as a yearly portion of whatever we can “till from our lease-holds”. We would all be speculators if we owned a piece of the equity, so that if the LORDS made money, we, the taxpayer serfs, would get an in-kind percentage. But that’s not the deal Geithner made – Treasury gave them the money and let the banksters keep 100%. The public has no “stake”. In essence, what has happened is that the banksters went broke at the roulette table, so we good serf-taxpayers bought them a bunch of chips so they could keep gambling. Never mind the serf-taxpayers can’t share in the spoils, if any… The good news is, if we serfs have any money left at the end of the year, we can eat it.
Professor, the use of TARP funds in this manner was a classic “bait and switch” – it’s FRAUD! It’s criminal! I suggest you have everyone involved ARRESTED and jailed for contempt of congress. Remember Paulson asking for immunity from his actions? Now what kind of honest man needs that? Remember Paulson taking congress into the back room and telling them that if they didn’t agree to his demands they would shut down the banking system come Monday morning? Only a blackmailer does that.
With the TARP, it appears, as it always has, that the financial community, specifically the TBTF group of nine or ten, believes in Machiavellian ethics (smethics bedamned they would say) such that the little guy will always lose in capitalism (American style), and the big guys will always win. It’s like financial reform is what we know about enacting any reform legislation and has been said many times, you can pass laws, but will never legislate morality.
TARP is just a very small part of that migration of ethical actions toward the bottom of Dante’s inferno. Sad, but expected. Why is it that human beings find immorality so appealing, once they get a taste of the benefits of corrosive things, like great wealth or great power? It’s just a part of living in a very sophisticated jungle.
Nice that guys like you, Simon,(and don’t get me wrong, I am a great admirer and supporter) can sit in their academic thrones and pontificate to those who will not do anything to make your vision of reality come to fruition. But, they like to hear from you, so that they can say that all things have been considered before stabbing all of us in the back.