The New York Times has a story about how the government is making a profit on its TARP investments: “The profits, collected from eight of the biggest banks that have fully repaid their obligations to the government, come to about $4 billion, or the equivalent of about 15 percent annually.” The article has plenty of appropriate caveats – the total bailout went well beyond TARP, the Citigroup and Bank of America investments and asset guarantees are still out there, we still have a ton of money sunk into AIG – but the fact remains that some of the investments are getting paid back, with interest and with a modest bonus from the warrants issued to Treasury.
There is also an ongoing debate about whether Treasury is getting full value for its warrants, which we’ve covered previously, but let’s leave that aside for now. The bigger question, I think, is this: Did Treasury get a fair deal for its investments at the peak of the crisis?
At the time I said no, and I still think the answer is no. The most important principle to bear in mind is that how a decision turns out has no effect on whether it was a good decision to begin with. In honor of the changing seasons, imagine it’s the first quarter of a football game and you have fourth-and-one at the other team’s 40-yard line. Anyone who studies football statistics will say you should go for it; it’s not even close. (Some people have run the numbers and said that a football team should never – that’s right, never – kick a punt.) If the offense fails to make it, the announcer, and the commentators the next day, will all say that it was a bad decision. That’s completely wrong. It was a good decision; it just didn’t work out.
The same holds true for investing. In this case, Treasury bought some securities from the banks and underpaid significantly, according to both the Congressional Oversight Panel and the Congressional Budget Office. The difference between the amount paid for the securities and their fair value at the time was a subsidy to the banks. What happened here was that Treasury made what was in strictly financial terms a bad investment and then got bailed out by later events. Or, you might say, it bailed itself out by undertaking a series of bank-friendly policies that had the effect of bolstering banks’ share prices and making it easier for them to raise capital. Which raises a whole other question: whether Treasury was counting on their ability to themselves out, and thereby avoid any eventual criticism for losing money on the deal – but which, at the same time, gave them the incentive to do what was best for bank shareholders.
By James Kwak
36 thoughts on “Paulson Was Right (?)”
bought some securities from the banks and underpaid significantly
You mean overpaid?
Your analysis of the Treasury decision is pretty good. As we know in the game of poker, a person can make a mathematically correct decision and have the outcome turn out badly. Another person might make a long call and hit one of his few outs to take down the pot, but that is not ex post justification for an otherwise stupid decision.
In decision making under uncertainty, you should generally choose the action which maximizes the expected payoff. However, one must also consider the variance of the payoff and one’s own level of risk aversion. Then there are separate concepts of loss aversion, risk of ruin, etc. to consider.
Using your football analogy, we all know a team with little time and a lot of distance to go will (and should) throw a Hail Mary pass. Why not throw a Hail Mary pass every down? It’s the same as the decision making process of whether to punt. Of course, a team which never punted and always threw a Hail Mary would prompt a change of strategy on the other side.
In this financial game, the Treasury was willing to take high risks because the consequences of a cascading failure of the banking system were too terrible to contemplate. It’s endless supply of money (at the expense of inflation) eliminated the risk of ruin. With the Bush Administration on its way out, there was no political loss aversion.
Sometimes you have to call the risky play, draw to the gutshot straight, roll the hard six, or lend money to help the banking system without a certain expectation of adequate returns.
“What happened here was that Treasury made what was in strictly financial terms a bad investment and then got bailed out by later events. Or, you might say, it bailed itself out by undertaking a series of bank-friendly policies that had the effect of bolstering banks’ share prices and making it easier for them to raise capital.”
How does this differ from a speculative bubble created by insider trading?
“The most important principle to bear in mind is that how a decision turns out has no effect on whether it was a good decision to begin with.”
Please tell Dick Cheney that!
Here’s Yves on the question over at naked capitalism:
Thank god for Yves. How many unapologetic, uncritical and misleading government-mouthpiece articles will it take before people stop reading the NYT?
“How many unapologetic, uncritical and misleading government-mouthpiece articles will it take before people stop reading the NYT?”
… And stop voting.
and where does the approximately $15B we blew-off to Chrysler come into this “profit” equation?
I doubt the gov’t’s investment in the banks was thought out to the last semicolon; there was no doubt an intended subsidy and that has to be figured into the decision. I don’t think the gov’t’s intention was to be a sharp dealer. You could use the same analysis regarding Buffet’s coincident investments. For a while he too appeared to have overpaid. For his part too, I seriously doubt that he intended any subsidy, or to rescue GE or Goldman.
Notwithstanding, it would seem to suggest that Paulson was correct for these banks, no? I understand the logic of why it was a bad investment and not a fair deal; that would be different as to whether or not there is a profit.
Is Goldman’s PR department contributing press releases to the Treasury department? This sounds like a load of PR BS to me.
When people talk about the “investment” made by the US government in these investment banking firms, what exactly are they talking about? The TARP loans that have been paid back?
The AIG bailout was extremely beneficial to firms like Goldman Sachs. Is the $12.8 billion in AIG funds received by Goldman courtesy of the feds counted in this “investment?” What is the fed’s return on the billions it invested in bailing out AIG?
What about all the low interest loans the investment banks can now access as a result of becoming bank holding companies? Has that helped the economy get back on track? With talk of a jobless recovery, it seems that the only companies that benefiting from the access to all that federal money are the investment banks. If I’m wrong, please feel free to show me how the other economy – the one outside of Wall Street – has been strengthened by these actions. That the number of job losses is not as bad as last month is not an acceptable answer.
I’ll bet if you add up all the various ways the feds have supported the financial sector in the last year, the returns are nowhere close to 15 percent. The $1.4 billion the feds have seen from Goldman doesn’t even remotely come close to the $11 billion in bonuses that Goldman is planning to pay out to its employees….
Focusing on the “profits” reaped by the feds in this transaction overlooks the fact that the investment banking sector exists today only because of the extraordinary support of the federal government in the last year.
Framing the debate in terms of the “profit” made for the feds as a result of their unprecedented action to save the financial firms moves us further away from any considerations of the moral hazard of such an action.
And it seems we’ve forgotten that the initial reason Paulson set up TARP was to clear the bank books of the toxic assets – (it’s the Troubled Asset Relief Program, remember?) blamed for clogging the system way back in 2008. Those same “troubled assets” remain on the books of those banks, which means the sector remains full of disease and toxicity.
“Or, you might say, it bailed itself out by undertaking a series of bank-friendly policies that had the effect of bolstering banks’ share prices and making it easier for them to raise capital. Which raises a whole other question: whether Treasury was counting on their ability to themselves out, and thereby avoid any eventual criticism for losing money on the deal – but which, at the same time, gave them the incentive to do what was best for bank shareholders.”
What you’ve added on as an afterthought seems very important to me and an essential part of any analysis of the price that the Treasury paid.
1) Suppose that market prices for the warrants are determined by supply and demand by traders who are uncertain about what the Treasury will do.
2) Suppose that the Treasury knows what it will do and that this causes it to value those securities more highly.
3) Now suppose that the Treasury pays what it feels the securities are worth, which is more than the market assessment. Why was this a bad call at the time?
Sometimes players are just given money to throw the game and it really doesn’t matter what strategy you decide to follow.
Here’s a horrible realization: it doesn’t matter how much we understand what’s really going on. Not a damn bit. (or at least that’s how I’m feeling for a fleeting moment)
you can’t have it both ways.
the banking system, as you and simon have argued, is in many ways an arm of the treasury and fed.
even so, there is a fundamental question that you are missing here.
the treasury bailed out the banks because it didn’t want to cut off that arm. cutting off that arm would have damaged the treasury / fed in their ability to intervene in stemming the collapse of the economy.
so you have to ask, and i don’t think you ask anywhere: how much were the other available options going to cost the treasury? you’re saying they overpaid, but compared to what?
I assume there is some real value that all of this is worth (the banks the loans the houses the investments) and there is a real way of estimating those real values, and so as they see it instead of creating a bubble they created a floor so all of this couldn’t be undervalued. that is my guess.
How are we doing with AIG?
when I read the article in the NYT I asked myself, if we are now supposed to feel grateful to the financial wizards for paying their debts the way any Joe SixPack has to?
I think a better way to put it is that the
Fed and the Treasury are vital arms of the banking and energy monopolies.
When you think of the war in Iraq as a strategy to increase the price of oil, it begins to make sense for the first (and only) time. Viewing it that way, Bush was correct to declare victory as soon as the Iraqi oil infrastructure was torched in the first forty days. That oil was kept safely in the ground and oil went from $20 to $140 per barrel, and even if it has now fallen to $75, the energy industry and its lenders are doing just fine.
I don’t think we can really expect our elected plutocracy to operate for the benefit of actual people. When and where in history has this ever happened? The joke under Communism was that the bosses pretended to pay the workers and the workers pretended to work. The joke under our system is that politicians pretend to represent the public interest and the voters pretend that it matters which side wins.
“Here’s a horrible realization: it doesn’t matter how much we understand what’s really going on. Not a damn bit.”
Like being executed, it’s only horrible the first time, Uncle Billy. And if it doesn’t matter what we understand of what’s going on, if we’re as powerless as you realize, then voting and elections carry all the meaning that did those in post-war Bulgaria. In such an environment the precision of Josef Stalin can be enlightening:
“The people who cast the votes don’t decide an election, the people who count the votes do.”
And there you have it, eh? :-)
Stalin sounds a lot like Henry Kissinger, who is still running around drooling on people.
Where did the profits come from? (the consumer)
How does that help the economy recover? (it doesn’t)
Do the Fed shareholders still get 6% of everything the Fed makes? (it’s good to be the King)
Of course we know there are losses “off balance sheet”.
It’s nice to be able to only put winners on the balance sheet — it makes everyone above average, doesn’t it?
More Bogus Bailout Reporting, Yves Smith —
While I’ll concede that drooling is indeed an issue with Kissinger, I’d suspect that, secretly, its more a question of incontinence. Just be careful if you’re in the same room with him and see him squint at any time.
Reminds me of poker. In any particular poker play, there is an calculable expected value. It can be positive or negative, but it exists regardless of the actual outcome. And the actual outcome is a result of chance.
The fact that you hit your gutshot straight on the river does not make it a good play.
Of course every tax payer should be happy with this very partial outcome… because of course it could be worse, they could even be losing when skimming the froth and the fat of the milk… On what is still out there, we still have no idea, perhaps blessedly, just as we do not have a clear idea where interest rates would be without all the quantitative easing made by the Fed.
And to understand but to be lonely in that understanding is also the worse that could happen to you, so let us pray at least for being kept fooled en masse.
A thing should be mentioned as well, even with all the money paid back along with a substantial bonus, the real result is banks’ customers (virtually all taxpayers) paying the money, which makes it (or part of it at least) an extra, though very indirect, tax
Let me get this straight: the taxpayer takes equity risk under incredible circumstances, gets bond returns, and celebrates? Talk about anchoring around zero…
Don’t be a party pooper.
Isn’t the analogy here rather with insurance than with poker?
The insurance analogy would run like this:
– Financial institutions bought insurance *while* their houses were burning
– Now that the risk of burning down has subsided, financial institutions are no longer willing to pay the insurance premium, because they know that next time the house is burning, the insurer will be willing to step in again, with a “temporary” insurance.
– The so called profit the government is making on its TARP investments is most surely lower than what financial institutions would have to pay under normal insurance conditions (otherwise, why would they be willing to pay back?)
“The bigger question, I think, is this: Did Treasury get a fair deal for its investments at the peak of the crisis?”
Unlike a prospective investor who has no pre-existing stake in a company and can walk away and put its money somewhere else if the prospective return is not great enough, the Treasury has a roughly 20% stake in the economy to begin with and thus has to measure the return on its investment in two ways: 1) the profits it will make if it invests vs 2) the losses it will sustain if it does nothing. That was the real investment calculus.
The other point missing from this thread is that the government is the only investor whose aftertax return is greater than its pretax return. That is, when the government sends money to money losing company X then, to the extent that company pays out that money for goods and services or in finance charges, the government recaptures the marginal tax rate times that money and does so pretty quickly. If X is money losing then there is no tax effect from the deductibility of those payouts. Those tax receipts have to be considered as part of the return to the Treasury, or alternatively perceived, the amount of lost tax receipts avoided does.
lets see. we have pumped about 2.3 trillion into the markets and taken on backstops of potentially 23 trillion according to neil bartofsky. so to be nice we have taken on potential laibilities of 20 trillion. we now made 4 billion. It does not sound like a winning proposition to me. I get it we keep spending more to prop up the worthless assets we bought, hide the amount we are spending to keep the asset inflated, then report that the asset has turned a profit!!! plese give me a break. My boss was telling me this, I laughed, and told him we spent 2.3 trillion so far to earn that profit, and it may just keep going!!!
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