TARP: What Has Happened So Far and What Will Happen Next?
June 2, 2009
The Troubled Asset Relief Program ("TARP"), created by the Emergency Economic Stabilization Act of 2008, was originally intended to aid bank balance sheets by authorizing the government to purchase illiquid and difficult to value assets from banks, such as collaterized debt obligations. Trading of these assets had virtually stopped. Without a flowing market, banks could not easily value the assets. Because banks could not clear these assets off their balance sheets, banks were stuck with depreciating assets (which hurt their balance sheets) plus they needed to value those assets under "mark to market" accounting rules (which hurt their balance sheets). With impaired capital positions and unable to generate cash by selling bundled loans, significantly fewer new loans started coming down the pipeline. TARP was originally intended to relieve burdens from banks' balance sheets and jump start the market.
Surprisingly, TARP quickly evolved into a means by which the government could provide capital injections into banks. The goal of both TARP strategies (direct capital injection and removing troubled assets) is to put banks in a better position to lend. TARP money is the coal that will be put into the furnace to make steam to drive the financial market's gears.
Former Treasury Secretary Paulson's decision to use TARP funds for direct capital injections created problems of its own. In arguing for passage of TARP, Secretary Paulson said that failure of the government to buy bad assets immediately would result in catastrophe. Yet after establishing TARP on that justification, the government proceeded to do something else with the money. The government may have changed its course for multiple reasons; regardless of the reason the change of direction robbed the TARP program of some of its confidence-building raison d'etre and instead suggested that the government was making things up as it went along. To add to that sentiment, on December 19, 2008, then President Bush issued an executive order stating that TARP funds could be used for any program the President deems necessary to avert the financial crisis. So TARP funds are now being used for the auto industry and every other industry is lining up for relief. The first half of the $700 billion in TARP funds was paid out before most government overseers had even been hired, let alone devised a plan for oversight.
Unless one argues that the situation would be worse were it not for TARP, thus far TARP has not succeeded in its original goal of jump starting lending. The Wall Street Journal reported on January 20, 2009 that lending by 10 of the 13 largest TARP-fund recipient banks actually decreased by 1.4% in the fourth quarter of 2008. Unfortunately, banks are using TARP money to buy each other and position for the future rather than to alleviate current problems. Bank of America bought Merrill Lynch, PNC bought National City, Citigroup fought hard to buy Wachovia (when weeks later Citigroup was forced to sell Smith Barney to raise cash), Wells Fargo did buy Wachovia, and Chase bought Bear Stearns, Countrywide and Washington Mutual. On the other hand, one could easily argue that the low point of 2008, and the largest shock to the market, was the failure of Lehman Brothers. Perhaps the recent TARP-fueled buyout spree prevented another major collapse like Lehman Brothers.
An alumnus of the University of Illinois named Neel Kashkari is at the helm of the newly created Office Of Financial Stability, which was created to oversee TARP. Mr. Kashkari is organizing his newly created team into seven administrative units:
- Mortgage Backed Security purchase program;
- Whole loan purchase program;
- Insurance program (because perhaps the government can insure troubled assets rather than buy them outright);
- Equity purchase program;
- homeownership preservation (because the collapse of the residential market is the root of the problem and many believe that the economy will not pull out of recession until the residential market stabilizes)
- executive compensation (because Treasury does not want headlines showing taxpayer money going to CEO pay packages); and
- compliance and oversight.
We should expect more oversight of the use of TARP funds. On February 10, 2009, new Treasury Secretary Timothy Geithner proposed that the second half of the TARP funds be used for foreclosure relief ($50 billion), a private-public toxic asset-removal partnership ($50 billion), a plan to restart markets for securities backed by consumer loans ($100 billion) and more bank capital ($120 billion). Financial markets immediately criticized Secretary Geithner's plan as inadequately funded.
The government will likely use TARP funds for TARP's original intent: purchasing troubled financial assets. What price should the government pay for these troubled assets? If the government offers too little, banks will not be motivated to sell. If a bank sells for a low price, all the other banks will dislike the selling bank because of mark to market; everyone else must value comparable assets on their books at that low price. If the government offers too much, the government is arguably giving away taxpayer money and rewarding institutions who made bad business decisions. Furthermore, the country cannot afford to overpay, voters will be displeased if elected officials give away the store; and many would say that it is un-American for the government to step in to cover someone's bad bet. So we need a Goldilocks solution.
Many people have asked how TARP protects taxpayers. Critics have argued that TARP amounts to a handout to politically-connected large businesses, while smaller businesses are being left to fend for themselves during these difficult times. To the government's credit, the government is making an effort to protect taxpayers. Thus far, the government on occasion has taken an equity stake in companies receiving TARP funds, such as taking preferred stock or non-voting warrants, which give the government the right to purchase shares, thereby putting the government in a position to share in potential upside of the transaction. The government has taken steps to limit executive compensation for TARP fund recipients. Stung by bad press after insurer AIG held a lavish corporate event immediately after receiving bailout money, the government recently talked Citigroup out of purchasing a new corporate jet. The government also has proclaimed a goal of "recoupment." The Treasury is supposed to come up with a plan to recoup losses incurred via its TARP investments. Notably, the government will not necessarily seek to recoup its losses only from the institutions that receive TARP funds. For example, the government may impose a fee on the entire financial industry, much like the FDIC charges a premium for its insurance. The government also intends to protect taxpayers through disclosure and transparency (though the rules are still being developed) and through judicial review. Originally, Treasury asked for unfettered discretion to spend the money. Congress did not give Treasury that wide discretion.
The continuing evolution of TARP will be interesting to watch. In 2009, commercial real estate may be next in line for government assistance, whether through government purchase of existing loans, the government making direct loans to permit refinancing, or by insuring loans made by others. One thing is for sure, the new administration will not sit idle.