Arnold Kling  

Was TARP Necessary?

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Simon Johnson writes,


There is no question that passing the TARP was the right thing to do. 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.

I watched over the Internet some of the hearing at which Johnson and others spoke. At one point, several speakers pointed out that in trying to suggest an alternate history without TARP, one has to assume some alternative. This leads me to think about the policies that have been followed and my proposed alternatives. These are alternatives that I proposed at the time.

1. Existing Mortgages and home owners.

Actual policy: attempts to implement loan modification programs

My policy: pay the moving expenses of homeowners who default on their mortgages. But do not interfere with the foreclosure process.

2. Mortgage Markets

Actual policy: keep Freddie Mac and Fannie Mae going, and we now have 90 percent of mortgage loans made by federal agencies.

My policy: Limit Freddie Mac and Fannie Mae to their existing oook of mortgage loans (I wrote this in September of 2008) and not allow them to purchase any new mortgages. Let banks take up the slack in mortgage lending.

3. AIG

Actual policy: creditors bailed out 100 percent.

My policy: Send in a "stern sheriff" to protect the liquid assets of AIG from creditors making "collateral calls." I was thinking of a government-suggested mediator, perhaps a former bankruptcy judge. If the parties did not like it, they could go to court. But my guess is that the parties would have preferred a mediated solution.

4. Big banks

Actual policy: bailouts of nearly all of them

My policy: Triage. Shut down the ones that have clearly failed, using FDIC procedures. Those that are clearly solvent should be allowed to proceed. Those that are neither clearly failed nor clearly solvent should be given forbearance, but with tight supervision to ensure that they do not use this forebearance to expand their risk-taking. Again, this was what I advocated in September of 2008.

Conclusion

Overall, the goals of actual policy were to try to achieve a much less painless outcome than what my policies were intended to achieve. In terms of goals, my policies were inferior in that sense.

But what about results? I am struck by the fact that even though banks seem to be doing well, taxpayer losses are going to be high and the recession has been quite severe. From the standpoint of the typical American, the results of the financial rescue policies represent what to me seems like a pretty low bar. Surely, alternative policies could have done better for the average American. I think mine would have.


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COMMENTS (7 to date)
Greg Ransom writes:

But the system isn't designed to produce good outcomes for average Americans, is it?

The system served those it is structured to serve.

And note well -- economists are a central part of the Fed / government / Wall Street complex that does well for Wall Street and the government, but not so much for the children
of average Americans.

wm13 writes:

'Send in a "stern sheriff" to protect the liquid assets of AIG from creditors making "collateral calls." '

What does that mean? Secured creditors are entitled to seize collateral. Indeed, to the extent that the financing is done in repo form, even bankruptcy does not prevent the seizure. Maybe Mr. Kling could flesh this out, or link to a place where he has done so previously.

Also I don't see why a hotly contested mediation lasting many months would be better than a bankruptcy, where the court has the usual judicial powers at its disposal. Anyway, it only takes a single party to force the matter into bankruptcy court.

Mike writes:

The issue is one of perspective. You nailed it in your post on Limousine v. Main Street America.

If you're inside the beltway or living in New York, of course the bailout was necessary. The question to ask is: For whom?

Based on the results, we can see clearly for whom the bailouts were necessary. Goldman Sachs will pay bigger-than-the-bubble-years bonuses. Meanwhile, many Americans won't be able to afford Christmas presents.

The bailouts worked. Again, though, the question is: For whom?

Dr. T writes:

"... My policy: Limit Freddie Mac and Fannie Mae to their existing oook of mortgage loans..."

What's truly weird is that the sentence with its typo reads better than the corrected sentence would read.

Tom West writes:

The bailouts worked. Again, though, the question is: For whom?

Well, in the "frighten the children" scenario, whose plausibility I lack the skills to determine, the bailouts worked for anyone employed by a firm that required an active line of credit to make payroll. i.e. almost all of them.

I have vague memories of the apocalypse scenario being 40-60% of companies failing to pay all their employees as the banks immediately withdraw all open LOC in a desperate attempt to keep themselves afloat as nobody differentiates between "good" and "bad" banks and withdraw all their money and capital, effectively killing them all.

And that would probably qualify as "end of the world" for the USA.

Personally, I don't think that such a scenario was likely, but I suspect it's a matter of paying lots to avoid a 1-2% chance of the apocalypse.

Jim writes:

As implemented it may be too early to pass judgment on whether TARP was the right thing to do. The foundational changes to the regulated banking system demanded by its spectacular failure have yet to come.

Perhaps they never will, in which case TARP will have been an utter failure the next time Wall St. collapses, mostly for the same reasons.

I am somewhat surprised that the crisis has not spawned more discussions on the foundational purpose of banking given that there is now so much evidence that trillions in capital on Wall St. are being wagered rather than invested in productivity and innovation, even to the risk of the whole economy.

CJ Smith writes:

Arnold said:
***
Actual policy: bailouts of nearly all of them

My policy: Triage. Shut down the ones that have clearly failed, using FDIC procedures. Those that are clearly solvent should be allowed to proceed. Those that are neither clearly failed nor clearly solvent should be given forbearance, but with tight supervision to ensure that they do not use this forebearance to expand their risk-taking. Again, this was what I advocated in September of 2008.
***

Here's a list of TARP fund recipients - hardly all the banks in the US:
http://bailout.uslaw.com/?page_id=353

Here’s a list of bank failures in the U.S., note the number and dollar volume for 2008 and 2009:
http://www.fdic.gov/bank/individual/failed/banklist.html

Here’s a list of banks that underwent stress testing by the Fed. Note that these banks comprised more than 50% of the total non-governmental assets in the U.S. financial system:
http://blogs.wsj.com/economics/2009/04/24/list-of-19-banks-undergoing-stress-tests/

Arnold, I am by no means a fan of the Fed or the banks, but your statements imply that:
1. no banks have suffered as a result of the past two years;
2. that government simply gave every single bank in the U.S. free money with no strings attached; and/or
3. that the Fed didn’t attempt some degree of triage (granted, not nearly enough).

I think you’ve crossed the line from political hyperbole into outright fabrication. A little balance and intellectual honesty, please?

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