Despite the propaganda machine’s attempts to label TARP a success, it was not

A friend who is a well-connected Washington insider sent me the text of a piece by Ben Smith on how successful TARP was late last night, asking:

This is the first mention I’ve seen in the more mainstream media. Anybody raise this in the financial press?

Here are the crucial bits of the piece:

The Obama administration this week will mark the second anniversary of the collapse of Lehman Brothers and the ensuing Wall Street meltdown with an ironic bit of bipartisanship: letters of thanks to some of the congressional Republicans who helped fashion the government’s response in fall 2008.

No one in the Treasury Department is expecting any appreciation from House Minority Leader John Boehner, Sen. Minority Leader Mitch McConnell or former House Minority Whip Roy Blunt for the gesture. In a reversal of the old adage quoted by President John F. Kennedy, that victory has a thousand fathers, there’s hardly a Republican who wants to be associated with perhaps the most successful and least popular American economic policy in the past decade: TARP, or as it is more generally known, the bank bailout.

The Troubled Asset Relief Program is widely viewed as the original sin of the Obama administration — though it was put together under President George W. Bush and succeeded far beyond expectations. It’s widely seen as the tipping point for disgust with elites and insiders of all kinds — though it could also be seen as those insiders’ finest moment, a successful attempt to at least partially fix their own mistakes.

Rammed through Congress in the final months of the Bush administration by a political and financial establishment that felt it had looked into the abyss, TARP had the support of not just President Barack Obama but also his likely foes in 2012, such as former Govs. Mitt Romney and Sarah Palin. But it has been only sporadically defended, or even explained, by leaders of both parties who have shown decidedly little courage of their convictions.

“It’s become demonized on the left and the right by screamers — Glenn Beck and Rachel Maddow — who have no interest in the facts; they’re just interested in hyperbolizing and generating attention,” lamented New Hampshire Sen. Judd Gregg, a key player in guiding the measure through the upper chamber and one of the few Republicans willing to talk about TARP in positive terms.

Perhaps it’s not a coincidence that Gregg is retiring from the Senate at the end of the year — or that hardly anyone from either party is joining him in praising TARP.

While Obama last week made reference to having narrowly avoided another Depression, he and other leaders have generally avoided trying to explain that mechanism, in favor of trying to change the subject.

All that, despite a broad consensus of economists who think things would have been worse without the bank rescue — and perhaps far worse: In one simple example, American workers’ paychecks might well not have arrived. Think bread lines — and cat food.

“The TARP is probably the most effective large-scale government program that the public has vehemently decided was a bad idea and therefore has only the most tepid political defenders,” said the Brookings Institution’s Douglas Elliott. “Unfortunately, the right thing to do for the public just sounds so wrong to Main Street in this case.”

My short phone mail answer back was that:

TARP was not a success. That’s just propaganda. Banks are still under capitalized on a mark to market basis. You need to have stripped the bad actors of their seat at the table, given haircuts to bond holders and taken control of any bankrupt institutions instead of pumping them full of taxpayer money.

My answer was short because I soon went to bed. Before I did so, I asked a few other friends including Marshall Auerback and fellow blogger Yves Q. Smith for their take to quickly e-mail my friend back with a more substantive reply than I could give.

Here’s what Marshall said:

Well, first of all, it was completely unnecessary.  The same goals could have been achieved via regulatory forbearance.  You could say that this would place the banks further behind in their efforts to be ready for Basel III, but that’s a joke anyway. Inadequate capital didn’t cause the financial crisis.  Lying and corruption did. 

Nothing in Basel III addresses the fundamental perverse incentives that cause recurrent, intensifying financial crises. The Enron era “control frauds” should have taught us that we can have financial crises without bank failures. You don’t need to bulldoze the banks.  You can keep them functional via government control (i.e. the FDIC) and get rid of the corrupt management before you undertake anything else.  We’ve kept all of the liars in power or paid them off with massive golden handshakes.  At least with Enron, Jeffrey Skilling and Andy Fastow went to jail (although the way things are going, maybe Skilling will get released).

That aside, why doesn’t anybody mention the fact that the banks have basically been able to engage in perpetual backdoor bailouts via Fannie and Freddie? Because of the intense Congressional pushback on TARP, Geithner and Summers (who has a history of doing end-arounds Congress – see Mexico 1995), decided to continue the bailouts by using the GSEs as a dumping ground for the toxic junk?

And Ben Smith seems to forget that Congress adopted unprincipled accounting principles that permit banks to lie about asset values in order to hide their massive losses on loans and investments, which allowed them to raise the capital.  Well, I guess you can say that this is good, but it basically entrenches lying as a legitimate tool for economic policy. When we lie about accounting and leave zombie banks in the hands of those that looted them and caused trillions of dollars of losses we eviscerate our integrity and our efforts at economic recovery. 

And lying does not work very well – look at Japan. It prevents markets from clearing, it leaves failed banks under the control of failed bankers, and it leaves banks twisting slowly in the wind and unable and unwilling to fund the recovery. I think it is a symptom of how badly we have fallen that journalists are willing to attempt to justify an abomination like TARP.

I agree with Marshall except I would add that regulatory forbearance to systemic issues leads to zombie institutions; you need to act quickly. This is historical revisionism that relies on two factors.

First, it is easier to construct a historical narrative for posterity from events that actually took place than one from events that did not. We did have TARP and we did recover from the depths of panic. But, in economics there is a concept called opportunity cost which comes to mind.

Opportunity cost is the cost related to the next-best choice available to someone who has picked between several mutually exclusive choices. It is a key concept in economics. It has been described as expressing "the basic relationship between scarcity and choice." The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs.

The opportunity costs in this situation are the ones both Marshall and I spoke of. But those are costs that remain hidden from view because this was the road not taken and therefore, it is difficult to construct a narrative from them. What would have transpired had we prosecuted control frauds in the financial sector or had we seized bankrupt larger institutions is unknown. This is the approach the United States took after the S&L crisis but have not taken today.

Second, TARP and the associated bailouts relied on hidden costs in the form of zero interest rates and a steep yield curve, borrowing for cheap rates against less than stellar collateral, and regulatory forbearance as many institutions are severely undercapitalized or bankrupt on a mark-to-market basis.

I should also point out that all of these "the bailout was successful" stories rely on dismissing the time value of money – a basic economic concept which says money today is more valuable than money years later. If I give up $10 today and get $10 back many years later, isn’t that relevant?

In my view, the Ben Smith types of analyses are designed to promote a narrative solely for political purposes. Earlier this year in April or May there was the same kind of attempt being made about the economy. The thinking was that the sustainability of recovery was increasing, so it was a good time to begin a narrative based on the economy for the mid-term elections. Unfortunately, that narrative has been sidetracked by events, as the economy has hit a rough patch. Therefore, increasingly, you will see attempts to paint the bank bailouts in a favourable light – despite the bipartisan loathing for them in the general public.

I don’t know what immediate purpose this kind of revisionism serves because it is not likely to be helpful in the mid-terms given how mad Americans are about the bailouts. Moreover, I do think it is too early to label TARP a success because, despite regulatory forbearance, another downturn would expose the banks to serious losses.

In the end, I am left with the sense that this is how history is made. It pays to fashion a history early. The simplification of all historical narratives means whitewashing events of the intricacies of competing contemporary accounts. Thus, if the US economy recovers, I expect historians will look back on TARP as an unmitigated success – largely due to simplified contemporary accounts like Ben Smith’s; Opportunity costs will become irrelevant. If we double dip on the other hand, this narrative will be for nought anyway.


*Also go to Naked Capitalism to see Marshall’s more fleshed out version of the email he sent.

  1. Terry says

    Hi Edward,

    I know this is off subject but the recent move by Japan to devaluate their currency has set off some protest in other Aisian Nations. I wonder if a currency war is upon us and how this will manifest in the US and World capital markets?

    There are a lot of moving part in the present economy and I suspect that the main component will be a “currecny war”



    1. Edward Harrison says

      I think the competitive currency devaluations are on and that means heightened trade tensions as well. The unilateral Japanese move was a significant salvo in this as Japan is the G-7 country with the lowest inflation rates – and I can believe their currency appreciation has to do with this. As other countries and zones hit stall speed, the desire to use the exchange rate safety valve will grow.

    2. Edward Harrison says

      P.S. – People like Barry Eichengreen think this is a good thing. Read here:

      I think it increases trade friction and the potential for negative outcomes unless addressed correctly i.e. through a coordinated approach. Unilateralism leads to trade wars.

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