Simon Johnson: TARP was a missed opportunity

TARP goes to the legal graveyard this Sunday. Looking back, Simon Johnson says some sort of injection into the American banking system was necessary. So, in a basic sense TARP or some Swedish equivalent would have been necessary to avoid financial Armageddon.

I would agree with that, my preference being bankruptcy followed by seizure, (subordinated) bondholder haircuts, manager dismissal, recapitalization and re-privatization for the few large banks which were truly bankrupt. That’s not what we got, of course. We got something much more favourable to those institutions. Johnson says:

[T]hree serious mistakes were made in the implementation of TARP.

First, there was no need to be so excessively generous to the financial executives (and their boards) at the institutions that had to be saved. In part this generosity was due to insufficient safeguards in the legislation (a point Ken Feinberg makes persuasively with regard to compensation), but mostly this was a choice insisted upon by key people in President Obama’s economic team.

The bankers were not even embarrassed by what happened – this was extraordinary, probably unprecedented and completely at odds with what the very same administration officials had advocated when their advice (and money from the United States and the International Monetary Fund) was needed by other countries (we cover this in detail in Chapter 2 of 13 Bankers). The historical record on this point is not in question.)

Second and closely related, the Obama administration missed the opportunity to change the structure and the incentives of Wall Street when it had the chance, at the very beginning of 2009. The Treasury line, then and now, was that the “essential functions” of the financial system had to be preserved, and this meant no one could be “punished.”

This is again a complete divergence from best practice, for example as recommended by the I.M.F. (with United States backing) in many situations over the last 50 years. The issue is not punishment or retribution; it is responsibility – and it provides incentives to be careful in the future. (Again, for more technical details, see 13 Bankers.)

Failing to seize an opportunity for reform is not sophisticated or the work of adults (as some members of the Obama administration self-servingly assert); it was simply a political mistake – and terrible economics. The idea that some banks were too big to fail arguably played a role in the run up to 2007-8; we can have that debate. But the notion that our biggest six banks are untouchable today is uncontroversial.

Their creditors know this, so these banks can borrow more cheaply than their smaller competitors, they can become larger relative to the economy, and if you doubt the risks that this poses, just look at the situation today in Ireland.

Third, by the time the administration put forward its financial reform ideas, the big banks were back on their feet – and ready to throw huge numbers of lobbyists and unlimited cash into the fight to preserve their right to take inordinate risk and to mismanage their way into disaster.

The administration’s proposals were weak to start with and were diluted by the House of Representatives (with a very few holding actions, most notably by Representative Paul Kanjorski).

Johnson doesn’t name names, so I will: Tim Geithner. It is clear The Treasury Secretary is the person Professor Johnson refers to throughout.

I should also add that Tim Geithner urged AIG to withhold information and Tim Geithner has been the one pushing the protectionist line against the EU and China throughout from within the Administration. Moreover, Tim Geithner was warned by Enron-slayer Jim Chanos of the impending financial debacle but chose to ignore it because he was "not a regulator" as head of the New York Fed.

And Tim Geithner is the last man standing of the senior members of the Obama economic team. What does that tell you?

TARP Is Gone – But May Soon Be Back.

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