As a student of Economics 101 at Columbia University, President Obama would have learned how even good outcomes in economic policy usually produce unwelcome side-effects. Herbert Hoover, one of Obama’s predecessors, once remarked: “Please find me a one-armed economist so we will not always hear, ‘On the other hand…’”
The shock success of TARP – the much-maligned, $700bn bank bail-out programme – has provided the president with a refresher course in Economics 101. The Troubled Asset Relief Programme is working out so much better than anybody dared to predict that its success has triggered a squabble on Capitol Hill about how to spend the proceeds and whether it should be extended. On the one hand TARP looks likely to cost roughly half of the original estimate; on the other Main Street America hates TARP because it’s seen as a cripplingly expensive exercise in saving the bonus boys of Wall Street.
But first, those profits. Just before christmas, the US Treasury revealed that Wells Fargo and Citigroup will repay a further $45bn between them, bringing total repayments so far to $164bn. At the current rate of recovery, the government is banking on receiving up to $175bn from rescued firms by the end of 2010, and that’s $175bn more than was expected in the dark days of October 2008 when the failure of Lehman Bros precipitated the rout.
With the money flowing nicely and endorsing his faith in TARP, Treasury Secretary Tim Geithner has formally extended the programme until October 2010 on the argument that financial instability still represents “an immediate and substantial threat to the economy”.
Most economists like Paul Krugman, a Nobel Prize-winner and a fearless critic of government policy, believe that’s true. “We have what is really an ongoing economic emergency,” Krugman said recently. “The level of unemployment we have got is doing enormous damage. So, I think the president is justified in reaching for whatever mechanism he can.”
Stop TARP?
But you can’t win in economics. Despite the fact that TARP has worked far better than anybody dared to predict – “[it was] instrumental in avoiding a global financial meltdown, a far worse scenario than we have today, at much lower cost than was originally expected,” agreed a Congressional panel in December, the Republicans and some Democrats want it stopped and all further proceeds pumped into America’s mounting deficit. They fear the deficit will undermine the greenback and lead to its demise as the world’s reserve currency.
And yet, a little over a year ago, TARP was the only thing standing between a rock and a financial meltdown. Let’s backtrack a little.
In September, with the storm clouds looming, then Treasury Secretary Hank Paulson went to Congress to ask for $700bn and carte blanche to spend it. They were days of panic and the general assumption was that the money would be used to buy the toxic assets that triggered the crisis, however worthless they may prove to be.
The situation was certainly dire, with giant insurer AIG and the biggest banks fighting for their lives. However Congress baulked at giving Paulson unprecedented departures from normal legislative practice and a much-modified, legislatively compliant TARP was approved on October 3, 2008.
By then however, the meltdown was spreading rapidly across the US and beyond its borders. Britain had announced an emergency recapitalisation programme for some of its own banks and most major European countries were following suit. Events were moving at breakneck speed. With recapitalisation clearly the favoured form of rescue, Paulson now opted for the same route. Thus on October 14, TARP became the instrument for capital injections into banks, unlimited deposit insurance, and guarantees of new senior debt.
However, as Simon Johnson, former chief economist at the IMF, wrote recently in the New York Times, nobody outside the Bush administration could understand why the treasury didn’t just take over troubled banks, which was normal practice and exactly what Britain and other countries were doing. As the administration “studiously avoided” absorbing large banks, notes Johnson, “there was a great deal of confusion in financial markets about what exactly was the Bush/Paulson policy that lay behind various ad hoc deals.”
To many, it looked like Wall Street was getting an unconditional bail-out. Still, most economists agree with Johnson that “TARP was an essential element in restoring confidence.”
Stress tests
By early 2009 however, the new Obama administration had hastily refined how TARP worked. Under new secretary Tim Geithner, the treasury deployed a small army of forensic supervisors to run stress tests on the biggest banks to determine their ultimate solvency. By and large, those tests established which firms were under-capitalised and which needed to buy in capital. The results were better than expected and confidence turned a corner.
Since then, freakishly low interest rates have done the rest. With the big banks’ cost of money at levels that would make a usurer’s eyes water, they can hardly not trade their way out of the abyss.
And now? Thanks to dividends, interest, early repayments and the sale of warrants (the government’s own investments in the firms) to the investing public, the present and remarkable situation is that Uncle Sam won’t lose the $350bn on TARP that it feared.
Nobody expected this to happen. In the first few months of the Obama administration, most economists and commentators could not see how half of Wall Street could escape nationalisation. Indeed some thought it might be a good thing – the first step before the markets could stabilise and recover.
TARP’s critics
However the situation is not nearly as pretty in other areas of the great bail-out. According to the latest data, Treasury is losing a bundle – over $30bn at last count – on its lifeline to AIG and roughly the same amount on Chrysler and General Motors.
And TARP still has its critics, like the government accountability watchdog that delivered a scathing report in December, alleging that TARP’s opacity had helped damage “the credibility of the programme and of the government itself, and the anger, cynicism, and distrust created must be chalked up as one of the substantial, albeit unnecessary, costs of TARP.”
Although the language smacks of the publicity-seeking in which government agencies sometimes indulge, the report does have a good point. Instead of every one of the hundreds of benefactors from TARP funds providing chapter and verse on how they use the money, only three have had to do so and they are the biggest benefactors by far – AIG, Citigroup and Bank of America.
The critics also blame the bail-out programme for, in effect, not yet saving America. Elizabeth Warren, chairwoman of the Congressional panel, warns about what many are calling “the world according to TARP” – a play on the award-winning novel by John Irvine, that there’s a long way to go yet: “Unemployment and foreclosures continue to plague the economy. The stability of the financial system remains uncertain.”
Nobody can argue with that. A quick perusal of the Federal Deposit Insurance Corporation’s latest list of failed banks tells the story. Some 130 of them closed in 2009 alone, 16 of them in December. That’s nearly four times as many as in 2008 and a whole thirty-three times more than in 2007. None at all put up the shutters in 2006 and 2005.
While most of the failures were relatively small institutions and their assets were quietly bought up by bigger brethren, there’s nothing like a round of banking bankruptcies to sow alarm into the populace. Americans have keen memories of the thirties when so many Main Street institutions collapsed that, as Federal Reserve chairman Ben Bernanke occasionally reminds people, many kept their savings in coffee cans buried in the back garden.
However TARP was designed to avert a catastrophe and, as Krugman explains, it’s done that: “In the face of the greatest economic catastrophe since the Great Depression, it’s much riskier to do too little than it is to do too much.”
The main thing is that those banks deemed “too big to fail” such as Citibank, which will shortly emerge from TARP, are through the worst and can with reasonable certainty be described as now unlikely to fail.
At the same time, the administration has decided that some salaries are too big to pay. The US treasury has appointed a “special master” who dictates in explicit terms remuneration policy to the TARP-supported titans of Wall Street. There’s one set of rules for the 25 highest-remunerated executives and another for the next 75. It’s all covered in 20-page sets of instructions, agreed and signed by the CEO, that define maximum cash salaries, bonus clawbacks, total compensation levels, please-explain provisions for any exceptions. As humiliating this may be for the bosses of some of the world’s biggest banks, it’s the inevitable price for using public money to stay afloat.
The overall result is that average salaries on Wall Street have taken a hit. For instance, nobody outside the top 25 at AIG can earn more than $500,000 a year in cash. At Bank of America, total direct compensation must be precisely 62 percent below that of 2008. And under pain of the treasury’s public wrath, let alone that of Congress, the shortfall cannot be made up in sham bonuses.
Doom loop
The $175bn question is where TARP goes from here. There’s still work to do at the banks, as the Congressional panel points out. “Our largest banks remain undercapitalised, given the likely trajectory of the United States and global economy. This is a serious impediment to a sustained rebound in the real economy.” Just one of these impediments is a dearth of credit to SMEs, something the Obama administration is trying to fix through a series of tax incentives, shorter loan pipelines and other measures.
Just as importantly, TARP’s gold-plated government guarantees might just tempt the big banks off the straight and narrow and into what is now described as the “doom loop”. As Johnson shrewdly observes: “Even more problematic is the underlying incentive to take risk in the financial sector. With downside risk limited by generous government guarantees of various kinds, the head of financial stability at the Bank of England bluntly characterises our repeated boom-bailout-bust cycle as a “doom loop”.
And although the horror of a total financial calamity is behind us – the same horror that confronted president Roosevelt when he took office in 1934, the full catastrophe of household finances is still emerging. As the Congressional report notes, home foreclosures are still rising, the availability of credit (“lifeblood of the economy”) is low and, as we’ve seen, banks are still failing.
Tempting surplus
Expect a war of words in early 2010 about what to do with TARP’s surplus. Can they be diverted to Main Street in the form of a fiscal stimulus for job creation? White House press secretary Robert Gibbs, clearly reflecting the view in the Oval Office, certainly thinks so. As he said just before Christmas, “the message to Main Street will be your economic vitality is just as important as anybody that lives or works or breathes on Wall Street.”
However there’s legal debate about whether this is possible under the original legislation which, TARP-watchers point out, mentions job creation only twice. Moreover both of those references are made in the context of the need to stabilise the nation’s financial system rather than as a separate goal, however worthy. The administration’s chief economic adviser Lawrence Summers promised Congress that any measures taken under TARP “will reflect the Act’s original purpose of preventing systemic consequences in the financial and housing markets” and there was no intention of “using any funds to implement an industrial policy.”
The Republicans criticise the Democrat president for using TARP “as a slush fund” for any kind of economy-boosting programme. For example, they opposed the inclusion of AIG and the struggling automakers GM and Chrysler in the programme. As senior Republican John Boehner sums up the attitude of the GOP: “Taxpayers have had enough of open-ended bailouts that have left them stuck with trillions of dollars in new debt. TARP should be shut down by the end of the 2009. It’s time to get the government out of the bail-out business.”
However as President Obama has pointed out many times, it was the Republicans who landed the government in the bail-out business. Meantime the fact that TARP will cost $350bn less than feared is convincing proof that this particular bail-out has been cleverly managed.
