Baker Institute
The Troubled Asset Relief Program (TARP) was enacted on Oct. 3, 2008. At the time, we were assured (by then-U.S. Secretary of Treasury Henry Paulson) that TARP was an investment, not a bailout, and that there was no need to expect that the program would cost taxpayers anything. However, a year after the creation of TARP, there are more questions than answers.
TARP was originally sold as a program that would purchase troubled assets from banks in order to improve bank balance sheets. However, it quickly morphed into direct capitalization program in which the government bought preferred shares and warrants. On the positive side, the effort did strengthen bank balance sheets. What is unclear is whether the biggest banks are now just zombie banks ― banks that are fundamentally insolvent that have been kept alive by government support.
Another problem is that banking institutions that were deemed “too big to fail” have only gotten bigger since the collapse, thus increasing systemic risks. On March 23, 2009, Treasury Secretary Timothy F. Geithner announced the Public-Private Investment Program to create a market for otherwise nonmarketable troubled assets; however, this program has also failed to significantly reduce the amount of troubled assets held by the banking sector. According to the Congressional Oversight Panel, “troubled assets remain a substantial danger to the financial system.” This raises serious questions about the efficacy of the TARP program to clean bank balance sheets.
Smaller TARP programs such as the $50 billion “Make the Home Affordable Modification Program” have also been relatively unsuccessful. Treasury originally stated this plan would offer assistance to up to 3 to 4 million homeowners, but according to the U.S. Government Accountability Office only 180,000 modifications are underway as of July 20, 2009. Moreover, many question the use of TARP to bailout the automakers and at the same time spend billions of taxpayer dollars to the benefit of the UAW, the labor union that represents much of the auto industry’s workforce, over secured creditors and bondholders.
While the lending crisis has eased over the past year, many commentators have speculated about the effect of TARP, especially in regards to its significant costs. The effects are probably small compared to the $2.1 trillion increase in the Federal Reserve’s balance sheet and the reduction in the Federal Funds rate to virtually zero.
John W. Diamond is the Edward A. and Hermena Hancock Kelly Fellow in Public Finance at the Baker Institute and an adjunct professor of economics at Rice University.