The TARP we needed
Happy 10-year anniversary to the Troubled Asset Relief Program, the most widely reviled piece of American public policy in the 21st century.
For those who've forgotten the official name, TARP was the emergency bank bailout passed in October 2008 to stem the financial crisis. The legislation initially allowed the Treasury Department to use $700 billion to prop up the financial industry, but $426 billion was ultimately spent. While President George W. Bush signed the bill, it passed Congress with more Democratic than Republican votes. And the actual administration of the bailout largely fell to the incoming Obama administration.
Since then, public opinion of the bailout has cratered. At this point, even TARP's defenders would admit it did profound and lasting damage to the public's trust in America's leadership. But they would also argue it was necessary to prevent total economic collapse.
But what if the TARP we needed was not the TARP we got?
When you have a major financial crisis like in 2008, your ultimate goal is to protect the real economy: to make sure that people keep their jobs and livelihoods and that businesses continue functioning. But when major banks are failing (or threatening to fail), money flows and financial markets seize up. People and business can't get credit, and transactions can't get made. Businesses start failing and employment starts falling, setting off a cascade effect as each job loss leads to more job losses.
Of course, 2008 wasn't America's first major economic depression. And we already had some safeguards in place this time.
Whether they were enough on their own is the first question.
Dean Baker, a co-founder and senior economist at the Center for Economic Policy Research, argues they may have been. He points to agencies like the Federal Deposit Insurance Commission (FDIC), created in 1933 to insure ordinary Americans' deposits. The ceiling for its guarantee was actually raised to $250,000 per account in the crisis. And the FDIC was also designed to handle financial bankruptcies, to carve up a failing bank and sell off the parts in an orderly fashion.
Meanwhile, the Federal Reserve was created as the lender of last resort to the banking system. And the financial crisis saw the central bank break new ground in how it used its extensive powers. It provided trillions in liquidity to the financial system, it backstopped the market for the short-term loans than help businesses run, and more.
"The real economy was not fully insulated," Baker told The Week. But he also pointed out the rate of job loss — hundreds of thousands of jobs evaporating each month — continued in the months immediately after TARP's passage. Baker argued that the stress tests carried out by then-Treasury Secretary Timothy Geithner actually did more to restore market confidence in the banks, a key part of stabilizing the economy, than TARP did. Without TARP, Baker wrote, the 700,000 jobs we were losing a month after Lehman's fall might have accelerated to 800,000 or 900,000: "That is a very bad story, but still not the makings of an unavoidable depression with a decade of double-digit unemployment."
Of course, under Baker's alternative TARP-less scenario, we would've still needed a massive fiscal stimulus to the real economy, one much bigger than the 2009 stimulus we got. But you could also imagine that, without TARP, Congress' appetite for a stimulus would've been much bigger. Meanwhile, "the chain of [bank] bankruptcies would have been a form of instant financial reform, downsizing the bloated sector," as Baker put it.
Damon Silvers, the deputy chair of the Congressional Oversight Panel for TARP from 2008 to 2011, is less confident on that score. "I think it's very clear to everyone who was on the inside of this that if we had done nothing we would've had a Great Depression," he told The Week. "We would've had 25 percent unemployment."
He argued the 2000s' frenzy of financial deregulation left major banks so large and complex that the FDIC couldn't digest them on its own. "The FDIC process was not made for a post-Glass Steagall bank," he explained. "The FDIC process could not work for Citigroup or Bank of America, the two institutions that were sickest." As it was, the agency still scuttled several smaller banks — but largely by selling them off to even larger banks, which then also threatened to fall.
As for the Fed, while its powers are extensive, they're still limited by both politics and the legal requirements of its charter. The central bank can lend money to other banks, so they can either settle up with each other or pay out cash withdrawals. But the Fed is only permitted to lend that money in exchange for collateral of equal worth — and in a crisis like 2008, the collateral the banks might hand over is, by definition, cratering in value. Furthermore, by lending that money, the Fed is handing the bank a new asset and a new liability at once. But the whole problem in 2008 was that all those mortgages going bad at once meant the banks' liabilities already outweighed their assets to a catastrophic degree. To repair the banks' balance sheets, you had to get assets and liabilities back into balance.
TARP did that by having the government buy preferred shares in the bank, thus injecting fresh equity: an asset with no counterbalancing liability.
Ironically, that was not the bill's original purpose. Geithner's predecessor at the Treasury Department, Hank Paulson, sold it to Congress as a way to buy toxic mortgages off the bank's balance sheets. (Hence TARP's full name.) But it quickly became apparent this was unworkable. Buying the mortgages off the banks at their peak pre-crash price was a step too far even for Paulson. But buying the mortgages at their new post-crash value would've destroyed the banks' balance sheets rather than resuscitate them. So Paulson and then Geithner took a different tack entirely — and supplied the equity by exploiting a technicality in the bill's language.
Here's the thing Silvers is firm on: There's more than one way to repair a bank's balance sheet. And just because TARP found a way, doesn't mean it was the right one.
The right way, according to Silvers, was modeled by the Roosevelt administration in the Great Depression. First, the federal government fires management and brings in its own auditors, so it's not dealing with anyone with a stake in the machinations that got the bank into trouble. It also explicitly guarantees the failing bank's obligations. (It almost certainly won't have to pay those obligations, but the commitment will stabilize financial markets, just as the stress tests did.) Then the government restructures the bad debt owed to the banks so the debtors actually have a realistic chance of paying it. In this case, that would've meant a massive write down of the underwater mortgages owed by millions of American households.
If this was being conducted under the old FDIC process, the bank would then be sold to a bigger competitor which would have to honor its long-term debt. But since the bank is so big and its competitors are in such disarray, that's not an option here. Instead the government would pay off the bank's debt by giving equity stakes to its long-term creditors. This would, of course, dilute the equity of the pre-existing stockholders down to almost nothing. Alternatively, the government could get really bare-knuckle and simply demand that pre-existing stockholders surrender their equity at massively reduced prices. Either way, the shareholders who were in charge of the bank when it ran itself into the ground would take massive or even total losses. But the bank would also see its balance sheet stabilized again.
Then, finally, once the bank is repaired, the government releases it to the market and sells off whatever equity stake it took to private hands.
The advantages of this alternative approach are myriad: It would've stabilized the financial markets, and punished the people responsible for the disaster. Crucially, it would also remove two enormous drags on the real economy: By eliminating so much bad housing debt, it would've helped the recovery move along faster. Instead of losing their homes and pouring so much money into the sinkhole of their mortgages, millions of Americans would've been able to get back to spending in the economy. And by quickly returning the banks to health, it would've allowed them to rapidly start supplying credit to businesses again.
"I'm not gonna stand up and say the traditional way of dealing with a banking crisis would've cost nothing," Silvers told The Week. His approach would've required, for a brief period, a much more muscular use of federal government power over the banks. "But it would've involved a lot less federal money."
This is actually where Baker and Silvers' preferred scenarios converge: Baker has also written that "it would have been best to do a bailout that imposed harsh terms on the banks," which is what Silvers is describing. And again, a Roosevelt-style restructuring of the banks would almost certainly still need to be matched with that much-bigger fiscal stimulus.
At any rate, that's not the TARP we got.
Instead, Geithner preserved existing management and shareholders and then injected just enough equity to keep the banks from going under, but not enough to allow them to function or lend on their own. Fully recapitalizing the banks required that all those bad mortgages slowly be paid back at their at their full pre-crash price — or that the banks had to take people's homes in lieu of payment. Underlying this brute reality was the massive mortgage fraud documented by David Dayen and others; a veritable factory line pushing millions of people through the courts and into foreclosure, without proper documentation.
That's the key thing to understand: Under Geithner's TARP approach, returning the banks' balance sheets to health necessitated bleeding American families dry.
"Tim [Geithner] thought he was smart enough to have it both ways; that he could protect the bank executives and stockholders and get the same result when they actually restructure the banks," Silvers told The Week. "And he was wrong." That choice also goes a long way towards explaining why, even though the crisis in the financial system itself passed rather quickly, the massive collapse in employment took 10 grinding years to repair. It's why 10 million American families lost their homes, and why, almost a decade later, the bank bailouts remain a source of simmering rage, nihilism, and distrust among voters.
"It was an extremely costly mistake," Silvers concluded. "In terms of homeownership, jobs, small businesses, and perhaps most of all the American people's trust in their government."