Four years later, TARP was still a mistakeEconomicsFeaturedPolicyPolitics

Earlier today, General Motors announced it would buy back about 200 million shares of itself from the Treasury Department – at a loss to the taxpayers of over $5 billion (CBS). The Treasury still owns 300 million shares of GM, and unless the share price hits $70, the “investment” will come to a loss.

Now, as numerous TARP supporters will insist, it’s not just about the bottom line of a profit-loss statement. I said something similar when it looked like TARP would be a money-making venture (overall, it’s looking more like a money-loser now). The difference is this: the “other factors” surrounding TARP make it a far less sensible move.

While I’m fairly sure I hold the minority view among the BD contributors, I have opposed TARP from the start. My reasons then still, in my view, hold up well. To wit…

TARP was the wrong medicine, based on the wrong diagnosis. The weaknesses of mortgage-backed securities was highly overblown in the fall of 2008. Yes, numerous mortgages were heading into foreclosure territory, but not nearly enough to explain the dramatic fall in MBS prices. Making matters worse, the SEC regulated that all MBS holdings be listed as “mark-to-market” (i.e., listed in value at the depressed market price) rather than “mark-to-model” (determining how many mortgages in the MBS holdings were in trouble, and reducing the value in that manner). As a result, artificial losses totalling over $500 billion were slapped on the banking industry. William Issac, former FDIC Chairman, detailed the unnecessary carnage to CNN:

In recent years, firms were required by the Securities and Exchange Commission and the Federal Accounting Standards Board to use mark-to-market valuations for all the MBS on their books.

As more subprime borrowers started to default on their loans, that quickly eroded the value of many MBS pools. Major banks and financial firms around the globe have taken writedowns topping $500 billion in the last year, as a result.

For this reason, some have argued that fixing the rule would solve the credit crisis.

“The SEC has destroyed about $500 billion of capital by their continued insistence that mortgage-backed securities be valued at market value when there is no market,” said William Isaac, a former chairman of the FDIC.

“And because banks essentially lend $10 for every dollar of capital they have, they’ve essentially destroyed $5 trillion in lending capacity,” he added.

Isaac believes that since the overwhelming majority of loans packaged together in even the weakest MBS pools are not in foreclosure, it is proper to value these securities based on the flow of cash from all the loans instead of a non-existent market value.

Richard Kovacevich, who was head of Wells Fargo at the time, gives a specific example of this idiocy (Forbes):

People thought the world was coming to an end because everyone was reporting huge book but not actual losses because of MTM accounting. We had to write off $900 million on a prime mortgage portfolio that we thought had a maximum loss exposure of $100 million. Our current loss estimate for that portfolio is now just $35 million. But we had to report nearly a billion-dollar loss that never came to fruition. And that was just one relatively small portfolio. I could give you many more examples. Also, we wanted to purchase some assets because we knew they were undervalued. We were very reluctant to be a purchaser, however, because we would have to take an MTM loss if the asset went down further, even though we knew over the cycle it would be profitable. This caused the markets to cease functioning. It destroyed a lot of companies and ultimately forced the Fed to intervene with trillions of dollars and be the buyer of last resort. Mark-to-market accounting was a huge culprit in the financial crisis and caused unnecessarily massive damage to the economy, and to housing in particular

So did the Bush Administration order the SEC to change the rule? No, they instead demanded $700 billion from the taxpayers to ostensibly buy these MBS (the Troubled Assets of the Troubled Asset Relief Program), demanded the right to redirect the money however it saw fit after Congress appropriated it, and insisted the world would end if they didn’t get it.

This leads to the second problem – the damage to expectations. With the misdiagnosis and incorrect “cure,” the Administration made the economy appear worse than it really was. They exacerbated the problem with their insistence of a complete financial collapse without the $700 billion (the fact that only $418 billion ever left the Treasury – and less than $400 billion actually went to banks, is just part of the evidence of how the problem was overestimated). When cooler heads managed to convince the House of Representatives to hold off and vote this down, they were drowned out by the screaming from the Administration, the Fed, the Senate, and the House minority (which in this case does not mean the Democrats, but rather the minority of members who voted Aye the first time).

When the House revoted, enough Congressman were spooked into passing the debacle, but then the Administration made matters infinitely worse by using the dictatorial powers given to it and changing the plan to “recapitalizaion” (i.e., buying of stock in the banks). As a result, banks that were largely healthy could be lumped into the “bailout” mix. Kovacevich in particular recounts – to John Taylor and others – how he was threatened by Paulsen and Fed Chairman Ben Bernake into agreeing to the money for Wells Fargo. By forcing healthy banks to take the money and appear sick, TARP gave the impression that the banking sector was in far worse shape than it actually was. It should come as no surprise that the worst part of the Great Recession came in the final quarter of 2008, when these shenanigans were in full swing.

This also leads to the final strike against TARP – the damage to political accountability and limited government. TARP essentially turned Henry Paulsen into Julius Caesar, and as a result, a policy for which no one in Congress voted was enacted, in at least one case over the objection of one of the very “beneficiaries.”

Kovacevich’s comments on what he wanted Wells Fargo to do (namely buy undervalued MBS assets) but couldn’t due to mark-to-market shines light on why TARP’s extension into the auto industry was also a bad idea. Absent government interference, Wells Fargo would have since the events of the fall of 2008 not as a disaster, but as an opportunity to snap up undervalued assets and make long-term investments. Competitors of GM and Chrysler would have been in a similar position, but like Wells Fargo, they were blocked by the government (in this case the bailout itself was the reason). While Ford’s ability to avoid bailout funds is a testament to its financial strength, its political support for GM and Chrysler getting bailed out was a sign of microeconomic ignorance, or perhaps they feared a more competitive auto industry replacing the wheezing oligopoly that GM and Chrysler’s survival represented – an oligopoly of which Ford is obviously still a part.

In summation, TARP was an economic mistake on several levels, even it had been a net positive for the Treasury in funding; that it appears not to be even that simply makes it worse.

  • http://twitter.com/Rick_Sincere Rick_Sincere

    You’re not wrong, even if that makes you (and me) a minority among Bearing Drift contributors.

  • http://twitter.com/icanhasbailout Santa Claws

    In 2009, the Tea Party was formed as a response to the outrage of TARP, and quickly also adopted opposition to Obamacare as its two main reasons for protest.

    In 2012 the GOP ran on its Presidential ticket 2 TARP supporters, with the top of the ticket being the guy Obama got the idea of Obamacare from.

    If there’s any question why this past election was the overwhelming catastrophe it was, and why so many traditional GOP voters stayed home, voted Libertarian, or wrote in Ron Paul, re-read the above two sentences until you get it.

    Your moment of zen for the day, Paul Ryan begging us to accept massive debts on our grandchildren so failed bankers could continue to pull billions in bonuses every year: http://www.youtube.com/watch?v=RyJBZYz858M

    • http://www.facebook.com/profile.php?id=1427002848 James Cohen

      Santa, as a “tea partier” who drove to DC on tax day April 09, I will share some history. TARP had little to do with undercurrent leading to the formation of the Tea Party Movement. The preceding problem was the housing debt bubble, the same one that I saw George Allen look the other way from while delusionally planning for a WH run while he was in the senate.

      On 2-19-09 CNBC’s Rick Santelli criticized the federal governments ill conceived plan to refinance mortgages, which had just been announced the prior day, from the floor of the Chicago Mercantil exchange. Santelli yelled that those plans were “promoting bad behavior by subsidizing losers mortgages” and then he caught on fire and very emotivationally suggested holding a tea party for traders to gather and dump the derivatives in the Chicago River on 7-1-09. A swarm of floor traders surrounding him loudly applauded his proposal. Later the same day this CNBC rant went viral after being featured on Drudge.

      That night, a conservative radio show who already had a site set up by the name http://www.chicagoteaparty.com went live as did http://www.reteaparty.com which was promptly set up hastily to organize and coordinate Tea Party events scheduled for Independence Day. Neither web page could handle the traffic within hours of going live and the Tea Party Movement coalesced out of thin air from the words of one man named Rick Santelli. The day after Rick’s CNBC video went viral, Fox shopped the term “Tea Party” and their IT department had a server crisis that morning. So, for accuracy’s sake, the movement started out the eve of 1-19-09 as the “Nationwide Chicago Tea Party” and by mid day 2-20-09 events were being promoted for a protest on 2-27-09. This was the first Tea Party protest, however, with all due respect, this movement was inspired by the Boston Tea Party 07 that led to the money bomb for Ron Paul leading up to his run in 08 where he raised 6.5 million in one day.. Many of these same activists were instrumental to the formation of todays tea party as were others active in the GOP who regrettably our own George Allen shunned.

      Here is the original unedited video that lit the fuse.. http://video.cnbc.com/gallery/?video=1039849853

      Keeping it real on BD.. Yours truly.

      • http://twitter.com/icanhasbailout Santa Claws

        ” TARP had little to do with undercurrent leading to the formation of the Tea Party Movement.”

        I also went to my local Tea Party on April 15 2009, and TARP was the main rallying point. Perhaps you are misremembering, or perhaps the rally you went to was atypical. TARP was indeed the #1 issue of the Tea Party back when it was formed – the connection to the mortgage issue is that TARP was for the explicit purpose of bailing out bad mortgages – those were the “troubled assets” of the Troubled Asset Relief Program. It’s the same thing.

        If you need a reminder, here’s (otherwise solidly conservative) Gresham Barrett (R-SC) being booed by a Tea Party crowd on that date for the specific and sole reason that he voted for TARP:

        • http://www.facebook.com/profile.php?id=1427002848 James Cohen

          I was in DC. Left later that day for Cali.. The undercurrent was already there as in the fuel was already spilled, Tarp was the match. I know plenty of Liberty Movement activists who were on this path well before the term TARP was coined and many of them worked in the trenches to raise the Tea Party banner from the start.

          • http://twitter.com/icanhasbailout Santa Claws

            we’re pretty much on the same page here… fiscal sanity, wherefore art thou?

    • greg aldridge

      Id like to add that the “movement” doesn’t exactly have a singular catalyst with respect to an issue. Just as there are countless individual tea parties, there are countless reasons and focuses for each as well. if you remove all the tea parties that are just republican fronts from the mix, what is left is quite unified on a lot of things really. I have been a board member of my tea party for 3 years almost, helped start 6 others and have worked with as many as 30 tea parties at a time on projects. There is agreement on the big stuff, but all these groups are very individualistic as can be most obviously seen when you bring electoral politics and candidates into the mix and once you do that – the “movement” fractionalizes with alarming speed and ferver

  • http://www.facebook.com/people/Dj-McGuire/1040496090 D.j. McGuire

    SC,
    Although my post was focused on the policy errors of TARP, I will agree that the GOP made a mistake by nominating two TARP backers, and I would further say those of us who recommended Romney for the nomination (I say “those of us” because I was one of them) erred, and erred badly.

  • http://www.facebook.com/michaelj.barrett.355 Michael J Barrett

    TARP was not perfect, but it was necessary, and when combined with the effects of the Stimulus, began recovery and put us back on the path toward prosperity. Now is the time to go back and get redress from those who engaged in predatory lending practices and immoral financial transactions that were at the heart of the meltdown. Further, implementation of financial regulations to prevent such a meltdown again are essential. If we learned anything, it is capitalists will be capitalists, and left unrestrained, will engage in immoral and unethical behavior to make a buck even at the expense of their clients.

    • http://twitter.com/icanhasbailout Santa Claws

      TARP was not only not necessary, it was extremely damaging to the US economy and began a still-uninterrupted process of bailouts (this includes “quantitative easing” which just a cynical euphemism for Federal Reserve-driven giveaways to privileged parties) that made a total mockery of any claims to this country having a free market. There has been no recovery whatsoever, just a long slow decline in real terms, barely masked by currency devaluation and unprecedented debt accumulation.

      We have years of debt-laden college graduates entering an economy with no work for them, and seniors unable to retire at zero interest rates taking part-time, low-paying work in order to survive. For citizens in their economic prime (24-54) there are actually fewer total jobs than there were at this time in 1997. Wages as a share of national income have plummeted to historically unprecedented levels as these government-driven policies shift income to only those wealthy enough to afford the lobbyists that direct where government spending goes, leaving almost all Americans out in the cold.

      If you think there is a recovery under way, you are wildly out of touch with the average American, who is experiencing nothing of the sort. We are following the Japanese model of perpetual stagnation and economic hopelessness with remarkable precision.