Farewell, Bailout Nation?

The Troubled Asset Relief Program may be ending, but its controversial legacy lives on.

Let's remember the panic.

It was October 2008, and the financial system—in the US, in England, in the rest of Europe—stood on the precipice. Weeks earlier, Lehman Brothers had declared bankruptcy and Bank of America had acquired investment bank Merrill Lynch on the same day. The next day, the Federal Reserve Bank of New York bailed out American International Group (AIG) to the tune of $85 billion. Fannie Mae and Freddie Mac, the two wounded quasi-governmental housing corporations, were essentially nationalized. Washington Mutual and Indy Mac closed. Over a single weekend, bankers and lawyers and government officials scrambled to save investment firms Goldman Sachs and Morgan Stanley, subverting normal rules to convert each into bank holding companies so they could access federal loan money. "When TARP was created," Treasury Secretary Timothy Geithner has said , "the world around us was falling apart."

Although their first bailout plan failed in Congress, several days later a follow-up effort by then-Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke passed and was rushed into law. On October 3, 2008, the Troubled Asset Relief Program, was effectively born. This Sunday marks the second anniversary of TARP. It's also the technical "end" of the program, after which the Treasury Department can make no new investments.

The two-year mark offers a useful vantage point to gauge TARP's decidedly mixed, if not controversial, record. As an investment—which is what the centerpiece of TARP was—the bailout was a success: the program's $250 billion stock investment into banks in 2008 and 2009 averted an economic collapse, boosted confidence on Wall Street, and is now expected to make a profit of $16 billion. (The Congressional Budget Office reported in August that TARP's total cost would be a $66 billion loss, a relatively small one considering that some predicted the red ink would run into the trillions.) As an economic intervention of last resort, TARP is likewise seen as mostly a victory. "TARP spread a security blanket across the financial markets," writes Alan Blinder, an economics professor at Princeton University.

Through a political lens, however, nothing is as toxic as the "big bank bailout." Politicians who supported TARP have faced merciless criticism from angry voters who view TARP as a handout for bankers in pinstriped suits earning outsized bonuses; some lawmakers have been dumped from office for their bailout votes. "The TARP may well be the best and most useful federal program that has ever been despised by the public," Douglas Elliott, a fellow at the Brookings Institution and former director at JPMorgan Chase, told Bloomberg BusinessWeek.

Stopping A Runaway Train

After Congress killed Paulson's idea of spending billions in taxpayer dollars to buy up banks' "toxic assets" to cleanse their polluted balance sheets, lawmakers and Treasury and Fed officials decided in the fall of 2008 to instead buy up to $250 billion in stock in ailing banks to stabilize them. The Treasury called this the Capital Purchase Program. In October and November 2008, the Treasury invested tens of billions into nearly two dozen major banks, including Bank of America, Morgan Stanley, Citigroup, and JPMorgan Chase, and would go on to invest in hundreds more.

Paired with the Fed's rescue programs, the bank investment part of TARP did its job. Slowly, the financial markets regained their footing. In March 2009, the Dow Jones hit bottom and began its steady climb upward. By the fall of that year, the Dow had soared past 10,000; JPMorgan Chase and Goldman Sachs reported quarterly profits of $3.6 billion and $3.2 billion, respectively; and the New York Times trumpeted on its front page, "Bailout Helps Revive Banks, And Bonuses."

But the actual act of injecting cash into banks was riddled with controversy. Why, for example, did Warren Buffett negotiate far better terms—a higher interest rate, better options to buy company shares down the road—with his $5 billion investment in Goldman than the US government? Why, as the Congressional Oversight Panel (COP) noted in its February 2009 report, did the Treasury only receive, on average, $66 in assets for every $100 spent?

And why did the Treasury apply what looked to be a double standard to the shareholders of institutions it rescued? Where equity holders at banks like Citigroup and Bank of America and bank holding companies Goldman Sachs and Morgan Stanley saw only modest stock dilutions—the effect on existing shareholders of newly issued stock, decreasing the value of existing equity—AIG and Bear Stearns saw much more significant dilution. Yet no one has fully explained why these distinctions were made.

Meanwhile, Simon Johnson, former chief economist of the International Monetary Fund, laments the lack of institutional and structural change demanded of Wall Street by the federal government. As Johnson recently wrote:

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...

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."

A Tale of Two Bailouts

Then there were the auto bailouts, the $80 billion rescue of General Motors, Chrysler, and their financing subsidiaries. If TARP's Capital Purchase Program was characterized by favoritism and kid gloves, as its critics assert, then the restructuring of two of the Big Three was tough love.

In the spring and summer of 2009, both Chrysler and GM filed for bankruptcy. In court, the two automakers went through a grueling, comprehensive restructuring of their companies. They laid off workers, shut down dealers, and trimmed costs wherever possible to slim down from bulky Mack trucks to sleek, more profitable hot rods. In August, GM announced plans to reissue stock to the public, marking a near-complete turnaround; Chrysler, meanwhile, reported a small profit in early 2009, and projected it would be in the black this year. (By contrast, Chrysler had lost $3.8 billion in the second half of 2009.)

The execution of the auto bailouts, led by President Obama's Auto Task Force, hasn't escaped criticism, either. Another bailout watchdog, the Special Inspector General for TARP, blasted the Obama administration's push to close hundreds of auto dealers as part of the restructuring process and for the auto companies' paltry documentation and reasoning behind those cuts. It was unclear, SIGTARP stated, that the pressure to immediately shutter GM and Chrysler dealers "was either necessary for the sake of the companies’ economic survival or prudent for the sake of the nation’s economic recovery." The report went on to say, "Treasury made a series of decisions that may have substantially contributed to the accelerated shuttering of thousands of small businesses and thereby potentially adding tens of thousands of workers to the already lengthy unemployment rolls—all based on a theory and without sufficient consideration of the decisions’ broader economic impact.”

On the whole, however, the restructuring Chrysler and GM looks to have made them into far healthier companies. Of course, the tougher treatment of the auto companies begs yet another question: Why didn't the Treasury or Fed demand the types of wholesale changes to major banks as they did to the auto companies?

Extend and Pretend

Arguably the most unsuccessful part of TARP is its homeowner relief initiatives. The flagship program here in the Home Affordable Modification Program (HAMP), a multi-billion dollar effort to renegotiate the terms of home mortgage loans to keep Americans in their homes. Doing so, the thinking went, would help borrowers beset by job losses or health problems to ask their mortgage servicers to lower the cost of monthly payments. If a homeowner stays current on their payments, nearly everybody—borrowers, investors, mortgage companies, neighbors—wins.

Except, that is, for the mortgage servicing companies, the ones tasked with implementing HAMP. As Diane Thompson of the National Consumer Law Center has noted, the financial incentives are often greater if the servicer plows ahead with foreclosure instead of working out a loan modification with the borrower. "In the face of an entrenched and successful business model, servicers need powerful motivation to perform significant numbers of loan modifications," Thompson has written. "Servicers have clearly not yet received such powerful motivation. What is lacking in the system is not a carrot; what is lacking is a stick."

Yet the Treasury's HAMP program, run by Fannie Mae and Freddie Mac, is all carrots and few sticks. HAMP's architects continue to stand by the idea that enough financial incentives—$1,000 here, $1,000 there—will entice servicers into modifying more loans. They have yet to penalize the mortgage servicers, the borrower's negotiating partner in HAMP, despite rampant cases of wrongdoing, misdirection, and obfuscation.

Take Kristina Page, a bartender in Panama City, Fl. After coasting through HAMP's trial modification period, Page told Mother Jones in December, she received much higher monthly payments when it came to make her modification permanent. She couldn't understand why, so she asked her servicer, Saxon Mortgage Services of Fort Worth, Texas, about the bump. The company told her the increase occurred because "there is a letter in your file stating your sister Samantha will be contributing $1,300 per month toward your household income." One small problem: Page is an only child. Those kinds of mix-ups, say homeowners, attorneys, and consumer advocates, are endemic in HAMP.

Little wonder, then, that HAMP's success so far has been dismal. Servicers have made about 470,000 permanent modifications since March 2009—nothing to scoff at, but hardly on track to meet its goal of modifying the loans of 3 to 4 million homeowners. (It's worth noting that 663,000 trial modifications have been cancelled.) Moreover, Treasury officials have shifted positions on what those goals actually are. When Treasury rolled out HAMP, the goal was to provide 3 to 4 million homeowners permanent relief; since then, Treasury officials have said they meant 3 to 4 million "offers," a revision for which they've been roundly criticized. "Continuing to frame HAMPs success around the number of 'offers' extended is simply not sufficient," the SIGTARP concluded in a March audit (PDF).

In the end, an unofficial motto has been affixed to HAMP: extend and pretend. It's been criticized for not tackling the housing market's fallout and foreclosure crisis head on, but merely kicking the can down the road, hoping the problem fixes itself somehow. Princeton's Alan Blinder described TARP's foreclosure initiatives as "half-hearted." Or as the SIGTARP put it, "Foreclosure filings have increased dramatically while HAMP has been in place, with permanent modifications constituting just a few drops in an ocean of foreclosure filings."

Political Poison

Before HAMP had even begun, it had already become a political punching bag. It was, after all, the Obama administration's newly announced mortgage relief plan that sparked CNBC commentator Rick Santelli's infamous rant that some say ignited the tea party movement. Ever since, TARP, or just "the bailout," has been a consistent rallying cry for the graying tea party masses.

Sen. Robert Bennett (R-Utah) saw firsthand the political blowback. For supporting TARP, Bennett was dubbed Bob "Bailout" Bennett, jeered at Utah's Republican Party convention with chants of "TARP, TARP, TARP," and defeated in his reelection primary by a tea party-backed attorney and the conservative groups who mobilized against him. Rep. Bob Inglis (R-SC), who was trounced in his state's primary this summer, told Mother Jones in August that his bailout vote led in part to his crushing 42-point defeat. Even Democrats are bailout bashing: Missouri secretary of state Robin Carnahan has taken to calling Republican incumbent Rep. Roy Blunt, her opponent in the state's Senate race, "Mr. Bailout."

Another GOP supporter of TARP, the financially savvy Sen. Judd Gregg (R-NH), isn't running for reelection this fall. Whether his bailout vote figured into his decision to retire is unclear. What's obvious is that Gregg would've faced plenty of flak for his TARP support—criticism Gregg just can't fathom. TARP, Gregg told Politico, has "become demonized on the left and the right by screamers—Glenn Beck and Rachel Maddow—who have no interest in the facts; they’re just interested in hyperbolizing and generating attention."

An American Lost Decade?

TARP may be ending on paper, but in reality the bailout will linger for years to come. As the Wall Street Journal recently reported, more than 600 banks still hold $65 billion bailout funds, including Suntrust ($4.9 billion) and Regions Financial ($3.5 billion). Unwinding these remaining investments will no doubt last years into the future.

It's nonetheless worth asking now: Did TARP do its job? Was it a net gain for the banks and auto companies and homeowners and the economy as a whole? According to Herb Allison, a former Merrill Lynch executive and the top TARP chief until recently, the answer is yes. "When all is said and done, this program will be viewed as one of the most effective and least costly forms of assistance," Allison told Bloomberg BusinessWeek. "TARP was not perfect," adds Treasury Secertary Geithner. "But it has delivered in ways few could ever have imagined."

Watchdogs and financial experts are far less sanguine. TARP's generosity to mega-banks like Bank of America and Citigroup "greatly exacerbated moral hazard problems," writes Kenneth Rogoff, a Harvard University economics and public policy professor. While Rogoff believes TARP averted a second Great Depression, the bailout, he argues, has created an implicit government guarantee of the financial markets and failed to set the economy on the path to recovery.

Damon Silvers, a member of the Congressional Oversight Panel and counsel at the AFL-CIO, says he agrees that TARP prevented the wholesale collapse of the financial system and pulled us back from the brink. But he fears the bailout didn't go nearly far enough in making banks healthy again. Thanks to clever accounting measures, he argues, billions in toxic assets remain on banks' balance sheets but out of public view; lending to small businesses, meanwhile, remains paltry.

In Silvers' view, Treasury officials should've done to Bank of America and Citigroup and the other wounded banks what they did to Chrysler and GM. Instead they've set the stage of what he believes will be a Japan-like era of stagnant economic growth, America's own lost decade. "What we effectively did with TARP was preserve big banks, revitalize inter-bank credit markets, keep asset-backed security markets functioning, and we revitalized the bond markets," Silvers says. "On Main Street, there's no credit." He went on to say, "Like the Japanese, we're going to eventually have to [restructure the banks]. We're just postponing the inevitable here, at great cost to ourselves."