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Farewell, Bailout Nation?

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

| Fri Oct. 1, 2010 11:03 AM EDT

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.

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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."

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