Monday, December 27, 2010

TARP not big enough for those NOT too big to fail...

In recent months, there has emerged a terrible mythology around Henry Paulson's audacious plan to save our financial sector. The whispers have grown into kind of a roar: TARP will turn a profit for the government.

To understand this mythology, we need to go back to those dark days of the fall of 2008, when our economy went into a free-fall of its own weight and it looked like nothing would save us from a Depression as terrible as the one that we call the Great Depression. Henry Paulson, then Bush's Treasury Secretary, cobbled together his rescue plan we all know as the Troubled Asset Relief Program, or TARP.

In September 2008, Paulson did his best to explain his new plan. Here's some of what he said back then:

As we all know, lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing. This simply put too many families into mortgages they could not afford. We are seeing the impact on homeowners and neighborhoods, with 5 million homeowners now delinquent or in foreclosure. What began as a sub-prime lending problem has spread to other, less-risky mortgages, and contributed to excess home inventories that have pushed down home prices for responsible homeowners.

A similar scenario is playing out among the lenders who made those mortgages, the securitizers who bought, repackaged and resold them, and the investors who bought them. These troubled loans are now parked, or frozen, on the balance sheets of banks and other financial institutions, preventing them from financing productive loans. The inability to determine their worth has fostered uncertainty about mortgage assets, and even about the financial condition of the institutions that own them. The normal buying and selling of nearly all types of mortgage assets has become challenged.

These illiquid assets are clogging up our financial system, and undermining the strength of our otherwise sound financial institutions.

Here's what he wanted us to do about it:

The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy. This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible. The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars.

We all know that he was not immediately able to "remove these illiquid assets that are weighing down our financial institutions." He instead revised the plan to infuse billions of federal money into the financial system in an effort to recapitalize banks.

Today, some of the big banks are paying back their TARP loans with interest. The cost of the program appears to be significantly less than the $750 billion figure Paulson had originally thrown out for us to consider.

And thus today, the loud claims that TARP is a profitable enterprise for our economy. In fact, Tim Geithner, the man who replaced Paulson as the nation's Treasury Secretary, calls TARP "one of the most effective crisis response programs ever implemented."

And for the big banks, those too big to fail, it's been nice. But TARP was just one element in the generous bailout package the government offered them.

For smaller banks, however, a different story. TARP was, for many, the extent of the bailout they received. And now many continue to struggle. In fact, a recent Wall Street Journal story reports that the number of TARP recipients on the verge of collapse is on the rise. According to the story, there are nearly 100 banks now in jeopardy of failing.

And "seven TARP recipients have already failed, resulting in more than $2.7 billion in lost TARP funds."

TARP's failures are not the big banks:

Most of the troubled TARP recipients are small, plagued by wayward lending programs from which they might not recover. The median size of the 98 banks was $439 million in assets as of Sept. 30. The median TARP infusion for each was $10 million, federal filings show.

What we are seeing is that the "too big to fail" institutions, the ones that got TARP AND other programs, are doing well. Paying out enormous bonuses. Spending large sums on advertising. (Here's one example!)

The smaller banks, the ones that got some funds from TARP, but little else, remain in trouble, which means our financial system has grown even more imbalanced. Far from fixing the financial system, TARP has created an even bigger disparity between large and small banks. Large banks remain too big to fail. Small banks... well, they fail. And the TARP monies invested in them simply vanish.

So the next time someone talks about the profitability of TARP, remember those small, struggling banks. Despite what you hear, TARP is the kind of profitable venture we simply cannot afford to repeat.