SCORECARD ON THE TROUBLED ASSET RELIEF PROGRAM
By Stephen Smith
December 2nd, 2010
In the April 2009 Market Insights, I wrote about the Troubled Asset Relief Program (TARP). Here is a brief overview of the program, why it was needed and how it has fared. In October 2008, the Emergency Stabilization Act of 2008 established the TARP program. An economy’s natural, self-correcting mechanism during a recession is for interest rates to fall as the Federal Reserve lowers monetary conditions and demand for credit abates. The financial system was in such a distressed state that credit availability remained difficult and borrowing rates were elevated, despite historically low policy rates (Fed Funds rate at or near zero). The financial crisis continued to exaggerate the economic downturn by choking off the flow of cheap credit that has played a role in previous economic recoveries. The $700 billion Troubled Asset Relief Program (TARP) was to relieve banks of the troubled assets that weighed on their balance sheets and depleted their capital. Most of the first portion of TARP (over $350 billion) was spent directly recapitalizing banks through the purchase of preferred stock, in addition to customized rescue operations for a handful of the country’s largest institutions.
The once much debated program now has fewer and fewer skeptics. It seems each month brings better news from the Congressional Budget Office (CBO). In August, the CBO report predicated a cost of $66 Billion for TARP. The newest report which was published in November of this year predicates a loss of $25 Billion. Through the TARP’s Capital Purchase Program (CPP), the Treasury purchased $205 billion in shares of preferred stock from 707 financial institutions. Preferred stock purchased through the CPP carries a promised dividend equal to 5 percent for the first five years and 9 percent thereafter. As of mid November, $153 billion in preferred stock had been repurchased by more than 120 of the issuing institutions. CBO estimates a net gain to the government of $15 billion from the CPP. Treasury purchased $25 billion of preferred shares of Citigroup and CBO estimates a net gain to the government of nearly $7 billion on that investment alone. AIG received financial assistance in two forms through TARP. The Treasury purchased $40 billion in preferred stock and established a $30 billion line of credit. AIG announced that it had reached an agreement with the Treasury to restructure the company’s obligation under TARP. CBO estimates the subsidy cost to the Treasury of the assistance to AIG to be $14 billion. General Motors and Chrysler, along with associated financing intermediaries, received just over $79 billion in TARP funds. CBO estimates a cost of $19 billion for assistance to the automotive industry.
The TARP program will cost less than half what it took to clean up the massive savings and loan crisis of the 1980s! It was not apparent when the TARP was created two years ago that the cost would turn out to be this low. At the time, the U.S. financial system was on the brink of collapse, and the transactions undertaken through the program engendered substantial financial risk for the federal government. However, TARP has greatly improved the financial system and the amount of funds used was well below the $700 billion initially authorized. The outcomes of most transactions made through TARP were favorable for the federal government, the economy and the market.
