Friday, October 1, 2010

Sometimes Government Policy Does Work Part II: Not All Bailouts Are Equal

During the depths of the global financial crisis, there was a lot of anxiety over the “bailout” of the US banking system (later extended to other corporates such as GM) via the Troubled Asset Relief Program (TARP), which on its own amounted to nearly USD700 billion (about half of which was expected to be lost). Consisting of injections of capital and purchases of illiquid, risky assets, TARP provided a backstop to the banking system’s liquidity risks when the interbank market collapsed in late 2008.

While TARP can be criticised for reinforcing moral hazard problems in the banking sector, it looks like the US Treasury might get off with at worse a small loss (excerpt):

TARP Didn't Bust the Bank
The much-maligned bailout program made money on most Wall Street investments and cost less than expected

Bailed-out banks, insurers, and automakers are a sore spot for millions of Americans hit hard by the financial crisis. Candidates running in November, especially those waving the Tea Party banner, are using "no more bailouts" as their mantra to attract voters. Yet there's a disconnect between the political rhetoric and the facts on the ground.

The Treasury Dept.'s investments in banks through the Troubled Asset Relief Program have done surprisingly well. Lower-than-expected losses on auto and insurance company rescues, as well as the financial markets' return to strength, mean the $700 billion rescue plan launched in October 2008 will cost less than one-tenth its initial price tag. "The TARP may well be the best and most useful federal program that has ever been despised by the public," says Douglas J. Elliott, a fellow at the Brookings Institution and a former JPMorgan Chase (JPM) managing director.

As Treasury gets ready to shut down the spending phase of the TARP program on Oct. 3, it now expects to turn a $16 billion profit on the $250 billion it plowed into banks in 2008 and 2009. And TARP's final price tag is expected to be about $50 billion, according to an Obama Administration official. The Congressional Budget Office in August had estimated a $66 billion loss. Treasury Secretary Timothy Geithner is expected to brief President Barack Obama on Sept. 30 on the brighter outlook.

"When all is said and done, this program will be viewed as one of the most effective and least costly forms of assistance" in the financial crisis, says Herbert M. Allison Jr., the former Merrill Lynch (MER) executive and Fannie Mae (FNM) official who has shepherded the rescue effort for Geithner and leaves the job on Sept. 30…


US$50 billion is a pretty small price tag for saving the entire global financial system from collapsing. Of course, that doesn’t mean we can generalise this to mean that all bailouts are effective or should be encouraged. Every crisis is different and demands a different response.

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