Financial Crisis and Its Impacts Thesis

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The second purpose of the $700 purchase of troubled assets is to create a market for the securitized versions of these assets. As a result of the crisis, the market for these assets became illiquid. The value of securitized debt obligations became near zero, which severely impacted the balance sheet of all banks that held these assets. By creating a secondary market for these products, the government hopes to increase their value. This will improve the balance sheets of the banks.

The second key clause in TARP is that banks selling troubled assets to the government are required to give the government warrants. This, in theory, protects the government from losses. The theory is that the banks will see an increase in value as a result of the government's efforts, allowing the government to profit from the warrants.

Ancillary to TARP was the FDIC's excusing of troubled assets in its loss-share plan. In order to expedite the sale of the assets of the 100+ banks, the FDIC has limited the downside loss potential for the purchasers of failed banks. While this allows the banks to remain in business, it also places the downside risk of the troubled assets that helped to bring those banks down directly onto the backs of the American taxpayer (Paletta, 2009).

Analysis of TARP

In order to determine the success of the Troubled Asset Relief Program, measures of success must be determined. The first objective was to stabilize the economy. This can be measure with a wide variety of economic metrics, including the stock market, the GDP and unemployment. The second objective was to stabilize the banking system. This can be measured on the basis of the bank run it TARP was supposed to prevent. However, it can also be measured by the number of bank failures. The third objective was to stimulate lending on the part of banks. The fourth objective was to create a secondary market for the trouble assets. The fifth objective was to do all of this without much waste.

With respect to the first objective, there is evidence that TARP has succeeded. The economy slumped through the fall of 2008, but began to stabilize in the winter of 2009. Growth of 3.5% was recorded for the third quarter of 2009, the first such quarter in over a year (Lam, 2009). The growth is expected to be coupled with pent-up demand and thereby continue for at least a few quarters. Furthermore, the stock market indices have all risen over the course of this year. The upswing in economic activity and the improvement in the stock market indicates that the first objective of TARP -- to stabilize the economy -- has succeeded.

The second objective has not been as much of a success. While consumer confidence in the banking system remains relatively high -- at least to the extent that a bank run has not yet occurred. That can be better attributed, however, to the FDIC's move to increase its guarantee on bank deposits beyond its usual $100,000. While the major banks have avoided collapse, over 100 regional banks have succumbed and this has placed significant stress on the FDIC. That agency has "proposed that banks pay their fees for the rest of the year as well as 2010, 2011 and 2012 by December 31" (Grey, 2009). This is to alleviate a major funding crunch at the FDIC that, if it occurred, could have jeopardized the banking system. In light of the stresses that the 100+ bank failures have put on the FDIC -- and by extension the taxpayer should the FDIC actually run out of money -- the banking system may not be as stable as it appears.

The third objective was to stimulate lending on the part of the banks. Indications are that the money has not been spent on lending. The prevailing attitude among banks is that they will not change their lending policies to suit public policy, and that as private entities they are free to do as they like with the TARP money they've received. To quote John Hope, chairman of a New Orleans-based bank "We're not going to change our business model or our credit policies to accommodate the needs of the public sector as they see it to have us make more loans" (McIntire, 2009). In general, the banks are not required to disclose what they have done with the money and few are willing to talk. The TARP watchdog is also working to uncover cases of misuse of TARP funds, and has uncovered 20 cases of fraud thus far (Liberto, 2009).

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The fourth objective was to create a secondary market for the troubled assets. TARP has created this market, based on a public-private model in which the government funds entities willing to bid on the assets. The underlying theory of this model is that the assets are trading below their fundamental value and with government intervention, market participants will be willing to purchase the troubled assets, thereby increasing their value (Bebchuk, 2009). "Market participants attached valuations exceeding fundamental values…we should be similarly prepared to accept the possibility that market processes once again are not working well" (Ibid). Thus, the rationale for the fix holds that intervention can restart the market.

While the funds have been activate, such as a secondary market has not yet become viable. In part, the assets are complex. The difference of opinion as to the value of such assets can vary significantly among market participants, which results in an illiquid market. So in part, the trouble with the TARP plan is it still has not resulted in a mechanism by which an accurate price of complex derivatives such as collateralized debt obligations can be priced (Mahoney, 2009).

The fifth objective was to enact TARP with a minimum of waste. This objective represents accountability to the taxpayers. In general, TARP has failed with respect to this objective. The program lacked fundamental oversight on the spending of TARP money. AIG executives awarded themselves rich bonuses, forcing the enactment of strict anti-bonus rules. Banks were not obligated to disclose their spending, and there is strong reason to believe that much of the TARP funds were not spent on lending as the program intended. Furthermore, the Treasury Department does not have an adequate system to measure the value of the shares it received in exchange for the TARP funds.

Overall, the performance of TARP has been reasonable. The program has succeeded with respect to some of its bigger-picture goals. The economy did stabilize. The stock markets recovered, even the bank stocks. There was no bank run as consumers found themselves convinced that disaster would not occur.

However, there were many problems with TARP. The program had little oversight, so it is relatively unknown what actually happened with the TARP funds. There is little to indicate that the funds were lent out as originally intended. The rate of bank failures increased dramatically in 2009, which has put considerable pressure on the FDIC and in turn the entire banking system. So while no bank "too big to fail" has collapsed, the program itself is in danger. The much-vaunted secondary market for the troubled assets has, by and large, failed to materialize. This market once existed, but was fueled more by euphoria than a deep-rooted understanding of the underlying fundamentals. Now firms today realize how little they understand of the fundamentals and are now having difficulty accurately pricing these assets, stunting the emergence of a liquid secondary market.

Conclusion

It is not that TARP has been a total failure. Some of its goals are going to take longer to come to fruition than others. There is no reason to believe that the issues with respect to the secondary market will not eventually be resolved. It should be considered, though, what will happen if that market does not develop. These assets will remain worthless. The Treasury and the FDIC are responsible for losses that accrue from the troubled assets. Thus, the long-term effects of TARP have yet to be seen. It may well end up that TARP is an even costlier program than it has been already.

The public is right to be outraged about TARP spending. The removal of accountability language from the bill before it was passed into law has left the program with a lot of money to spend and little way to guarantee -- or even measure -- the outcomes. Without the ability to measure outcomes, we are left with proxies. The economic proxies look strong -- the economy has finally rebounded and the stock market is looking up once again. But the cost of the program is high, and it is worth considering how much of the good news would have happened anyway. TARP has only seen moderate successes, and those are at the macroeconomic level and therefore cannot be directly attributed to the program. From what we can interpolate from the state of the banking system, TARP has benefited some….....

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