The Congressional Budget Office (CBO) recently released its November 2010 report on the financial costs of the Troubled Asset Relief Program (TARP). Democrats are likely to tout the CBO’s estimated net loss for TARP of $25 billion as proof the bailout was a worthy use of taxpayer funds. This figure results from an estimate of expected returns on capital investments in certain financial institutions and does not account for the broader economic damage of market expectations of future bailouts. Even in the improbable event that all TARP funds are recovered, costs will be borne by taxpayers in the years to come due to the federal government’s demonstration that some firms are “too big to fail” and the economic favoritism that implies. TARP compromised capitalism’s mechanism for market discipline, which will not be restored until fiscal policies affirm that the freedom to succeed must include the freedom to fail.
Issues of concern
Past performance is no guarantee of future returns: The CBO valuation for TARP’s outstanding capital investments shows a potential gain of $22 billion for the Treasury, including a $7 billion return on the government’s ownership of Citigroup. It is important to note that those amounts are based on the current market price of the Treasury’s holdings. These unrealized gains are contingent on dividend payments from the respective financial institutions required by the Treasury’s stock purchases. These proceeds are far from certain with firms struggling under government involvement. For example, the report referenced Treasury’s preferred stock holdings in bailout recipient AIG stating, “[T]he company failed to pay the quarterly cash dividends due on those Treasury investments.”
Failing its own mandate: The TARP legislation specifically authorized the Treasury Secretary to use funds in such a manner that “protects home values, college funds, retirement accounts, and life savings; preserves homeownership and promotes jobs and economic growth; [and] maximizes overall returns to the taxpayers of the United States.” Today national home prices are down nearly 30 percent since their peak, equity markets are down approximately 20 percent, and millions of homeowners are facing the threat of foreclosure. Since enactment of TARP, the uncertainty created by the federal government’s capricious involvement in the economy has caused the unemployment rate to remain above 9.4 percent for 19 consecutive months while GDP growth limped along at only 1.7 percent for the 3rd Quarter of 2010.
The biggest cost of all: TARP’s largest component was the Capital Purchase Program (CPP), through which the Treasury Department purchased $205 billion of equity in more than seven hundred financial institutions. With $52 billion of that amount remaining invested in 587 of the institutions, it is obvious that bailout money was highly concentrated. Stated differently, 71 percent of CPP money was injected into just three percent of the total number of banks that received TARP funds.
By targeting large firms, and in some cases forcing banks to accept government capital, TARP confirmed what markets perceived as an implicit government guarantee that some firms are “too big to fail.” This perception persists in markets today despite Democrats’ protestations to the opposite. The Congressional Oversight Panel’s September 2010 report assessing TARP concluded, “[T]he program’s moral hazard costs were much greater than necessary.” Panel member Mark McWatters stated, “[The guarantee] provides these large firms with a substantial cost advantage over their smaller, less systemically important competitors, which will lead to a more concentrated financial sector and higher prices paid by customers of banks and other financial companies.” Sadly, this dynamic appears to set the stage for a future financial crisis.
A $25 billion loss for taxpayers is an overly optimistic estimate. The CBO’s bottom line ignores intangible costs and is based on the potential “profit” from bank bailout funds not yet repaid. The true costs of TARP are, in some ways, incalculable.