The final COP Tarp report | FT Alphaville

The final COP Tarp report

Because estimates for the ultimate cost of Tarp have been declining continuously for some time now, it’s easy to forget that the CBO once expected the program to cost taxpayers a staggering $356bn.

Now the CBO pegs the final cost at just (erm, “just”) $25bn, slightly less than the $28bn loss estimated in the President’s 2012 fiscal year budget. But the price tag has always been only one part of the Tarp story.

The Congressional Oversight Panel released its final assessment of Tarp on Wednesday morning — 233 pages scrutinising every aspect of a program that began as an effort to save the US banking system by purchasing toxic assets, and evolved over time into one that included direct equity injections into banks, a bailout of AIG, the restructuring of the domestic auto industry, and (most disappointingly) Hamp.

From the summary, which begins with a reminder of the extraordinary panic that was gripping financial markets in the fall of 2008 before adding:

It is now clear that, although America has endured a wrenching recession, it has not experienced a second Great Depression. The TARP does not deserve full credit for this outcome, but it provided critical support to markets at a moment of profound uncertainty. It achieved this effect in part by providing capital to banks but, more significantly, by demonstrating that the United States would take any action necessary to prevent the collapse of its financial system.

The COP also acknowledges that Tarp’s overseers did a good job of maximising returns on some of its investments, in particular their management of AIG, Chrysler, and GM.

And that’s about the extent of the flattery. In addition to the purely financial burden on taxpayers…

Other costs include its distortion of the financial marketplace through its implicit guarantee of too big to fail banks. At the height of the financial crisis, 18 very large financial institutions received $208.6 billion in TARP funding almost overnight, in many cases without having to apply for funding or to demonstrate an ability to repay taxpayers. In light of these events, it is not surprising that markets have assumed that ―too big to fail banks are safer than their ―small enough to fail counterparts. Credit rating agencies continue to adjust the credit ratings of very large banks to reflect their implicit government guarantee. Smaller banks receive no such adjustment, and as a result, they pay more to borrow relative to very large banks.

By protecting very large banks from insolvency and collapse, the TARP also created moral hazard: very large financial institutions may now rationally decide to take inflated risks because they expect that, if their gamble fails, taxpayers will bear the loss. Ironically, these inflated risks may create even greater systemic risk and increase the likelihood of future crises and bailouts.

In addition, Treasury‘s intervention in the automotive industry, rescuing companies that were not banks and were not particularly interconnected within the financial system, extended the ―too big to fail guarantee and its associated moral hazard to non-financial firms. The implication being that any company in America can receive a government backstop, so long as its collapse would cost enough jobs or deal enough economic damage.

In other words, as necessary as Tarp was at the time, it’s an open question how much it will actually cost if the moral hazard described in the report leads to distortions in financial markets that in turn lead to more bailouts later on.

Implicit guarantees, a financial sector that is problematically consolidated in the largest institutions, an exacerbation of the already existing moral hazard problem — these legacies of Tarp have been debated ad nauseum, and we won’t rehash the arguments here.

(We previously tackled the history of financial sector moral hazard in this post, and we especially recommend this Free Exchange post from last October.)

Suffice to say here that we largely agree with the COP’s general conclusion: Tarp’s cost will probably be a lot higher than its price tag.

Related link:
A history lesson from the FCIC – FT Alphaville