TARP’s Lower Cost Doesn’t Assuage Critics
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The Fiscal Times
March 4, 2011

The Toxic Assets Relief Program, the most vilified corporate bailout in American history, is winding down at a cost far below the $700 billion that former Secretary of Treasury Hank Paulson scribbled on the back of an envelope in October 2008. But the final price tag of “only” $25 billion to $50 billion, the estimate offered by a top Obama administration Treasury official Friday, did little to assuage members of the five-member Congressional Oversight Panel during its last public session. The bi-partisan group used its final meeting to blast away at the mega-banks whose irresponsible lending practices led to the worst financial crisis since the Great Depression and left the nation with the lingering after effects of high unemployment and sluggish economic growth.

The committee’s primary focus was the “moral hazard” engendered by the bailout, which, even though it has been mostly repaid, enabled banks to rapidly return to profitability while the housing market remains in shambles and businesses on Main Street are still scrambling for loans. “There is this belief that the rules don’t apply to them,” said former Sen. Ted Kaufman, D-Del., who chaired the panel. “The cost of moral hazard is not easily quantifiable, but it is real and it is reprehensible.”

“Repayment is a mismeasure of the effectiveness of the TARP and should not serve as the metric by which the TARP is judged,” said J. Mark McWatters, a Dallas-based corporate attorney and Republican appointee to the oversight panel. “The TARP in essence reinforced the bubble bailout cycle as the government’s preferred business model.”

Final Report Still to Come
For its last meeting the oversight panel invited four prominent TARP critics to serve as its chorus. Their views will undoubtedly be reflected in the final report that will be issued later this month.

The witnesses, who spanned the ideological spectrum, agreed that legislative changes in the aftermath of TARP – primarily passage of the Dodd-Frank financial regulations reform law – are not sufficient to prevent another crisis from happening. Nor, when that happens, will the government be able to avoid another bailout of the monster banks that have emerged from the first financial crisis of the 21st century.

“If Goldman Sachs (which now has $900 billion in assets) hits a rock, does  anybody here believe they will be allowed to fail now or in the near future,” said MIT professor Simon Johnson, the former chief economist at the International Monetary Fund and a senior fellow at the Peterson Institute for International Economics, which is funded in part by Peter G.  Peterson, who also funds The Fiscal Times. “I’ve yet to find anyone who realistically thinks it could fail.”

The new regulations in the Dodd-Frank bill allow the government to take over non-bank institutions that pose a systemic risk to the financial system; created a coordinating council for financial oversight; legislated higher capital standards for banks; and set tighter regulation of riskier instruments like financial derivatives. “Dodd-Frank gives us a variety of tools which should enable us to minimize and prevent these sorts of conditions again,” Timothy Massad, acting Assistant Treasury Secretary for the Office of Financial Stability, told the panel. “While much work remains to implement that, that is the principle way we’re trying to address the moral hazard issue.”

Large financial institutions, the U.S. Chamber of Commerce and the Financial Services Roundtable have launched a massive lobbying blitz to weaken those regulations, most of which are still being written. “The banks have gotten much higher returns from their political investment than from any other investment,” said Joseph Stiglitz, the Nobel Prize-winning economist who teaches at Columbia University. “Where’s the best place to put your money? It’s on K Street.”

‘Regulations are Circumvented by Lawyers and Markets’
Allan Meltzer, a professor of political economy at Carnegie Mellon University who has long been associated with the conservative American Enterprise Institute, dismissed the notion that better regulation will be capable of reining in risky behavior by behemoth banks. “Watching the lobbyists every day influence the rules that were passed in Dodd-Frank tells me that regulation is not going to work,” he said. “Regulations are made by regulators and are circumvented by lawyers and markets. We need to have capital requirements where the incentives are on the banker to avoid TARP.”

Capital requirements refer to the percentage of assets (loans outstanding to the bank) that must be set aside for potential losses. Meltzer called for setting capital standards at 10 percent for banks beyond the community-bank size, with levels reaching 20 percent once they reach $50 billion in assets. That would go significantly beyond current international standards, which are known as the Basel standards.

Luigi Zingales, a business professor at the University of Chicago, cautioned that big banks can use accounting tricks to game capital requirements. “Washington Mutual didn’t violate any capital requirements before it failed. Lehman had 11 percent capital before it went bust,” he said. “This accounting-based capital requirement doesn’t work. It has to be market-based capital.”

Panel members also focused on the failure of TARP to resolve the home foreclosure crisis. Its Home Affordable Modification Program (HAMP) was initially slated to receive $50 billion in funding and help 2 to 3 million homeowners facing foreclosure. So far, only 600,000 homeowners have been helped and the program has only expended $1 billion, even though the foreclosure crisis and sinking home values continue to plague many areas of the country.

Damon Silvers, an AFL-CIO lawyer who was a Democratic appointee to the oversight panel, asked Treasury’s Massad what might have made the HAMP program more successful. The law prohibited Treasury from using funds to support homeowners with legal aid and counseling, and did not change the bankruptcy code to allow judges to write down the value of mortgages – so-called cram downs.

“We supported legislation to do that, but it didn’t go anywhere,” Massad said.

House Republicans have put housing aid on the chopping block. Earlier this week the House Financial Services Committee approved bills to eliminate a housing refinance program at the Federal Housing Administration and the $1 billion emergency mortgage relief program authorized by the Dodd-Frank bill. Next week, the committee will consider elimination of HAMP.

Related Links:
U.S. Treasury to Congressional Panel: TARP Worked (Reuters)
Treasury Defends TARP to a Panel of Critics (MarketWatch)
Treasure Official Praises TARP, Expresses Concern for the Housing Sector (ABCNews.com)

spent 25 years as a foreign correspondent, economics writer and investigative business reporter for the Chicago Tribune and other publications. He is the author of the 2004 book, The $800 Million Pill: The Truth Behind the Cost of New Drugs.