August 16, 2010
Based on Elizabeth Warren’s work as chairman of the Congressional Oversight Panel, it is not clear she has the balanced judgment needed to direct the new Consumer Financial Protection Agency within the Federal Reserve.
The oversight panel was created in the fall of 2008 to study and report on execution of the $700 billion Troubled Asset Relief Program intended to help stabilize chaotic conditions in U.S. financial markets that were threatening to bring on a second Great Depression.
Under Warren’s leadership, the panel has acknowledged — though only in passing — that actions related to TARP helped the country avert a financial collapse. The main focus of the panel’s reports have emphasized the program’s supposedly “enormous” costs while proposing cheaper alternatives that might well have failed to work.
As a result, the reports have undercut public confidence in the government and helped foster the widespread notion that TARP did nothing but bail out wealthy Wall Street investors who didn’t deserve it.
In a new study published last month ,“How the Great Recession Was Brought to an End,” economists Alan Blinder of Princeton University and Mark Zandi of Economy.com reviewed TARP: “Both the program’s $700 billion headline price tag and its goal of ‘bailing out’ financial institutions — including some of the same institutions that triggered the panic in the first place — were hard for citizens and legislators to swallow. To this day, many believe the TARP was a costly failure.
“In fact, TARP has been a substantial success, helping to restore stability to the financial system and to end the freefall in housing and auto markets,” with its ultimate cost to taxpayers of less than $100 billion and “with the bank bailout component probably turning a profit,” Blinder and Zandi said.
Most of the $100 billion involves subsidies to protect homeowners from mortgage foreclosures. Nearly $50 billion of TARP money helped fund the rescue of the American International Group, arguably the world’s largest insurance company, in September 2008 when it was on the verge of bankruptcy. AIG was in trouble primarily because it had sold a large number of credit default swaps — a form of insurance contract that pays off if a bond or other type of security goes into default — to financial institutions. Many of the securities involved subprime mortgages that turned sour. Had the government known much earlier that AIG was becoming a basket case — and the panel justifiably criticizes the abysmal failure of regulators to recognize this — some of those options might have been viable.
In June, Warren’s oversight panel issued a 337-page report on the AIG rescue, which initially required $85 billion from the Federal Reserve and later the TARP money. In a video linked to the opening page of the report, Warren said the total amount of about $182 billion was equal “to almost $2,500 for every household in America.” Moreover, “the government failed to exhaust all options before rescuing AIG,” putting taxpayer dollars at risk.
According to the report, before using taxpayer money, the government should have considered a type of public/private rescue, a loan conditioned on AIG creditors granting concessions, or a short-term bridge loan from the New York Fed to provide AIG time for longer-term restructuring.
Had the government known much earlier that AIG was becoming a basket case — and the panel justifiably criticizes the abysmal failure of regulators to recognize this — some of those options might have been viable.
But the Fed and the Treasury were also trying that September to find a buyer for the investment bank, Lehman Brothers Holdings, an effort that finally failed. The Lehman bankruptcy did enormous damage to financial markets and made AIG’s plight far worse.
In fact, AIG was attempting that month to find lenders on its own. When that failed, the company then hoped the Fed would back it up with tens of billions of dollars worth of loan guarantees. However, as the report notes, AIG couldn’t even tell how much assistance it needed and every day between Sept. 12 and 16 the amount shot up.
“Not only was the company not able to provide a sense of its balance sheet and its exposure to either potential private sector investors or the government, but its capital deficit was growing much faster than available capital,” the panel’s report said. “This also appears to have been a factor in the breakdown in private-sector efforts to provide a solution for AIG, as AIG could not produce certainty on any of the metrics on which lenders typically lend.”
Warren and the panel simply ignored reality in asserting that the government “failed to exhaust all options” before risking taxpayer money in the rescue.
In the video Warren even says, “A private rescue would have been difficult, perhaps even impossible to arrange. But if the effort had succeeded the impact on market confidence would have been extraordinary and the savings to taxpayers would have been immense.”
What might have been the cost to the financial system and the economy if the government had held off hoping for the best as rating agencies speedily lowered AIG’s credit rating — triggering new demands for payments under the credit default swap contracts — and some creditor had forced AIG into bankruptcy? A partial answer can be found on the New York Federal Reserve Bank’s website. The report speculates in detail whether the many AIG insurance subsidiaries might have been able to survive a bankruptcy by their parent. The conclusion was that nobody could be sure — and if worse came to worse perhaps the government could help pay policyholders claims!
“In the ordinary course of business, the costs of an AIG failure would have been borne by its shareholders and its creditors,” Warren said. “But the government instead shifted those costs in full to taxpayers. This meant we rescued highly sophisticated investors who voluntarily accepted grave risks.”
That sort of language is misleading and only reinforces the views that the government wasted taxpayer money to save the fat cats. It’s misleading, first, because AIG shareholders were virtually wiped out. Second, much of the government’s assistance has been repaid and there is a good chance that within two or three years it all will be. Third, the true cost of an AIG failure — with its disastrous impact on the financial system — would have been borne by the additional millions of Americans who would have lost jobs and income during the even deeper recession that would have occurred.
Almost grudgingly, at the end of the video, Warren says, “By at least one measure, the government’s actions were a success. America did not fall into a full-scale depression, for which we should all be grateful.”
Isn’t that the most important measure? Instead of carping about might-have-beens, shouldn’t Warren and the panel have thought about praising the policy makers who had the courage to take unprecedented steps and risks to avoid a depression? What does all this say about the quality of her judgment?