The Congressional Budget Office’s most recent assessment of the cost of the Troubled Asset Relief Program, in late May, occasioned far less thoughtful discussion of the role of government than it should have.
The original TARP program was signed into law three weeks after the September 2008 stock market meltdown and rolled a lot of financial activities into one piece of legislation.
The law allowed the U.S. Treasury to buy some $700 billion of collateralized debt obligations. These toxic assets were made up of billions of dollars of mortgages, which were, on average, remarkably safe. The problem was that it required months to determine the few that were not. As a consequence, they could not sell.
This meant the otherwise healthy banks that held them could not pay off depositors who wanted their money back. While most of these institutions were commercial or investment banks, a run on their assets would’ve likely sparked a run on banks across the country.
So, for all intents and purposes, TARP allowed Treasury to act a lot like George Bailey using his honeymoon money to quell a bank run. Just like George and Mary Bailey, Treasury got all its money back from supporting liquidity in healthy banks.
If TARP had ended there, it’d have cost the government nothing and been heralded as an unambiguous success.
But TARP was also used to take over financial firms that were basically bankrupt, including AIG, and Fannie Mae and Freddie Mac. TARP also bailed out GM and Chrysler. Here, the government lost money.
Popular discussion about the government’s interference in markets often conflates the process of insuring liquidity in healthy banks and bailing out failed businesses. It is important to understand the difference.
All governments work to insure a liquid banking system, and like it or not, it is part of a modern banking system. It is a fairly light touch of government.
But bailing out failing companies is bad practice because it encourages risky behavior. Freddie Mac failed in part because it was leveraged 70:1 on assets. The government takeover prevented widespread legal action that would have offered a clear lesson economy-wide.
Bailing out failing companies also effectively punishes those who were doing the right thing. Ford Motor Co. spent the last two decades making cars and trucks people wanted and streamlining production. GM and Chrysler instead hired lobbyists, and our government rewarded this.
The lesson for big business is to take heavy risks and hire lots of lobbyists. Those are the real costs of government bailouts.•
Hicks is director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at firstname.lastname@example.org.