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October 06, 2010

We’ve Been T*RPed

A man sat next to the window of a bus tearing paper into scraps and throwing them out the window. "Why are you doing that?" asked the woman next to him.

"It keeps the elephants away," he said.

"But I don't see any elephants," she objected.

"That's because it works," he said.

The same argument has been used to justify TARP: there is no depression so TARP must've worked and was therefore necessary. There are even calculations that we will almost break even on our TARP "investments". Baloney! The price of TARP will be at least a decade of over-regulation and, arguably, TARP has contributed to the length of the current malaise. The Fed, unfortunately, seems to be looking for a way to do a new mini-TARP, which will only make things worse.

Facts are facts: there were huge speculative excesses. Real estate had risen to unsustainable bubble prices and a wealth of Ponzi schemes had been built based on the conceit that the bubble would keep expanding infinitely. Wall Street and its global equivalents were on the brink of collapse. Bankers everywhere would have been in a world of hurt. In other words, the deregulated system was working pretty much the way it should have; those who took unreasonable risks were about to punished by the market and would have given back much of what they thought they earned – in some cases more. Golden parachute and other schemes of future compensation would have been properly voided in bankruptcy; high-paying banking jobs would have disappeared – all without the help of any regulators.

But the Fed, especially the New York Fed, felt the bankers pain. Common wisdom is that the Fed had to act to prevent a depression, and that the Fed's only mistake was letting Lehman Brothers go under. IMHO common wisdom is dead wrong: the Fed should have let Bear Stearns go under (it was rescued before Lehman collapsed). If that'd happened, chances are Lehman would have sold itself at a reasonable price before collapsing just as Merrill Lynch immediately sold itself post Lehman's demise. But, by saving Bear Stearns from bankruptcy, the Fed gave a signal that they would rescue bankers from their own excesses. BTW, note that the Bear Stearns shareholders were almost wiped out; but the counter-parties to its liabilities (largely other banks) and bankers owed future compensation were spared. The expectation of further bailouts STOPPED the market from sorting itself out by bankruptcy and M&A! The Lehman collapse was healthy (even though I was among the people who lost money in it) because it implied some discipline. But the Fed was quick to say that wasn't the lesson they wanted to teach; to this day they insist that, for technical reasons, they couldn't have saved Lehman rather than saying it was good policy not to do so.

No question that legitimate loans would have been hard to get and equity hard to raise during the disruption of investment banks collapsing – but notice these things have happened anyway and have been prolonged even though the banks were spared a trip through bankruptcy. It's just as impossible to prove that there wouldn't have been a depression had central bankers not saved their private sector brethren as it is to prove that there would have been a depression if they had allowed the market to assert its own discipline. But it's easy to enumerate the costs of TARP:

  1. Barriers to innovation. If the taxpayers are going to bail out feckless institutions, then it IS correct that those institutions have to be regulated in order to avoid future bailouts. Market discipline has been defanged; instead the jungle of the financial market place will be ruled by thousands and thousands of bureaucrats. Over-regulation works in favor of the status quo; over-regulation works in the favor of those with the best lawyers and best lobbyists; over-regulation prevents innovation (some innovation is bad, some good). Capital is and will remain hard to get for small companies and innovators. Banning risk-taking by bankers is terrible for the economy, but it is a necessary consequence of shielding them from the consequences of risk.
  2. The too-big-to-fail problem is worse. Those who won the bailout lottery swallowed up those who did less well and increased their effect on markets.
  3. Cascading bailouts. TARP for bankers made the bailout of the auto companies and the American Recovery and Reinvestment Act (aka The Stimulus Bill) politically inevitable. "How can you bailout bankers and not bailout auto workers and teachers and states and…?" Good question; impossible to answer once you've bailed out the bankers.
  4. Continued problems in the housing market. A big part of TARP has always been to make it possible for banks to avoid writing down their assets related to housing despite the fact that housing prices have obviously fallen. Since these assets are still over-valued on the balance sheets of banks, banks can't agree to write down the principal on loans even when that would make sense to both parties. So, like collapsed bubble gum, the legacy of the housing bubble is a sticky goo over the housing market which can't clear itself and resume. People can't refinance at new lower rates (isn't that convenient for banks?); people can't move from where jobs aren't to where jobs are. People can't trade one house for another even though their apparent loss on the old house is compensated by the apparent bargain on the new one.
  5. Continued lack of financing for small businesses. In order to allow banks to make "profits" with which to repay TARP (and gradually write down their mortgage portfolios), the Fed has made money available to the banks at almost no interest with which the banks can buy government debt on which we pay the interest. Since the Fed is giving the banks essentially free money, we can't charge the banks anything substantial for our deposits either. Just in case the banks think government bonds are too risky, the Fed is getting ready to start buying them up again. So, given this risk-free way for banks to make money AND the prospect of regulatory second guessing, why should the banks lend money to mere businesses?
  6. Loss of faith in the political system. For good reason, almost no one cites TARP as a positive example of bipartisanship even though it started under Bush and was continued by Obama, who also appointed TARP-architects to even more control over the economy. Instead TARP is a very clear indication that both major parties are in thrall to bankers, their lobbyists, and their campaign contributions. You don't have to look further for the heat that makes the tea party kettle boil.

TARP is not "breaking even"; we haven't begun to pay the bill.

Related posts:

Governments Hate Deflation – Should We?

Deflation – Is It Really So Terrible?

Time for the Citi to Sleep


Too Big to Fail


Now For the Good News…



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