On Monday I made the case that TARP's near-profitability is no indication that it was a good bill, and that it nevertheless has been hugely costly to the public. In the course of that argument I pushed back against the suggestion that the administration engineered the TARP banks' profitability through a back door bailout using Fannie Mae and Freddie Mac to buy the banks' bad assets.
The National Taxpayers Union has sent along some evidence that Fannie and Freddie have in fact cut some TARP banks sweetheart deals. Specifically, recently Bank of America settled claims from Fannie and Freddie to buy back faulty loans for a seemingly low price. The deal involved a payment of $2.8 billion for loans worth at least $4.1 billion, according to Bloomberg, and potentially far more. The agreement immediately lifted bank stocks significantly, presumably because it signalled that other banks would be able to resolve similar claims just as easily.
Yet this settlement occurred well after the banks covered by TARP had fully recovered and already had become enormously profitably. It had little to do with TARP's profitability. As with all the many other ways that taxpayers gave money to Wall Street, the relevant issue is not the monetary cost but the distortions introduced into the markets.
The outgoing TARP special inspector general Neil Barofsky has consistently articulated the argument that TARP generated massive inefficiencies, and he did so again yesterday in an interview with Federal News Radio. Emphasis mine:
One of TARP's "biggest legacies," said Barofsky, "is that when first Secretary (Henry) Paulson then Secretary (Timothy) Geithner guaranteed the nation's largest banks against failure,...they achieved the goal of helping to preserve the system, but they also created the expectation that going forward that these largest banks will be bailed out again if there's a problem. And right now, as we sit here in 2011, the market really perceives that these largest banks are still too big to fail and if they get into trouble the government is going to bail them out. And that really is a perversion on the market."
In turn, said Barofsky, that perception "terribly distorts market. It screws up incentives. Executives have the incentive, rational incentive, to take on more risk with the assumption the government will bail them out if their decisions go awry, and that creates banks that are even larger, even more systemically important, and therefore makes the financial system even more vulnerable to the exact type of catastrophe, of crisis, that we experienced in 2008, so I'm very, very concerned about where we are going forward if something isn't done dramatically and quickly to deal with these legacy issues."
Well thought out, proactive changes would be very different from how the program started. Barofsky noted "when you go back into the belly of that beast in October of 2008, there was really a sense of panic, and there really was a sense of 'let's try anything and everything.' And I'm sure they drew on the talented career government civil servants, who of course formed the backbone of so much of what we do, but ...the decisions were made at the highest levels and they were driven by an understandable panic. The real question has been since then, what has been done? And I think when you look at things like the failures to acknowledge mistakes, the failures to sort of address those issues, those are more political decisions...and that's really the political appointees who are driving that train."
In other words, the financial crisis was brought on by problems related to policial economy. TARP made the biggest problem -- the existence of banks too big to fail -- even worse, in a variety of ways. The fact that those banks were then able to turn a profit for the government doesn't make up for that fact.
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