Is Treasury Really Profiting from TARP?

by Avik Roy

According to the Congressional Budget Office, the government actually made money bailing out the banks—to the tune of $22 billion. (CBO says TARP has lost $14 billion on aid to AIG; $19 billion for the auto industry; $12 billion for mortgage programs; and $2 billion for other activities.)

An interesting op-ed from Paul Atkins, Mark McWatters, and Kenneth Troske in the Wall Street Journal argues that the government’s accounting is misleading. For example, Treasury changed its valuation methodology for its losses in AIG:

The Special Inspector General for TARP criticized Treasury in October for inadequately disclosing a change in its valuation methodology that reduced a $45 billion loss in AIG to $5 billion, making TARP losses appear smaller than they really are. This data manipulation is only part of a much larger problem with Treasury’s representations regarding the supposed success of the bank bailout payments that lie at the heart of TARP.

In addition, the Federal Reserve is inflating bank profits with low interest rates, and artificially propping up the mortgage market, postponing the inevitable defaults of the future:

The focus on repayment fails to consider the huge taxpayer costs from non-TARP programs that directly and indirectly enabled many of the large banks to repay their TARP funds. These intertwined programs, operated by the Treasury and the Federal Reserve, dwarf the size of TARP and lack its accountability.

The financial crisis was born in the housing bubble caused by the policies of Fannie Mae and Freddie Mac, the two bankrupt government-sponsored entities (GSEs) charged with buying and packaging mortgages into mortgage-backed securities (MBS). TARP banks own billions of dollars worth of MBS and have remained liquid in part because the Federal Reserve has bought more than $1.1 trillion of these GSE-guaranteed MBS in the securities markets—all outside TARP.

The Fed purchased the MBS at fair market value, but this value reflects Treasury’s bailout and continued support of the GSEs—also done outside of TARP with taxpayer money. Had the GSEs failed, TARP recipients probably would have been stuck with these MBS, writing them down at significant loss. Their ability to pay back TARP funding would have been hurt, and they might have had to obtain more TARP funds or go bust.

So the taxpayer-backed GSE guarantee enables the Fed to prop up the market with taxpayer funds, in turn allowing the TARP banks to “repay” their TARP funds. The bailout of the GSEs by Treasury thus shifts potential losses from TARP to other programs that have less oversight and public scrutiny. Any evaluation of TARP’s success must take into account the interaction among all government programs designed to prop-up the financial system, and the shifting of costs among these programs.

“The government’s efforts inside and outside of TARP have sown the seeds for the next crisis,” the authors argue, “and, unfortunately last year’s 2,319-page Dodd-Frank Act does nothing to fix these problems.” These are important points: veteran finance watchers I know are deeply concerned about the instability caused by Treasury and the Fed, and other problems ossified by Dodd-Frank. (Pick up any given copy of Grant’s Interest Rate Observer to get a sense of what I mean.)

Given the real possibility of a second financial crisis in the next few years, it’s quite possible that Dodd-Frank, and not Obamacare, was the single greatest policy mistake of 2010. And that is saying a lot.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.