The Agenda

But What Exactly Did TARP Buy Us? Plus the Case for Punto Final

Perhaps you’ve heard that the U.S. Treasury made a healthy return on TARP. Yalman Onaran and Alexis Leondis make that case in Bloomberg BusinessWeek:

 

The government has earned $25.2 billion on its investment of $309 billion in banks and insurance companies, an 8.2 percent return over two years, according to data compiled by Bloomberg. That beat U.S. Treasuries, high-yield savings accounts, money- market funds and certificates of deposit. Investing in the stock market or gold would have paid off better.

When the government first announced its intention to plow funds into the nation’s banks in October 2008 to resuscitate the financial system, many expected it to lose hundreds of billions of dollars. Two years later TARP’s bank and insurance investments have made money, and about two-thirds of the funds have been paid back. Yet Democrats are struggling to turn those gains into political capital, and the indirect costs of propping up banks could have longer-term consequences for the economy.

But there’s a small problem. What exactly did taxpayers get in exchange for TARP? Felix Salmon raised this question in an excellent post published earlier this month — and it really was Felix this time!

We’re still a long way from being able to render a final verdict on TARP. But the best that can be said for it at this point is that it helped to arrest the sickening downward spiral that the global financial system was falling into, and that it came in handy for bailing out the automakers. Against that, it failed to get banks lending again; it failed to do anything about the foreclosure crisis; it failed to make any kind of a dent in the unemployment crisis; it failed to hold bankers accountable for their actions; and it succeeded in generating a broad-based mistrust of institutions: the government and the financial-services industry certainly, and the judicial system possibly as well.

My own view is that TARP should have been compelled with a U.S. version of punto final, as Charles Calomiris suggested in October of 2008: 

The government would share losses borne by lenders from mortgage principal write-downs on a proportional basis. For example, taxpayers could absorb 20% of the write-down cost borne by lenders on any mortgage so long as it is agreed through a voluntary renegotiation between lenders and borrowers, and so long as doing so creates a sufficient write-down for borrowers to be able qualify for refinancing under the FHA facility.

Calomiris estimated that this approach would cost roughly $10 billion while making a meaningful difference for the balance sheets of middle class households:

 

Here is how it works. Suppose Joe has a mortgage of $130,000 on a home that is now worth $116,000. Joe’s lender realizes that Joe can really only afford an $85,000 mortgage, so any voluntary write-down that makes sense in avoiding foreclosure would have to entail a $45,000 write-down of principal. If, instead of a write-down, the lender forecloses, he will get a home worth $116,000 minus the cost of foreclosure (say that the foreclosure cost is $30,000), which would be $86,000. So a value maximizing lender in this example–in the absence of any loss sharing from the government–would rather foreclose (and be left with $86,000 worth of house) than write down the loan to the $85,000 Joe can afford.

In Joe’s case, if the government were willing to bear 20% of the lender’s write-down cost, the lender would be willing to write the loan down to $85,000 and not foreclose, since the lender would end up with $94,000. That figure comes from the $85,000 loan plus a loss-sharing payment of $9,000 from the government (equal to 20% of the write-down cost of $45,000)–which is more than the $86,000 he would end up with from foreclosing.

It would be easy to show, however, that if Joe were in worse shape and needed the loan to be written down to $40,000 in order to stay in his home, the lender would still prefer foreclosing since the value received from the write-down ($40,000 plus 20% of 90%) is only $58,000, which is less than the $86,000 payoff to the lender from foreclosure.

And Calomiris’s plan is variable — it could be made more or less generous, as Congress deems necessary:

The percentage of loss sharing (10%, 20% or more–the Mexican government set the loss sharing at 50%) could be set according to a reasonable cost-benefit analysis, depending on the weights attached by Congress. I would guess that a 20% loss sharing offer would make a big difference at modest cost.

Following Mexico’s example, the government could put a deadline on the plan, requiring that agreement be reached quickly in order to qualify for loss sharing. This worked to speed up resolutions of distressed loans in Mexico, which obviously would be helpful under the current circumstances.

It is possible that we’ll need something like a punto final approach in the near future regardless. TARP did nothing to address the underlying problem that Calomiris addresses. And I think that’s good reason to be, well, really, really mad, even if TARP “makes a profit.” 

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