A Look Back at TARP-- The 2008 Bank Bailout by youdontsay

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A Look Back at TARP-- The 2008 Bank Bailout
https://www.mintpressnews.com/wp-content/uploads/2014/03/occupy_oakland_gen_strike_23.jpg

In August of 2007 the United States economy began a plunge that would rival the great depression of the 1930’s.  Financial institutions lost billions of dollars, unemployment and homelessness skyrocketed, and the national debt surpassed ten trillion dollars.  While the collapse occurred rapidly, it was precipitated by the housing bubble which had been growing for decades.  The bubble was formed by climbing rates of household debt coupled with rising housing prices.  Increases in the price of housing vastly exceeded the general inflation rate.  The high cost of housing perpetuated a building boom that culminated in a surplus of unsold homes, which caused housing prices to unexpectedly decline in mid-2006. Believing that house prices would continue to climb, many borrowers relied upon adjustable-rate mortgages. Adjustable-rate mortgages offer loans at low interest rates for a set period, followed by market value interest rates for the remainder of the mortgage's term.  Many borrowers could not afford the higher payments after the end of the low rate period, but planned to refinance their mortgages after the value had appreciated. 

When housing prices plummeted, refinancing became useless. As a result, borrowers began to default on their loans at staggering rates, catching the financial institutions off-guard.  Large banks had invested a great deal of their finances in mortgage-backed securities and CDOs— essentially giant bundles of mortgages, which became valueless as borrowers stopped paying their mortgage payments.  The investment banks issuing the CDOs earned a commission at the time of issue and management fees throughout the life of the CDO. Disastrously, the enticing profits offered by these fees convinced banks to pursue loan volume over loan quality.  As banks saw the value of their assets disappear, foreclosures and the increasing supply of homes caused housing prices, along with homeowners’ equity, to continue falling.

In order to combat this catastrophic collapse, congress passed TARP— The Troubled Asset Relief Program— as part of the Emergency Economic Stabilization Act of 2008.  Commonly referred to as “the bailout,” The Troubled Asset Relief Program provided congress with seven hundred billion dollars with which to insure transactions and purchase “toxic” assets from major financial institutions.  In doing so, congress hoped to “restore liquidity and stability to the financial system” by ensuring that banks continued lending to companies, consumers, and each other.  In the aftermath of the crash, financial panic kept most banks from making even the most prudent loans. 

![Screen Shot 2018-09-11 at 2.15.04 PM.png](https://cdn.steemitimages.com/DQmZULekXRy8CwBEPHFsFUynn4sAi6dZ5e73oQ5jipkhb36/Screen%20Shot%202018-09-11%20at%202.15.04%20PM.png)
<center>[Image Source](https://s3.reutersmedia.net/resources/r/?m=02&d=20180802&t=2&i=1289613099&r=LYNXMPEE711TN&w=1280)</center>

The Act specified that financial institutions selling assets to the Treasury were required to also issue equity warrants, equity, or senior debt securities to the Treasury. An equity warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed, low price until the warrant expires. The Treasury would only receive warrants for non-voting shares, meaning it would have no control over company policy but would still benefit from company profits.  This quid pro quo was put in place to help the Treasury recoup the cost of the bailout by profiting from ownership stakes in the very institutions being bailed out. If the banks recovered or surpassed their former strength, the government would be able to share in the profits.  Meanwhile, the Treasury would still be able to sell the immense numbers of mortgage-backed securities purchased from the financial institutions.  “Toxic” or not, selling these assets would recoup much of the cost of purchasing them in the first place.  For safety’s sake, the Treasury would begin with investing only 250 billion of the allotted 700 billion dollars.  Congress would then have the option to authorize another 250 billion if such a move was deemed beneficial. Ultimately, 416 billion of the allotted money was invested.  

The plan, though it took months to be put into action, was actually fairly simple.  The Treasury would buy the troubled assets from the banks and insure their loans, guaranteeing that banks would have enough capitol to continue doing business and recover their losses.  In exchange, the Treasury would receive stock in those companies and an immense quantity of sellable assets.  As the banks recover, the Treasury would profit from the bank stocks and sell the troubled assets in order to recoup the the bailout money and, ideally, turn a profit.  

In very real sense, The Troubled Asset Relief Program turned the Secretary of the Treasury into a sort of national hedge-fund manager, with all American tax payers as investors.  TARP’s provisions gave the Secretary the power to buy troubled mortgage-related assets from finance companies as well as the power to invest in "any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability.” This sweeping clause grants the Secretary the authority to manage virtually any assets in any manner he sees fit.  The Treasury would also have the ability to wheel and deal with the institutions it is helping, demanding large equity states or new debt securities in exchange for funds. The Treasury can even bring in outside traders to manage the investment, outsourcing the financial decision making in much the same way that investors outsource their decisions in a traditional hedge-fund.  Unlike a traditional hedge-fund, however, the Treasury’s financial decisions were to be made with maximum transparency.  Taxpayers had to be kept informed on where their money was going, and all new sales and purchases had to be promptly disclosed on the Treasury’s website within two days of the purchase.  Additionally, the Treasury had to post “mechanisms for purchasing troubled assets,” “methods for pricing and valuing troubled assets,” “procedures for selecting asset managers,” and “criteria for identifying troubled assets for purchase,” as well as provide written reports to a congressional committee disclosing:

*A)  a description of all of the transactions made during the reporting period; 
B)  a description of the pricing mechanism for the transactions;
C)  a justification of the price paid for and other financial terms associated with the transactions;
D)  a description of the impact of the exercise of such authority on the financial system, supported, to the extent possible, by specific data; 
E)  a description of challenges that remain in the financial system, including any benchmarks yet to be achieved; and
F) an estimate of additional actions under the authority provided under this Act that may be necessary to address such challenges.*

All of these disclosures were meant to create transparency, reassuring the American people and congress that their money was being spent wisely.  This transparency would also provide some accountability in the event that the money was lost through mis-management.  A traditional hedge-fund, on the other hand, would operate with strategic secrecy, perhaps even hiding its decisions from its own investors. Another key difference lies in the mechanism for the distribution of proceeds.  Rather than pay dividends to each of the investors— in this case the taxpayers— The Troubled Asset Relief Program specifies that revenues and profits "shall be paid into the general fund of the Treasury for reduction of the public debt.”

C.A.M.E.L.S. ratings were used to help decide which banks to save and which to ignore. C.A.M.E.L.S. ratings— which assess Capital adequacy, Assets, Management capability, Earnings, Liquidity, and Sensitivity— are used to assign all of the nation's banks a 1-5 ranking, where 1 indicates the strongest performance.  In the case of the bailout funds, a ranking of 1 indicated a bank most likely to be helped and a 5 most likely to be passed over. The government loosely defined what constitutes a healthy institution, funding the largest banks and the banks that were most profitable in the preceding year.   The criteria clearly favored the financial institutions most likely to survive, the wealthiest banks, and the banks “too big to let fail,” though it is important to remember that this was a financial investment and not merely an altruistic, charitable offer of funds.  By working with the largest and most secure banks, the Treasury Department made a safe investment while simultaneously maximizing their efforts to grease the financial wheels into motion. 

![Screen Shot 2018-09-11 at 2.17.20 PM.png](https://cdn.steemitimages.com/DQmRm3RBZVMu9N8Ly7GCYkgfVhqp6fir7BgsFPK7jZ2Voce/Screen%20Shot%202018-09-11%20at%202.17.20%20PM.png)
<center>Pretty much how the CAMELS system worked</center>
<center>[Image Source](https://i.ytimg.com/vi/Co2-0ICtRlU/maxresdefault.jpg)</center>

Some lawmakers were upset that banks in their districts were skipped over for TARP funding.  However, it seems that even more lawmakers were successfully using TARP to fund the weak financial institutions in their own districts.  Banks and credit unions located in the districts of key Congress members received an anomalous amount of TARP money.  Forty-eight credit unions received funds through The Troubled Asset Relief Program.  Curiously, the odds of a credit union receiving bailout funds leapt from 29 percent to 81 percent if the institution’s headquarters happened to lie in the district of a member of the U.S. House Financial Services Committee (HFS). 

Ironically, the credit unions that received funds from TARP became significantly less likely to make loans available to their communities, in spite of the fact that one of TARP’s chief goals was to encourage financial institutions to make more loans. Credit unions were largely overlooked until they began receiving more funding in September 2010, just before the window for new investments closed permanently.  Small fish in comparison to the major banks, bailing out credit unions was not the top priority for stabilizing the economy.  Eventually, however, they collectively received more than 69 million dollars of funding, and much of that funding seemed to have contradicted TARP’s stated goal of “improving access to credit for small businesses” and “[investing] lower-cost capital in Community Development Financial Institutions (CDFIs) that lend to small businesses in the country's hardest-hit communities.”  The credit unions were evidently not selected based on their necessity in the community nor their propensity to grant loans, but instead their relationship to the people in charge of awarding the funds.	

The revelation that credit unions may have been awarded funds on an unfair basis resulted in a notable controversy, but the drama of the credit union controversy was dwarfed by the drama of the A.I.G. executive bonus controversy.  A.I.G., one of the largest financial institutions in America, suffered extraordinary losses in the housing market crash, including 61.7 billion dollars in the fourth quarter of 2008 alone, the greatest loss in a single quarter by any corporation in history.  A.I.G. had insured various financial institutions through the usage of credit default swaps, but did not have the capital to support its many CDS commitments. In spite of this catastrophic mismanagement, the Treasury provided over $180 billion in government support to A.I.G. during 2008 and early 2009 and purchased 67.8 billion dollars in preferred shares.  The public hardly batted an eye until they were informed that A.I.G. would be awarding 218 million dollars worth of bonuses to various employees in their financial services division, and hundreds of millions of dollars more in other sectors of the business.  Citizens, many homeless, unemployed, or otherwise struggling to make ends meet, were outraged to see their hard-earned money being funneled into the pockets of the very people whose reckless trading had squandered billions. 

http://www.canadiantimes.ca/ct2/images/Hold-Banks-Accountable048.png
<center>[Image Source](http://www.canadiantimes.ca/ct2/images/Hold-Banks-Accountable048.png)</center> 

Even President Obama expressed disgust with the staggering bonuses.  He requested that the Treasury attempt to block the bonuses and said to the American people, “This is a corporation that finds itself in financial distress due to recklessness and greed… This isn’t just a matter of dollars and cents. It’s about our fundamental values.”  The provisions of The Troubled Asset Relief Program addressed the issue of executive compensation and were intended to prevent large swaths of taxpayer money from being placed in the pockets of wealthy executives.  Unfortunately, the provisions were not neither strict nor rigidly defined.  The bill called for:

*A) limits on compensation that exclude incentives for senior executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary holds an equity or debt position in the financial institution.
B)a provision for the recovery by the financial institution of any bonus or incentive compensation paid to a senior executive officer based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate; and
C)a prohibition on the financial institution making any golden parachute payment to its senior executive officer during the period that the Secretary holds an equity or debt position in the financial institution.*

Effectively, these provisions made virtually no impact on the awarding of bonuses except to prevent new golden parachute contracts, which would award large sums of retirement money for brief periods of employment.  Otherwise, financial institutions were free to award bonuses so long as they didn’t misrepresent earnings or “take unnecessary and excessive risks that threaten the value of the financial institution…”  Congress was in an uproar over the A.I.G. bonuses, and quickly began discussing a tax on the money being awarded to executives, with some congressmen going so far as to call for an absurd 100% tax.  The house passed a bill that would impose a 90% tax on bonuses for employees earning more than $250,000 a year at companies receiving more than $5 billion in government aid.  A senate version of the bill called for a 70% tax.  Both efforts were pleasing to much of the public but heavily derided by the financial industry.  Some compared it to extortion, highly paid employees claimed to have no incentive to work through the year, and several institutions chose to avoid accepting government aid altogether.  The controversy was also exacerbated because it coincided with outrage regarding Henry Paulson, the current Secretary of the Treasury, being a former employee of Goldman Sachs, one of the largest recipients of TARP assistance.  

Goldman Sachs would have undoubtedly been bailed out regardless of Henry Paulson’s position, but the apparent conflict of interest, coupled with the bonus scandal, was enough to make people fume.  It was ironic, also, because the TARP legislation contained a passage related to conflicts of interest which reads, “The Secretary shall issue regulations or guidelines necessary to address and manage or to prohibit conflicts of interest that may arise in connection with the administration and execution of the authorities provided under this Act, including… post-employment restrictions on employees.”  Evidently, Paulson was immune to these post-employment restrictions on employees.

In spite of the controversies, The Troubled Asset Relief Program was actually remarkably successful, perhaps even surprisingly so.  For many people it is hard to accept that “corporate welfare” allowed reckless banks to ride out the recession without fully enduring the consequences of their unscrupulous money management.  On the other hand, the TARP funding succeeded in reestablishing liquidity and rescuing the stock market from the brink of oblivion.  The plan had a positive impact before it even went into effect, eliciting a 3% rise in the stock market on September 19th, 2008, the day it was announced to the public.  

Ultimately, the Treasury used only 416 billion dollars of the 700 billion it was allotted.  Of the 416 billion dollars invested, all but 37.3 billion had been recouped as of August 2015.  While inflation, unemployment, and homelessness remain dire problems in the United States, TARP allowed a semblance of hope and normalcy to return, preventing the nation’s financial gears from grinding to an utter halt.  However, hindsight is twenty-twenty, and thus it is inevitable that we find areas of the legislation that could have been tweaked and improved.  

The bonus controversy could have been avoided entirely if the bill had placed an explicit cap upon salaries and bonuses for TARP-funded institutions.  After all, large bonuses for CEO’s do virtually nothing toward strengthening economy— aside from, of course, a marginal boost to yacht and Mercedes-Benz sales.  The TARP funds could have also been more evenly distributed.  Due to the skewed nature of the CAMELS rating system, the largest banks received extraordinary amounts of capital, while smaller, regional banks were almost entirely overlooked.  Big banks may have held larger sway over economic trends, but there was plenty of available government money that could have helped the large swaths of regional banks that were crippled by the crash.  Meanwhile, the regional banks and credit unions that did receive funds were helped out on the basis of political connections instead of genuine merit.  The unbalanced distribution of funding, though effective in salvaging the stock market, sent a message to ordinary citizens that the government will ensure the rich stay rich, even when they squander their money.  

All in all, however, The Troubled Asset Relief Program accomplished what it set out to do, more or less establishing a federal hedge-fund to invest directly in America’s most critical financial institutions.  
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<center>**Works Cited**</center>

Cooper, Helene. "Obama's Statement on A.I.G." Nytimes.com. The New York Times, 16 Mar. 2009. Web. 20 Jan. 2016.

Gross, Daniel. "How the Bailout Scheme Is like a Hedge Fund." Slate.com. The Slate Group, 1 Oct. 2008. Web. 20 Jan. 2016.

Holt, Jeff. "A Summary of the Primary Causes of the Housing Bubble and the Resulting Credit Crisis: A Non-Technical Paper." The Journal of Business Inquiry 8.1 (2009): 120-29. Uvu.edu. Utah Valley University. Web. 20 Jan. 2016.

H.R. 1424, 110th Cong., Govtrack.us (2008) (enacted). Web.

Pana, Elisabeta, and Linus Wilson. "Political Influence and TARP Investments in Credit Unions." N.p., 30 Oct. 2012. Web. 20 Jan. 2016.

Soloman, Deborah, Damian Paletta, and Aaron Lucchetti. "U.S. to Buy Stakes in Nation's Largest Banks." WSJ. The Wall Street Journal, 14 Oct. 2008. Web. 20 Jan. 2016.

Stein, Sam. "Paulson's Conflicts Of Interest Spark Concern." The Huffington Post. TheHuffingtonPost.com, 23 Oct. 2008. Web. 20 Jan. 2016.

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@tts ·
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@franciscana23 · (edited)
Una publicación muy completa @youdontsay sobre la crisis económica que atravesarón los Estados Unidos de América dn el año 2007 que esperemos no vuelva a repertirse en ese ni en ningún otro pais del mundo por que los que más sufren son las clases más desprotegidas
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@glorimarbolivar ·
article interesting friend thanks for sharing
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