April 18, 2012

TARP Success TRAP

Hester Peirce

Former Senior Research Fellow
Summary

The Treasury Department has released its latest effort to persuade us all of the merits of the financial crisis bailouts. 19 colorful charts tell the story of the crisis, the government’s response, and the current state of the economy, but the picture is not nearly as pretty as Treasury’s optimistic rendition would have us believe.

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The Treasury Department has released its latest effort to persuade us all of the merits of the financial crisis bailouts.  Nineteen colorful charts tell the story of the crisis, the government’s response, and the current state of the economy, but the picture is not nearly as pretty as Treasury’s optimistic rendition would have us believe.

First, Treasury does not demonstrate a link between the bailout programs and the recovery (such as it is).  Simply drawing a chart that plots the bailout programs and the economic growth rates side-by-side is not enough to show that the programs caused the economic growth.  Correlation does not equal causation 

Second, Treasury completely ignores opportunity cost.  Money that the government spends on one thing cannot be spent on other things.  It was hard to get a loan in 2008 and 2009, so the government could have commanded quite a premium for the money it was handing out.  When private sector lenders make money available at the height of a financial crisis, they charge a rate of interest high enough to compensate them for the risk they are taking.

Third, Treasury downplays losses.  For example, Treasury reports that rescuing the auto industry cost $22 billion, but explains that “the cost of a disorderly liquidation to families and businesses across the country that rely on the auto industry would have been far higher.”  Treasury presents no evidence for that statement.  Even assuming it is true, there may have been cheaper ways for the government to address the dislocation that would have resulted if the companies had gone through a normal bankruptcy process.  Similarly, Treasury slides past the loss of $46 billion in foreclosure prevention funds, because “they were not intended to be recovered. 

Finally, and most importantly, attempts to twist facts and figures so that the bailout looks like a financial success story set a terrible precedent for future politicians and regulators.  When the next financial crisis hits, expect to see Treasury’s colorful charts as Exhibit 1 for why a bailout is not only necessary, but profitable.  We will be assured that the government, at a time of crisis, can turn a quick profit by throwing money at failing institutions.  In fact, government is not equipped to make brilliant investing decisions, especially in a time of crisis.  If there were fast profits to be made, private investors would snap them up.

It is wonderful that, using Treasury’s optimistic assumptions, the bailouts might not cost as much as they could have in a worst-case scenario.  Let’s not let the government use that small success to convince us that using our money to bail out big banks, auto companies, and large insurance companies is something we should thank them for doing.