The lead editorial of the Washington Post today mourned the "TARP martyrs" (seriously) who lost their seats in Congress for having supported the bank bailout. The Post's main points are that we were threatened with "financial Armageddon" had TARP not passed (talk about shrill), and it really didn't cost us any money.

Starting with "financial Armageddon," let's use a little common sense. Suppose TARP had not passed. The Fed actually already had enormous power to lend money to keep the financial system operating. The most immediate threat to the system, which Fed Chairman Ben Bernanke and others highlighted, was the risk that the commercial paper (CP) market would shut down. They claimed that even healthy corporations were unable to borrow in the CP market. Since most large corporations depend on the CP market to finance their payroll and other ongoing expenses, the loss of this market would quickly cause the economy to grind to a halt.

While there is some debate as to how bad things were in the CP market at the time (the Minneapolis Fed disputes the claim that the market was shutting down), the more important point is that this issue was irrelevant to TARP. The Fed had the power to single-handedly support the CP market. In fact, the weekend after Congress approved the TARP Ben Bernanke announced the creation of a special lending facility to support the commercial paper market. So, that part of the financial Armageddon story was just a fairy tale for children, reporters and columnists, and members of Congress.

Suppose the TARP money had not started flowing and we saw the chain of bank collapses continue. The two remaining independent investment banks, Goldman Sachs and Morgan Stanley, would surely have been killed absent TARP and other special assistance from the Fed. It is all but certain that Citigroup and Bank of America would have gone belly up as well, along with many other large financial institutions.

Would this have led to financial Armageddon? Well, it surely would have created considerable disorder in the financial markets and led to a few million lawsuits, but the Fed and FDIC no doubt would have taken over these institutions to keep the system of payments operating. The Fed had a contingency plan to take over the money center banks in the 80s when they were threatened by large amounts of bad debt in Latin America. It is inconceivable that it did not have a similar plan in place following the collapse of Bears Stearns in March.

This means that "financial Armageddon" would have meant the demise of Goldman Sachs, Morgan Stanley and most of the other Wall Street titans, but probably would not have led to a qualitatively worse economic situation for the rest of us than what we actually saw. In fact, there would have been a great benefit from this financial Armageddon in that it would let the market wipe out the fast dealing high flying Wall Street gang in a single blow.

This would eliminate the culture of synthetic CDOs and naked credit default swaps that provide ever more sophisticated and expensive ways to gamble. It would also eliminate many of the huge multi-million dollar paychecks that the Wall Street boys take home every year (or week). In other words, this is not obviously a bad story.

The other misleading aspect of the Post piece is its haughty claim that the TARP did not cost taxpayers any money. It is not clear whether this is an assertion based on ungodly stupidity or is just plain dishonest.

The TARP money was a form of insurance. The vast majority of insurance policies are never paid off, but that does not mean they have no value. The point here is that the banks were on the edge of going bankrupt. Private investors would not touch them. The government, through the TARP and the Fed, gave the banks the loans and the guarantees that assured the markets that the banks would survive. This meant that private investors could trust their money with the banks. That allowed the banks to weather the crisis that they had themselves created. They are now back on their feet and again paying their "top performers" tens of millions a year in bonuses.

Does the Post really not understand that TARP money was enormously valuable and imposed huge cost on society? If, back in the fall of 2008, the government had given a thousand community groups hundreds of billions of dollars of loans, accompanied by trillions of dollars of loan guarantees, these organizations could have used this money to make loans at very high interest rates and buy up assets at bargain basement prices. In this story, there would be no risk to the community groups, since if things went badly the government would be out the money. Of course, if the economy recovered, then they would be enormously rich, with large claims on society's resources as a result of successfully betting with the government's money.  In the Post's account, the prosperity created for these community groups would have cost taxpayers nothing.

This is the story of the TARP. If the government had not been so generous with the Wall Street banks, Goldman Sachs shareholders would not have claims to $67 billion of the economy's output. Morgan Stanley's shareholders would not have claims to $32 billion of the economy's output. This is all a gift from the taxpayers to some of the richest people in the country. It is hard to believe that the Post's editorial writers do not understand this fact.



Site Maintenance

"The CEPR website currently takes longer to load than usual. We hope to have this and other issues addressed shortly. While this much needed site maintenance is taking place, our content is still available so please continue to slooowwwly surf the pages of our site. Thank you for your patience."