Tuesday, March 5, 2013

A TBTF TARP exchange

Over the past two weeks I've been having an on-going conversation with a colleague at work debating the virtue of TARP back in the fall of 2008. While the colleague agrees with me on virtually all points related to the problems with Too Big Too Fail (TBTF), the government's role in creating the financial crisis, the problems with the responses, etc., he disagrees that TARP could/should have been avoided. He tends to see it as TARP or catastrophe  Because I thought it was interesting, I've included here some of our exchange as conducted over email. Some names have been changed to protect the innocent.

From me:
I see the case against TARP as follows:
  •  The common pro-TARP narrative is basically fiction.
    • We were not at the edge of doom (at least there is next to no evidence for this view)
    • It was not approved as originally sold nor implemented as approved
  • TARP rewarded through bailout those who had made very poor economic decisions.
  • TARP did not and could not ease credit conditions nor bring liquidity to the system. That responsibility was The Fed’s and if they had done their job, the recession would have been a bump rather than a crater, and the financial crisis would have been short lived if nonexistent. The financial crisis was 80% an effect but only 20% a cause.
  • TARP was an avoidable mistake in that there was ample time to come up with alternative solutions even if we assume the basic premises supporting TARP’s passage.
    • There were weeks before the first TARP bill and between the initial failure and eventual passage.
    • There were alternative ideas and other methods to buy time such as suspension of mark-to-market accounting, bankruptcy options including “speed bankruptcy” whereby equity is wiped out and creditors become the new equity holders, et al.
His response (in red):

I see the case against TARP as follows:
  •  The common pro-TARP narrative is basically fiction. DISAGREE
    • We were not at the edge of doom (at least there is next to no evidence for this view)  DISAGREE (DEPENDS WHAT DOOM MEANS)
    • It was not approved as originally sold nor implemented as approved  AGREE
  • TARP rewarded through bailout those who had made very poor economic decisions.  AGREE
  • TARP did not and could not ease credit conditions nor bring liquidity to the system. That responsibility was The Fed’s and if they had done their job, the recession would have been a bump rather than a crater, and the financial crisis would have been short lived if nonexistent. The financial crisis was 80% an effect but only 20% a cause.  DISAGREE WITH THE FIRST SENTENCE (AT LEAST THE FIRST PART), AGREE WITH THE SECOND SENTENCE AND UNSURE AS TO THE THIRD.
  • TARP was an avoidable mistake in that there was ample time to come up with alternative solutions even if we assume the basic premises supporting TARP’s passage. AGREE
    • There were weeks before the first TARP bill and between the initial failure and eventual passage.  
    • There were alternative ideas and other methods to buy time such as suspension of mark-to-market accounting, bankruptcy options including “speed bankruptcy” whereby equity is wiped out and creditors become the new equity holders, et al.
So we’re in agreement, then, to separate investment banking from “traditional” banking....
My response:
I think you have to separate “doom” for the big, problem banks and “doom” for us all. They are and were not the same.
That applies as well to the credit easing part. Did it ease credit between the problem banks (banks as a broad term where financial institution is more appropriate)? Possibly this was helped by TARP, but even that is debatable. It is not clear that TARP made anyone more willing to lend to those bad banks.
Are you unsure of my 80/20 probabilities or unsure about what I mean in general. I believe the monetary contraction beginning in 2007 created the financial crisis largely. That is what I mean by 80/20 effect/cause. I am not firmly committed to exactly 80/20 . . . I know you know that.
I see little to no help in separating “investment” and “traditional” banking. If any financial institution gets into trouble, we did and will bail them out. If you can wall them off and credibly commit that we will only bailout the banks that fit a specific description (maybe only those who qualify for and pay into the FDIC), then maybe I could come around. But that is a second-best solution at best with lots of potential for major downfall.
He then asked me under what circumstances would I condone or authorize a bailout. I emailed my response:
quick answer to the "who would I bailout" question
On a personal level, I would bailout my kid. But think of [a person] who obviously has severe financial problems. Assuming the bailout(s) from her father are just simply money gifted, they don’t really help her. They only kick the can down the road. Bailing out the kid doesn't really count as a solution.
In the same guise, bailouts in the larger world only address one part of bigger problems. To the extent our problems are magnified by past behavior and bailouts (moral hazard), the problem only grows bigger. In the continuum of the economy we end up favoring one group (those living now who supposedly benefit from the bailouts) at the expense of another group (the future who has to deal with the next bigger problem and who has to pay the debt incurred along the way).
Would I bailout Illinois, California, Europe? What does it mean to bail them out? Make others pay for their mistakes (promises that now can’t be kept)? I would not. No bailouts. Workouts, yes. Bailouts, no.
TARP was a bailout. Very far from a workout. I just can’t see the existence of TARP in the vacuum of this or nothing. That doesn't make sense to me.
A very long (and good in my opinion) discussion followed a few days later where another colleague was pulled in. I enjoyed the two-versus-one debate as the other colleague opposes my negative view on TARP as well. If anything, this colleague is even more convinced that it was the end of days but for TARP. Neither colleague likes TARP, they just don't see that there were other solutions available. When all we can muster is cronyism, we have fantastically failed. I see TARP as the creation of corrupt interests with the backing of plainly unimaginative, pitifully ignorant, and foolishly panicking leaders--leaders in name only as they were devoid of leadership.