TARP a “Qualified Success” Says Sprague

Q&A WITH MARK SPRAGUE
Mark Sprague is a noted and respected expert on the real estate industry and the Austin market, in particular. He is also the Director of Business Development for Mission Mortgage and we are fortunate to have access to his expertise and opinions. Recently, Mark was asked to clarify a statement he made about TARP.  His answer proves to be quite enlightening…and not the same tired analysis as we get from the national news.

 

Question:  I’ve heard you say before that the TARP program was a successful and necessary stimulus program.  Can you explain why you feel this way?

Answer: First, let’s look at the purpose/definition of TARP Funds   TARP stands for Troubled Asset Relief Program. The program was part of the Emergency Economic Stabilization Act signed into law in October of 2008. The funds themselves were loans to banks and other entities from the U.S. Treasury. The total amount allocated was $700 billion. The original plan was for the government to purchase mortgage-backed securities deemed “toxic assets” from banks and later resell them. Ultimately, TARP funds were allocated to banks in the hope that they would purchase mortgage-backed securities to alleviate a credit crunch.  At the time, there was genuine concern about the possibility of banks failing, etc.  The enactment of TARP was successful in alleviating the panic and giving the banks and credit markets some breathing room.

What TARP Funds Were Supposed to Purchase   Again, the original focus was mortgage-backed securities, or the “troubled assets” (the assets causing the global panic!). A mortgage-backed security is an investment whose underlying asset is a pool of mortgages. These securities were created through a process known as securitization. The assumption on which these securities rested was that out of a large pool of people only a small percentage would default on their mortgage. The models did not account for the possibility of many people defaulting at once or that residential real estate could lose values. This is just what occurred when the housing market collapsed. Therefore in light of the great failure of Real Estate not continuing to appreciate, than the goal was to get Congress to grant the government the authority to spend hundreds of billions of dollars to save the financial system from collapse.

The collapse of the value of mortgage-backed securities led to problems for banks and the credit markets. Because the mortgage-backed securities were/are complex and difficult to value, they were not being traded and were instead sitting on the balance sheets of banks at original values.  The holders of these mortgage-backed securities would also have to write down the securities if they were sold.  The banks purchased insurance against this with derivatives (a whole discussion in itself – just know that Warren Buffett had referred to derivatives as having the capability of being “financial weapons of mass destruction” in 2006 when they were legalized).  The inability of the markets to gauge the failure of the mortgage-backed securities and the “derivative insurance” caused widespread panic in the investment banks. This created a freezing of the credit markets (never a good thing – particularly in a nation that is so credit driven!) which TARP sought to remedy. The fear was at the time, if we continued to see the freezing of credit, it would cause a domino effect for all credit markets (this includes stocks, derivatives, currency trading, credit cards, etc.). With the massive trading of debt and derivatives, and the lack of tracking of all this debt, and debt insurance, the central banks of the G20 countries had to step in and loosen up the “fear” of lack of credit in the capital markets

What the average consumer was not aware of was the “investment banks” participation in all this debt.  Investment banks such as Lehman Brothers, Merrill Lynch, JP Morgan and others were holding massive amounts of this “securitized debt”/mortgage-backed securities and therefore were eligible for massive amounts of the TARP monies.  The public’s concern was, “weren’t these the guys that caused the problem?”

Let’s look at the largest recipients of TARP Fund   While many small banks were awarded TARP funds, just a few entities were awarded a substantial block of the money. According to the New York Times, A.I.G. was awarded $69.8 billion, Citigroup received $50 billion, Bank of America received $45 billion and the automakers received $85.3 billion. The award of TARP funds to automakers was initially controversial, as it was not in keeping with the purpose of the program. This is because the automakers did not own mortgage-backed securities but were rather victims of general problems in their management, their labor contracts and the economy. However, the supposed purpose of TARP, to buy troubled assets from banks, shifted over time in practice and the executive branch realized that automakers are an important part of the economy.   As the administration began to stray from the original focus of the fund, the average consumer and the media began to lose confidence in how the funds were used.  (Consumer confidence is a major pillar of any economy, particularly one like the US where consumer spending makes up 70%+ of our GDP).

Yes, it was beneficial Supporters say the program pulled the financial system back from the brink of disaster (it may have).  The stock market has rebounded, banks are making profits again. Disaster has been averted. The official spin is that TARP was a great success. But the official spin is questionable in its perceived motives.

  • Businesses have added jobs for nine straight months. Private investment and confidence in banks have returned. The cost of borrowing for businesses, municipalities and individuals has declined dramatically (lower cost of funds).  According to a Wall Street Journal article in April 2010, $169 billion of the $245 billion in bailout money invested with banks had been returned and the government is expected to make a profit on the investment.
  • The Troubled Assets Recovery program succeeded in preventing a catastrophic collapse of the financial sector (domestically as well as foreign).  The longer term goals were aimed at strengthening the overall economy and dealing with the alarming number of mortgage foreclosures and the financial instruments (mortgage-backed securities, etc.) backing them.  What Main Street did not understand was how much of the financial instruments were owned not by the major banks, but by the major investment banks on Wall Street.  The same group that was perceived to have started the securitization, insurance, and the belief that real estate never lost its value (those of us, who lived through the late 80’s would disagree – but I digress). The banks did not collapse and close their doors.
  • There were no internal controls to gauge success or failure. The goal was simply to dispense as much money as possible, as fast as possible. When Treasury began giving billions to the banks, the department had no policies in place to ensure that the banks were using the money in ways that met the purposes of the program, however defined. One main purpose, as noted, was to free up credit, but there was no incentive to lend and nothing to stop a bank from simply sitting on the money, bolstering its balance sheet and investing in Treasury bills. Indeed, Treasury’s plan was expressly not to ask the banks what they did with the money.

So we stopped the “catastrophic bleeding and confusion” in a timely manner.  The good news is that it was done as timely as possible.

This is true, but was it TARP? Instead, it looks almost entirely a function of monetary policy. TARP might have arrested the global panic for long enough that the previous administration and Bernanke’s policies had time to start working. Treasury complains that the public think of TARP as being mainly a bank bailoutbut in fact that’s exactly what it was explained to be. It was to loosen money at the banks for small business and help with foreclosure business (the devil is always in the details). The Detroit bailout might have been done very well, but it was an afterthought, done with funds left over which hadn’t gone to banks.

As a bank bailout, TARP was successful. The banks were largely responsible for causing the global financial crisis which left millions of people losing their homes, laid off from their jobs, or both. But then, with the TARP bailout, they rapidly bounced back; the bankers who remain — and that’s most of them — are now anticipating bonus checks to rival what they were receiving at the height of the credit bubble. The little guy on Main Street was hurt hard and is still hurting; and the appearance is that the Wall Street investment bankers are smiling and back to their old ways.

Politically speaking, bank bailouts are always going to be tough.  It never helps everybody and appears to hurt a lot. And the way to prevent the kind of public anger we’re seeing right now is to ensure that while the banks might survive, the bankers have to be prosecuted — just the way they were in the 1930s and in the 1980s, after the S&L meltdown. Time and writing assets “mark to market” down hasn’t happened: whereas the banks have survived, there seems to have been little to no accountability for the financial crisis at all, which is naturally going to make people angry. The government tends to go very quiet when asked whether TARP has lived up to its stated aims, which included much more than rescuing banks. TARP was meant to boost small-business lending, for instance; it hasn’t done that. And it was also designed to help the foreclosure crisis — which instead has gotten worse

We’re still a long way from being able to render a final verdict on TARP (history will be the best judge of that). 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. The negative is that it failed to get banks lending again; it failed to stem the foreclosure crisis; it failed to slow down or 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, the financial-services industry, and the judicial system possibly, as well.

TARP was always a rushed, ad hoc policy – even its architects never really had much of a vision for how it should be used (and other than paying it back, measurement is an opinion rather than a verdict).  As such, its questionable success comes as little surprise. But let’s not try to pretend that it was a great success. Yes, it’s good that most of the money is likely to be repaid. But that’s neither necessary nor sufficient for TARP to be considered a success.

We’re still a long way from being able to render a final verdict on TARP. And as pointed out earlier, history will be the judge, away from politics and emotion.  But the best that can be said for it at this point is that it was a “qualified success”.

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About missionmortgage

A full-service professional mortgage banker providing lending in Texas for over 25 years. Our main office is located at 901 S. Mopac Expwy, Barton Oaks V- Suite 120, Austin, TX 78746 with branches in Lakeway, Houston, and Sealy. Mission Mortgage has been ranked as a Top 10 Mortgage Company in Austin for the past 7 years (Austin Business Journal).
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