The problem with TARP

A claim in a comment over at Economist’s View that “we stand to make money off of the bailouts thanks to interest and warrants on the banks who took TARP funds” set off this rant.

While the press has been very misleading on this issue, there isn’t much reason to believe that this conclusion is correct.  For example, TARP is almost sure to have lost $2.3 billion on Sunday when CIT declared bankruptcy.  This pretty much wipes out the “earnings” from Goldman Sachs’ TARP exit ($1.5 billion) and JPMorgan’s ($0.8 billion).

(As far as I know the government hasn’t sold JPM’s warrants yet, so there may be some earnings on that — but there will surely be more CIT-size losses too.)

CIT is a perfect illustration of why TARP was a failure.  TARP deliberately lent banks money at the bottom of the capital structure so that the government was all but guaranteed to lose the whole sum when any TARP beneficiary goes bankrupt.  Now every TARP bank bankruptcy functions as a way of transferring cash from the government to the failed bank’s creditors — just like AIG.

The government could and should have insisted on being at the top of the capital structure, so that the taxpayer was protected and creditors of TARP beneficiaries would not be the indirect beneficiaries.  (Most federal loan and guarantee programs work this way:  FDIC, FHLB.)  In a capitalist system, it just isn’t possible for the government to “recapitalize” banks without nationalizing them:  equity implies ownership.  Period.  Using taxpayer funds to selectively transfer money to favored groups (== TARP) simply isn’t consistent with capitalism.

Note that some time after the government gave CIT $2.3 billion, Goldman Sachs lent the firm $3 billion. Because Goldman Sachs is at the top of the capital structure, it will probably profit from its loan to CIT.

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