The End of TARP to Be Met with Controversy

The Troubled Asset Relief Program (TARP) began with a single, basic idea: prevent imminent economic collapse. With that premise, then-Treasury Secretary Henry Paulson convinced Congress and President Bush to authorize $700 billion of emergency spending to undertake actions to avert such disaster. Now, with economic catastrophe averted but with the nation's economy still struggling, a new report turns policymakers' focus to the end of TARP.

Over the coming year, as TARP's mandate expires, Obama administration officials will have to make tough choices about whether to prioritize the program's original mandate – maintaining economic stability – or safeguarding taxpayer money. The two goals are supposed to be coequal, but in practice, Treasury has ignored the second priority – maximizing return on taxpayer investments.

The Congressional Oversight Panel (COP), which is charged with oversight of TARP, released its latest quarterly report [1] during the week of Jan. 18, examining Treasury's TARP exit strategy. The report notes that while Treasury's authority to undertake actions using funds allocated under TARP expires on Oct. 3, TARP investments will continue for at least another year. Indeed, on Oct. 3, Treasury is expected to still be holding billions of dollars' worth of TARP assets.

Most of the COP report focuses on the dueling TARP priorities, which are laid out in the authorizing legislation, the Emergency Economic Stabilization Act of 2008 [2] (EESA). The law states that the Treasury Secretary must "hold the [TARP] assets to maturity or for resale for and until such time as the Secretary determines that the market is optimal for selling such assets, in order to maximize the value for taxpayers." This single sentence contains both priorities noted above. The first, maximizing taxpayer return, is plainly stated, but the second, ensuring economic stability, is more subtle. Treasury has chosen to interpret the word "optimal" in the law to mean “when market conditions are optimal.” However, as the COP report states, "'optimal' timing might therefore not be the most profitable, but timing that best forwards Treasury's goals" of overall economic stability. Trying to ensure economic stability could mean that Treasury has to take a loss on an asset to stabilize the financial markets or prevent a too-big-to-fail bank from collapsing.

In practice, Treasury has had difficulty ensuring that the two goals are equal in priority. In particular, Treasury has opted to more frequently err on the side of protecting economic stability. Indeed, COP's report provides several examples of how Treasury is failing its statutory obligation to provide maximum return on investment.

The prime example of this is American International Group (AIG), the investment giant which almost collapsed in 2008. While Treasury has repeatedly stated that "taxpayers will be made whole" in the government's assistance to AIG, Treasury's actions indicate that it is in fact more focused on maintaining economic stability. In testimony leaked to The New York Times [3], the Special Inspector General for TARP (SIGTARP) estimates that taxpayers will lose almost $30 billion on the over $182 billion the government has invested in AIG, in large part because of bad choices the government made when bailing out the company. Instead of forcing AIG creditors to take a loss, Treasury insisted that they be paid in full. The COP report notes that Treasury said that it would rather reduce its AIG assets in an orderly manner, avoiding a premature sell-off, which could disrupt the economy, "than [make] a lot of money on it." This example does not bode well for when Treasury fully divests itself from AIG and the rest of TARP.

In its defense, Treasury has been driving a hard bargain when banks have tried to buy back their warrants, documents the banks gave to the government in exchange for financial support during the recession, which give the holder the right to purchase stock in the company. A recent Wall Street Journal [4] article reported that Treasury has received $2.9 billion from warrant repurchases, well above third-party valuations of between $2.2 billion and $2.7 billion, indicating that Treasury has forced banks to pay top dollar for their warrants. However, one could argue that Treasury had no choice but to drive these bargains, since Treasury's warrant acquisitions are one of the most public aspects of the department's bank support, and anything less than a full repayment of the warrants would have stirred public anger toward the government. Regardless, the revenue from warrant repurchases falls far short of compensating for the cost of the other TARP programs.

Perhaps to help fill that gap, the administration has recently proposed the "Financial Crisis Responsibility Fee [5]." The proposal is intended to repay the costs of TARP by making larger banks pay a fee based on the riskiness of their portfolios. The fee would be in place for ten years, although it could be extended if it had not yet covered the costs of the bailout.

The fee would seem to be an optimal solution to the problem of the competing TARP goals. By covering the cost of TARP itself, it would leave the Treasury free to divest itself of TARP assets in such a way as to ensure the greatest economic stability possible. By no longer having to worry about maximizing the return on investment, Treasury would be able to sell off its TARP assets whenever the market was most "optimal." This would save Treasury the excruciating back-and-forth process of asset sales to make sure taxpayers are made whole, or even earn a profit, as TARP would be paid for through the new fee.

The problem is that the fee is based on the state of a financial institution's books, not how much money they received from TARP. The more debt an institution has relative to its assets, the greater the fee it would have to pay. Therefore, organizations which greatly benefited from TARP, such as AIG, would only pay as much as other institutions with similar balance sheets. AIG could receive tens of billions of dollars in aid while paying mere hundreds of millions dollars back to Treasury. If Treasury is not concerned about maximizing taxpayer return when it is divesting its TARP assets, this problem will be exacerbated.

Ideally, the proposed fee would allow Treasury to continue to elide its statutory obligation to ensure maximum return on taxpayer investments. It has already ignored this obligation several times in pursuit of the competing goal of greatest economic stability. The greater-than-expected revenue from the warrants are a positive sign that the administration is willing to put safeguarding taxpayer money before corporate well-being, but considering TARP's past performance (with AIG losses indicating that TARP will still have significant costs), it is clear that TARP's demise will be, like its life, fraught with controversy and questionable outcomes.