TARP Numbers Don't Tell Everything, The Cost Of The Bailout Was Too High

Well government is patting themselves on the back again for a job well done. This time the self-congratulatory mood was brought on by the Congressional Budget Office's (CBO) rosy estimate for total bank bailout cost. According to the CBO the final cost of the Troubled Asset Relief Plan (TARP) will end up being only a fraction of the original amount deployed, at a mere $25 billion. The Congressional Oversight Panel (COP) shows their overall satisfaction with TARP's results in a final assessment of the program that was released on March 14. In the summary they said the following (on page 182):

"It is now clear that, although America has endured a wrenching recession, it has not experienced full credit for this outcome, but it provided critical support to markets at a moment of profound uncertainty. It achieved this effect in part by providing capital to banks but, more significantly, by demonstrating that the United States would take any action necessary to prevent the collapse of its financial system"

Hmm...... Although the COP also makes acknowledgements in the report that there are likely to be unintended consequences from the TARP program, overall they seem pretty pleased and justify these consequences with the often repeated mantra that the government's actions prevented the recession from turning into a depression.

Many Hidden Costs Of TARP

True if the $25 billion figure is correct (a debatable point in itself) it's allot less than the $700 billion of taxpayer money that the government put at risk. Still there are other important costs to consider besides the net loss or even gain on the taxpayer's forced investment. Even if the TARP scheme would have yielded a net profit as I remember some speculating that it might, there would still be many hidden costs unaccounted for. One example would be the huge moral hazard costs that don't show up on the surface. These moral hazard costs I refer to are what happens when government arbitrarily decides to provide a financial backstop to financial institutions that are deemed too big-to-fail. When this happens it creates a "heads I win, tails I still win" scenario for the executive management teams navigating the largest financial firms. If the executives take large risks with their firms money and the bets pay off, they will be rewarded handsomely. If the bets go wrong and the firm becomes insolvent, the government will bail them out and there will still be money for large salaries and bonuses. Under these rules of engagement the personal financial risks to executive level management are minimized. This creates a situation were highly risky and even reckless behavior is encouraged, making future bailouts more likely to occur if the government remains willing to pick up the tab for the financial system.

Government Can Get Cocky

That brings me to another thought about the moral hazard of bailouts. Not only do they skew decision making in the private sector for the worse, but it is also likely that future decisions by government will be skewed towards higher risk behavior like excessive borrowing and reckless spending. This is not something people ever bring up in regard to the moral hazard issue, but just think about it for a minute. If the perception among those in government is that their actions during the financial crisis saved the day, then won't they be more likely to intervene in bigger and bolder ways in the future? Unfortunately I think the answer is yes. To some degree I think we are already seeing it. Gigantic financial and healthcare reform bills along with a misguided and poorly put together economic stimulus package are all examples of government thinking they should play the role of hero. There is some push back against this trend, but I won't be surprised when more bailouts happen when economic turmoil erupts in the future. As evidence of this, I would point out that few if any in government are calling for legislation that would prevent or even just put limitations on using taxpayer money to bailout private entities. Also there hasn't been much talk about, reforming financial regulation by making the regulatory agencies smaller and eliminating the overlap that exists. No instead government has passed more regulations and created a whole new consumer protections bureau to watch the financial system. Big government along with interventionist actions are widely accepted right now.

Still More Costs.....

Moral hazard isn't even the only hidden cost related to the bank bailouts though. These actions also cause distortions within the financial markets. As the COP acknowledges the largest financial institutions are now thought to be too-big-to-fail by market participants. This has lead to bigger banks having lower borrowing costs than small community banks who don't have the same implied government guarantees. This of course makes it less attractive for businessmen and entrepreneurs to start up new banks and it puts small community banks at a competitive disadvantage to larger rivals. Over the long-term this leads to less choice for consumers and less stability in the financial system as the big banks grow bigger still due to the lack of competition and special government perks.

Government Is Aware Of The Problems They Create, But Still Thinks Their Actions Are Justified

Elected officials and regulators acknowledge that there are unintended consequences to government intervention. However, most still seem to think that the benefits of bailing out the economy outweigh the drawbacks. Ultimately it's up to every citizen to keep track of whether government is telling the truth about their economic management. A good start might be this hub I wrote on tracking and influencing government actions. Another point to consider would be government's historical track record on intervention. Have bailouts and more and more financial regulation really made the system better? they really made the system better? Well crisis have still occurred with regulators and tax payers have footed the bill for these bailouts. But don't take my word for it, take a good hard look and decide for yourself.

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