By Eva Norlyk Smith. Ph.D.
If you are among the many consumers whose blood pressure rises when you hear about new, large bonus pay-out at financial institutions propped up by taxpayer bail-out money, here, for a change, is some good news. While the credit crisis is not fully behind us, it turns out that taxpayers may still get the last laugh.
According to a new report from the Congressional Oversight Panel, the $700 billion allocated to purchase or insure “troubled assets” under the Troubled Asset Relief Program (TARP) may turn out to reap profits, not losses. The November 5 report notes that the income from the government guarantee programs issued under TARP and related programs will likely exceed the losses. Up to this point, the Treasury Department has received a total of $17.4 billion in fees for various TARP-related programs, while shouldering only $2 million in losses.
According to the Panel, much of the benefits from TARP and related programs have come not so much from purchasing assets directly from troubled financial institutions, but from supporting the value of assets indirectly by issuing government-backed guarantees. At the height of the credit crisis in late 2008 and early 2009, the government increased existing guarantees and stepped in as a guarantor in numerous other programs. The maximum guaranteed value of FDIC-insured accounts was increased from $100,000 to $250,000 per account. In addition, the FDIC created the Debt Guarantee Program (DGP) to encourage liquidity in the banking system, and numerous other programs. In addition, the government stepped in to rescue financial institutions deemed “too big to fail,” which included securing hundreds of billions of dollars in risky assets belonging to Citigroup and Bank of America.
Issuing guarantees instead of outright purchasing troubled assets enabled the Treasury to secure assets without paying an upfront price. For example, at the peak of the credit crisis in late 2008, the government stepped in to guarantee $300 billion in Citigroup assets with no immediate cost to taxpayers. Citigroup paid the government $7.3 billion in preferred stock for those guarantees. Bank of America was given guarantees on $118 billion of assets, but never went through with the agreement. In September, the bank opted to pay the government $425 million to exit the program.
By issuing guarantees, the Treasury and federal agencies were able to leverage the TARP money to secure a larger pool of assets. The Congressional Oversight Panel concludes that the guarantees succeeded in their ultimate objective to free up frozen credit markets and halt the tailspin of the financial markets.
Despite their advantages, the guarantees were also a high-risk gamble. At the high point, the federal government was backing $4.3 trillion in face value of high-risk assets held by financial institutions teetering on the edge of bankruptcy. Had the economy taken a deeper dive and the guaranteed assets declined dramatically in value, tax payers could have been on the hook for much higher losses than originally approved under the TARP program.
However, the gamble appears to have paid off. Under current conditions, the Panel concludes, taxpayers “appear likely to earn a profit from fees assuming economic conditions do not deteriorate further.”
The Oversight Panel noted that the Treasure had become more aggressive in safeguarding taxpayers’ money, but also recommends much greater transparency in disclosing the details of the guarantee programs and the rationale behind choosing one approach over another.
The Panel lastly comments that government guarantees come with a significant downside: they create moral hazard by limiting the amount of money investors can lose and possibly tempting lenders to engage in riskier behavior than they otherwise would. “The cost of moral hazard is not as easily measured as the price of guarantee payouts or the income from guarantee fees,” the report notes, “but it remains a real and significant force influencing the financial system today.” The Panel concludes that unwinding the implicit guarantee of government support will be a critical part of phasing out the TARP program.
