On The Ethics Of TARP

I want to try and argue here about the ethics of TARP:

First, I believe that there were free market ideas that we could have tried, so anyone who says that there weren't is wrong. However, I felt that these programs would not work well this time and be very risky and complicated because of the assumptions the markets were laboring under. But, we could have left things to the market.

Second, since the government had implicitly guaranteed intervening in the case of a crisis this time, I believe that such action was warranted. Once that was decided, I supported the Swedish Plan because:

1) It worked.

2) It was clear and easy to implement, assess, and exit.

3) It maximally protected the taxpayers, which I believe to be a moral requirement when taxpayer's money is used.

Now, I don't doubt that TARP can work, as Floyd Norris writes:

"The Treasury Department will make substantial profits on its investments in banks under the bailout program announced Tuesday — if the banks return to health within a few years. If not, the government could end up breaking even, or perhaps even lose money.

In a number of ways, Washington’s proposal comes with fewer strings attached than the rescue plans in European countries. That would seem to place the American government at a disadvantage, but Washington could benefit if that relative leniency helps banks recover quickly and provides a big profit on the equity stake it is receiving.

Whereas some European plans barred banks from paying dividends on common stock until the government got its money back and demanded promises that the banks would keep loans flowing to businesses and individuals, Washington allowed the banks that it invests in to continue paying dividends on existing common and preferred shares."

However, the fewer strings are, in my opinion, better guarantees for the taxpayers.

And also:

"How well it succeeded will become clear as more banks announce that they have signed up and receive capital infusions. If markets react by bidding up the share prices of those banks, the Treasury will have scored an early victory.

But the final verdict will not be rendered until all the money has been repaid, or lost. At best, that number will not be known for several years."

I find this risk too high. Remember, as well, this is simply one part of the plan, and it's complicated enough.

Instead, we should have done the following:

"Whereas some European plans barred banks from paying dividends on common stock until the government got its money back and demanded promises that the banks would keep loans flowing to businesses and individuals, Washington allowed the banks that it invests in to continue paying dividends on existing common and preferred shares.

In addition, while European banks are being required in some cases to put government representatives on their boards, the American government will not receive board seats or have voting power.

Those differences were reflected in stock market reactions on Tuesday. Shares in the British banks that are being partially nationalized fell, as investors adjusted to the fact that it could be years before dividend payments are resumed. Share prices in American banks generally continued to rise as details of the Treasury’s plan became known."

The TARP plan can work, and there are people, like William Gross who can help make it work. But, if you read it, it simply is more complicated, easier to lobby out of, and riskier.

On those grounds, I feel that we've made a mistake.

In fact, just this:

"Under the American plan, the government is guaranteeing new loans to banks — and planning to collect a fee for doing so — and it is planning to invest $250 billion by buying preferred stock from banks. That stock will come with warrants that give the government a chance to earn big profits if share prices recover.

The American plan provides both a carrot and a stick to encourage banks to repay the government as soon as possible with money they raised by selling shares to private investors.

The carrot allows banks to cut in half the number of common shares the government will eventually be able to purchase. That can be done if a bank sells stock by the end of 2009, and raises at least as much cash as the government is investing.

“If they can replace government capital with private capital, there will be much less dilution to existing shareholders,” said Robert Barbera, the chief economist of ITG. “That is important to current shareholders.”

Strikes me as evidence of the power of lobbying. I hope that I'm wrong.