UNDER THE TARP

When Congress authorized the Bailout Bill, it created the Office of the Special Inspectors General for the Troubled Asset Relief Program (or SIGTARP in the ubiquitous Washington acronym). SIGTARP was instructed to “keep an eye” on the program and keep the Congress and the people informed. We have been perusing these reports with great fervor finding them to be simultaneously amusing and infuriating.

Surprisingly the Special Inspector General (SIG) is very critical of the usage of funds and the execution of some of the programs within the TARP. However, it does acknowledge the positive effects of injecting hundreds of billions of dollars into the system, declaring that financial markets are stabilizing and large banks have begun to pay back what they borrowed. Alas, in the end, TARP has not effectively achieved the stated goals of the program. The moral hazard dilemma that still face the “too big to fail” banks means they can continue to take huge amounts of risk with little or no repercussions if they happen to be incorrect.

Furthermore, the “excessive compensation culture” that dominates Wall Street has not been adequately handled and will continue causing difficulty in the future. This is evidenced by the rush to repay TARP funds and leave the program as soon as a whiff of compensation restrictions permeated the halls of Congress. Officials say it is difficult to determine whether or not the taxpayers will lose money on the TARP. I can just about guarantee we will. To date, three TARP involved banks have filed for bankruptcy protection, with more likely to follow suit.

The method these companies have used to repay the TARP money has also been the subject of great criticism by SIGTARP, this, and other publications. While it is true that the recipients paid both dividends and interest on their loans, some sweetheart deals have been made that deserve more than a little scrutiny. You may recall the week of discontent in September 2008 when Goldman Sachs was on the ropes (swearing they were not). They were fishing around for equity investors when Warren Buffett came to the rescue. Through Berkshire Hathaway Inc., he agreed to invest $5 billion in Goldman Sachs Group for the purchase of preferred stock. Berkshire and the Treasury got the same investment warrants to buy up to $5 billion of Goldman Sachs common shares. The difference is the US Treasury had to pay $10 billion for its position, fully double the price paid by Buffett. Berkshire will earn a hefty 10% dividend yield on their preferred shares. We the people only received 5%.

The warrants, which were immediately exercisable, had a strike price of $115 a share. Goldman Sachs was one of the first banks to exit the TARP program. It repaid its loan in full with a meager interest payment. Worse yet, when it came time to redeem the stock warrants, Goldman Sachs was allowed to buy them back at a net 33% discount to the fair market price, resulting in a $364,170,000 profit.

The TARP is a failure because it was intended to free up capital to loan out to small businesses and to keep banks open. In practice, however, this has not been the case. The amount of loans granted actually shrunk every month in 2009 instead of increasing. It seems the bulk of the lending done by these banks during this period has been to their own proprietary trading operations and the SPV (Special Purpose Vehicle) or off-budget companies owned by these same institutions. Moreover there were 140 bank closures in 2009, nearly 6 times as many as there were in 2008.

Consider the case of American International Group (AIG) in the area of executive compensation. AIG was given an enormous amount of TARP money without any restrictions on where the funds could be spent. Although it is true that tens of billions were funneled out to foreign banks, in probably the most egregious misuse of funds to date, executives of AIG’s financial management division were awarded millions of dollars in “performance based” compensation or “bonuses”, despite the fact that the company was on the verge of bankruptcy. AIG was used as a conduit to funnel money to the banks. One of the biggest drivers of the current economic downturn is the sub-prime mortgage market. TARP money was given to both Fannie Mae and Freddie Mac, the two largest secondary mortgage market players. The underlying issue was that home prices were artificially inflated creating a housing “bubble.” Many homes were purchased using adjustable rate mortgages, and when the rates increased, homeowners defaulted. This caused the bubble to collapse.

The number of homes in foreclosure is at a record high, and is rising every month. TARP funds in the housing and mortgage market are artificially “steadying” the market. The fear is that by artificially manipulating market prices, the TARP is setting the market up for another crash. Furthermore, the public has not had the ability to properly leverage many of the programs that were available to them; only a small fraction of homeowners have had their mortgages rewritten under the Making Home Affordable program. While the government has been a large player in the secondary mortgage market since the creation of Fannie Mae and Freddie Mac in the 1960’s and 70’s, it wasn’t until the TARP plan that the United States government completely monopolized the mortgage market. It is a fair assessment to say that without this intervention there would not be a mortgage market.

The final area where TARP funds were invested was in the auto industry. It is doubtful that taxpayer money will ever be repaid by Chrysler and General Motors, or their financing companies GMAC and Chrysler credit. A majority of the funds are tied up in the “old” auto companies that were created after the companies emerged from bankruptcy. Both auto manufacturers are stabilizing. However it is highly unlikely that they will be able to repay the loans. Furthermore, in order for the government to make our capital back on the equity investment in either firm, the companies would have to be worth more than any prior valuation level. Despite initial estimates of the taxpayers making money on their investment in publicly held companies, it is now becoming clear that this is not the case. Despite allegedly being necessary for the stabilization of the economy, the TARP has cost the taxpayers billions of dollars and has provided dubious general benefit.

That is what we gleaned from our look under the TARP thanks to the SIGTARP. These quarterly reports are a worthwhile read. However, we suggest you clear it with your doctor because they can also cause your blood pressure to rise and induce a little nausea.

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