Why TARP Was The Right Thing To Do – Timing / Or Continuous Meme Alert: “TARP is bad, MmmK”.

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A news story appeared yesterday that revealed some 98 small community banks (a “ton” as described by the headline) that took TARP funds are on the brink of failure.

98 American banks that received $4.2 billion in bailout money are teetering on the edge of collapse, according to the Wall Street Journal.

In Q2 the number of unsound banks numbered 86; the increase to almost 100 institutions – most of which are smallish banks with about $439 million in assets – comes as a result of decreasing capital and more bad loans.

Also, unlike the big banks, which basically had access to liquidity from the federal government whenever they wanted during the crisis via various emergency lending facilities, these smaller banks received only TARP funds.

Of course this story is being used by the anti-government crowd as an example of the failure of TARP. Note the hypocracy that TARP was too much, yet faults the govt for not providing the same assistance to smaller banks that they did to larger banks.

The article ignores several factors. One is that there are over 8,000 banks in operation in this country, and the 98 troubled banks that are cited are a tiny drop in the bank bucket. A bigger story are the total number of banks that are considered troubled, 919, and even that number is a drop in the bucket when compared to the total number of banks in the US. TARP is funded for $700 billion, and here we are talking about $4.2 billion? It’s not clear from the story if those funds had been paid back, but, even if they hadn’t, $4.2 billion is a drop in the bucket. Remember, as of this point, the cost of TARP has been downgraded from the original estimate of $356 billion to about $25 billion. Assuming the worst case scenario, if every single TARP bank on this list did indeed fail, that would bring the cost of TARP up to a cost of $29 billion, still a far cry from the original estimated cost.

There is more rebuttal here.

Though I’m not a big fan of TARP and it’s sloppy administration, I see it’s necessity. Compared to September 2008, the financial system is now arguably much healthier than it was two years ago. How much of the bank recovery is due to TARP can be debated (and should be), but, given the fragile nature of the banking system two years ago, and given the lack of a strong economic recovery so far, it definitely played a role. Consider this – many of the 98 banks will NOT go out of business. There is this component of capitalism called mergers, where healthy companies by up unhealthy companies on the cheap! Many of the troubled banks will inevitably be bought up on the cheap by larger banks, banks which benefited from, and stayed healthy due to the TARP program.

Finally – on the issue of timing. For some strange reason, I’m fascinated by historical periods of financial and economic upheaval… Hey, some people are into wars, salivate over times of conflict: I’m all about the financial crisis! Many people consider the collapse of the stock market on October 29th, 1929, as the cause of the Great Depression. It wasn’t. It was the trigger that started the downward spiral; it was simply a symptom of the larger problem, the unsound financial practices of the entire world financial community. The causes of the Great Depression are many, too many to be listed here, and it’s difficult to compare the current situation to that of the 1920’s and 1930’s as there are now so many safety valves in place that prevent, or at least make it harder to achieve a complete utter collapse of the financial system. The FDIC for one lessens the likelihood of bank runs, though, as we saw in 2009, it doesn’t prevent them. When examining the Great Depression, 1931 and 32 are the key years that separates a normal, typical depression, which occurred every six to ten years, from that of the Great Depression.

In 1925, there were over 27,000 banks spread across the United States, most of them rural banks. As more and more people migrated to the big cities, those rural banks lost business and ended up out of business. This is not necessarily a concern as normal economic pressures were thinning the herd. By 1929, the number of US banks had thinned to about 25,000.

(graph is from this site)

Note the severe drop in the number of banks between 1930 and 1933, almost 10,000 in three years. When a bank went under, anyone who had money in those failed banks…. That money was simply gone! Unlike today, there was absolutely no way to recover any funds – no FDIC or ability to sue stockholders or board members. So, all those people who had money in those 10,000 failed banks lost every dime they had. The destruction of wealth was phenomenal. You may be asking “The Federal Reserve existed at this time; why didn’t they do anything”? There are two answers to that question. One was that there was a fractious environment within the Fed at that time – the New York branch and, say the Chicago branch had differing opinions on how much aid should go where, or even if anything should be done at all. Since the charter of the Fed required that their actions required unanimous consent, they were basically paralyzed by indecision. They did manage to get some funds to a few banks, but it was too little, too late. So many bank failures in so short a time doomed us to live through the worst economic crisis our nation had before or since seen.

This brings me right back to TARP and timing.

TARP, if nothing else, delayed the failure of many troubled banks by maybe two years or more. Currently we are seeing an awful lot of good signals and economic indicators that suggests that the economy is getting healthier. Granted, it’s not a magnificent recovery, but it’s there. Now, knowing a bit of history, and at the same time assuming the worst (the game being played here in the original article) which would you rather see; these banks starting to fail now, during a period where a stabilizing economy can absorb the losses, or, all failing during a severe downturn in economic conditions, where bank failures would only add to, and amplify the economic decline. Seeing that we’ve already seen the later, which we call the Great Depression, I think it would be wiser to choose the former.

But hey… That’s just me.

PS. Then, from the anti-Fed crowd, there’s this gem:

Many Bailed-out Banks May Fail Anyway

Already seven bailed-out banks have failed, at a cost to the taxpayer of $2.7 billion. But the real tale of the Great Bank Bailout has been the shameless financial favoritism lavished on the largest banks, in the United States and abroad, who are fortunate enough to be allowed to conduct business directly with the Federal Reserve. Those institutions are the first recipients of the massive amounts of new money the Fed pours into the money supply via the coyly named process of “qualitative easing.” Their balance sheets have ballooned well in advance of the inflationary rising prices that will hurt the rest of us once the money begins to circulate.

Uhm… Seven banks.. he’s whining about seven banks? You do realize that, with this crowd, if the Fed had done nothing, and the 98 banks would have failed, they would be complaining that the Fed is evil because it did nothing to help them… Oh, wait, here you go!

Thus it is, and has been since the inception of the Federal Reserve System, that the rich — the largest financial institutions and their direct benficiaries — continue to get richer, while the poor — the rest of us, including thousands of local banks nationwide — get poorer and poorer, both by having our taxpayers dollars siphoned away and by having our currency destroyed in order to keep the wealthiest banks afloat.

He writes “But the real tale of the Great Bank Bailout has been the shameless financial favoritism lavished on the largest banks, in the United States and abroad. This person probably has no idea that one of the key components of the Great depression is the collapse of the European banking system, which occurred in 1931, was also a major component of the Great Depression. So it’s not like it makes no sense to aid the European interests. Also note that this crowd is all about going back on the gold standard, ignoring the fact the financial system crashed in Europe BECAUSE of the inflexibility of gold backed currency… Thank you France.

5 Comments to “Why TARP Was The Right Thing To Do – Timing / Or Continuous Meme Alert: “TARP is bad, MmmK”.”

  1. By Jeff Alberts, December 29, 2010 @ 4:08 am

    As I’ve always said, IF they were going to pump money into the system, they should have given it to the consumers. So they could, you know, consume, and so the producers could produce. Instead they bailed out the producers, leaving the consumers unable to consume.

  2. By Scott Lassiter, December 29, 2010 @ 11:41 am

    I keep seeing the statement, ‘a drop in the bucket’, more and more in regards to budget issues. All these drops are easy to dismiss until it is too late. More attention to all the drops please.

  3. By Sonicfrog, December 29, 2010 @ 4:22 pm

    Jeff:

    A part of me likes that idea too. But it problem is two-fold. How much could you possibly give to matter? We saw what happened with cash for clinkers. Yes, car sales did ramp up for a bit, but as soon as the program ended, car sales tanked to even lower levels than before the program. You might think “OK, we’ll just give even more cash, an even larger amount”! The problem there is that if you flood the populace with too much unearned cash, and suddenly everybody is well off…. Well, if you’re a merchant, a landlord, a pool and spa repair guy… You see everyone is suddenly flush with cash… What do you do? You raise your prices, of course! I could get triple my fees if I worked in Beverly Hills vs being here in Fresno. Not that it would matter, as the distribution of that much cash would devalue the dollar anyway.

    Scott:

    I was thinking the same thing when I was typing that. Ultimately, it’s an opportunity cost situation. Every choice here has consequences. Does the money get lost, thrown down the pit by propping up some banks that are doomed to fail anyway, or do you do noting and let the banks fail, thereby keeping the billions spent on TARP but losing three times as much by entering into a second Great Depression vs a Great Recession? Don’t get me wrong, I don’t like the situation one bit. But if I were President (fat chance on that – why would anybody want that job) I too would pick TARP over the other option. And, as I explained in the post, we already know what happens when you follow the other option.

  4. By Sonicfrog, December 29, 2010 @ 4:23 pm

    Screw this economics stuff… I’m writing about music on the next post!

  5. By Jeff Alberts, December 30, 2010 @ 3:05 am

    My thinking was more along the lines of, give say 50k to families making under a certain threshold. They use it to pay the mortgage, make the car payments, buy new clothes, computer, anything. And then, if they’re still getting foreclosed, screw them, they deserve what the get. But rewarding the banks who made bad-faith loans is not an acceptable solution by any stretch of the imagination.

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