The end of TARP as we know it

December 10, 2009
By: Eric Lundin

Two years ago the U.S. economy had many symptoms of a bubble ready to burst-runaway stock prices, rapidly inflating real estate prices, and interest rates that encouraged many homeowners to refinance (that's a synonym for "take unnecessary risks with") their most valuable assets. One symptom, however, wasn't revealed until it was too late: a troubling practice among banks to bundle assets-including mortgages, many of which were shakyand sell them to investors who weren't fully aware of the bundles' contents.

So the bubble burst. The Dow Jones Industrial Average fell from 14,000 to 6,500 in 18 months; new-home construction, which was a healthy 1,192,000 (the annual rate) in October 2007 was less than half that at 551,000 in October 2009; the unemployment rate doubled from 4.8 percent to 10.2 percent in the same time frame; and the economy tanked.

The crisis began to emerge early in 2008, and in October that year the U.S. government passed Public Law 110-343 (based on H.R. 1424), the Emergency Economic Stabilization Act (EESA) which included the Troubled Asset Relief Program (TARP). Intended to purchase assets and equity from financial institutions, TARP enabled the Treasury Department to use $700 billion to rescue and strengthen the financial sector. Although TARP was to expire on Dec. 31, 2009, Treasury Secretary Timothy Geithner recently used his authority to extend TARP until October 2010.

Was this really necessary?
By most accounts, the economy is on the mend. The Dow Jones Industrial Average is higher than 10,000. New-home construction actually hit bottom at 498,000 in April and has been relatively stable since then. The unemployment rate edged downward by 0.2 points to 10 percent in November. That doesn't tell us much, but another indicator, initial applications for unemployment insurance, has been falling since March. GDP, the most comprehensive measure of the economy, grew nearly 3 percent in 20093Q.

Having said all that, I think that extending TARP is necessary. Don't get me wrong—I fully realize that most fabricators are straight-talking, no-nonsense types who take a dim view of government intervention, and I agree that markets are best left to themselves with minimal government intrusion. I'll go so far as to say that it's next to impossible to measure accurately the effectiveness of government programs such as this one. However, this is an extreme case, probably on par with the disaster 80 years ago, so I think that government help is warranted.

In a letter to Speaker of the House Nancy Pelosi and a few other members of Congress, Geithner stated that credit is again flowing, the economy is growing, and private capital is replacing public capital in major institutions. He goes on to say that the recovery is strong enough that the government is likely to recover nearly 90 percent of the TARP funds it distributed in 2009.

However, he also stated that foreclosures are increasing, unemployment is too high, and businesses remain cautious. Regarding lending, he mentioned that many categories of bank lending continue to contract, and that this "has hit small businesses very hard because they rely heavily on such lending."

While Geithner indicated that TARP's days are numbered (he mentioned the program's "exit strategy"), he also said, "history suggests that exiting prematurely from policies designed to contain a financial crisis can significantly prolong an economic downturn." In other words, the government wants to curtail its programs slowly, giving the economy sufficient time to recover.

What do you think? Should he have allowed TARP to expire this year or extend it for another 10 months?
Eric Lundin

Eric Lundin

FMA Communications Inc.
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Elgin, IL 60123
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