The Troubled Asset Relief Program of the United States Essay

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Definition

The troubled asset relief program (TARP) of the United States government was signed into law by the former US president George W. Bush on October 3, 2008 (Hillman 16). The program was meant to tackle the subprime mortgage crisis as part of the $700 billion Bank Bailout Bill (Muolo 13). The TARP program initially allowed banks and other financial institutions to propose a bid price to sell their distressed (toxic) mortgage-backed securities to the federal government as part of a reverse auction. While banks would offer to sell their mortgage-backed securities, Treasury would purchase such securities at the lowest offered price in a bid to stabilize the economy in the wake of the 2007-2008 financial crisis (Bonner and Wiggin 34).

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The initial program was revised following concerns that the government would end up paying too much while banks estimated that they could not get sufficient funds. The alternative was a fund that bought preferred stock and warrants in nine of the largest American banks, making use of the phrase “too big to fail” and other financial institutions. In the announcement by then-president George Bush and Treasury Secretary Paulson, $250 billion would be used to buy the preferred stock of the nine major companies and the other smaller financial institutions. Among other requirements for a company to be eligible for the troubled asset relief program, companies would also face restrictions on their tax benefits and limit compensations paid out to executives in the company in terms of bonuses and golden parachutes.

Background

The subprime mortgage market started experiencing difficulties in 2006, thereby affecting American financial institutions that relied on them for business. The effect of this was a greater impact on the US economy, which later sent shockwaves around the world, leading to the global recession of 2007-2008. TARP came as a result of the Emergency Economic Stabilization Act of 2008, whereby the US Government sought to exploit ways to protect the economy from further downturns in the markets in response to the subprime mortgage crisis (Vazquez 11, United States Congress et al. 1, CCH Editorial Staff 3). The aim of TARP was to stimulate the economy by freeing up assets of big businesses, thereby allowing them to lend to the economy, and discourage further down-closures in the housing market.

The Emergency Economic Stabilization Act, alternatively referred to as the bailout, authorized the Treasury to spend almost $700 billion to purchase troubled assets from financial institutions, thereby freeing up the capital of these banks. Then Treasurer Secretary Henry Paulson is credited for proposing the Act (CCH Editorial and CCH tax law editors 5). Other people who supported the initial draft include former President George W. Bush, SEC chairman Christopher Cox and chairman of the Federal Reserve Ben Bernanke. The purpose of purchasing the distressed assets was a way of reducing the uncertainty prevalent in the credit markets, thereby restoring confidence in the country. The effect of the announcement was a sense of stability in DOW Jones Industrials and NASDAQ indices, bond and currency markets (Organization for economic co-operation and development 27).

Positions held

There is still debate on whether or not the Troubled Asset Relief Program achieved its intended objectives. While banks stabilized their balance sheets, most members of the Consumer Advocacy Group believe that TARP did not meet its goal. These groups argue that banks cannot be trusted with the TARP funds set aside by the government, such as the Bank of America, by focusing solely on their personal gains while putting the needs of individual homeowners in the background (Howard 57). The Consumer Advocacy Group claims that lenders have been given money by the government to maintain the stability of the financial community while taxpayers bear the burden (Brown 61). The companies are said to be using the TARP money to bail out chosen few failing companies, such as Meryl Lynch, rather than using those funds to help out struggling homeowners (Zandi 129). Some of the companies that bailed out have also failed to abide by the conditions set out Troubled Asset Relief Program. Some institutions have also issued out golden parachutes through multimillion-dollar exit bonuses.

Inflation and deflation have also been discussed in light of the Troubled Asset Relief Program. A permanent increase in money supply in the economy is likely to lead to price increases, while momentary money supply may cause deflation in the economy. When the Federal Government buys out troubled assets from financial institutions, banks are able to free up their money capital in the process of creating a money supply in the economy. Most of the agency securities are guaranteed by Fannie Mae and Freddie Mac. Once the mortgages are repaid, security agencies get reimbursed while the money supply reduces in the economy at the time of the repayment.

Solutions offered

Policymakers have been pressured to formulate policies that will benefit the main economy, as the original TARP was for Wall Street. Politicians have been urged to determine the root causes of subprime mortgages in an analytical process (Ashcraft 115). Chairman of the FED Ben Bernanke has been trying to focus on the cause-effect relationship of troubled assets and bank capacity to lend in the future. This may require companies to reveal their SEC filings without necessarily having to make changes in their regulatory capital.

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The Treasury Department, by going back to the initial goal of the bailout, could use trap II so as to get rid of troubled assets from bank balance sheets. In TARP II, the government has realized the importance of the price discovery mechanism as a way of coping with future financial crises (Shiller 86). Here, banks would determine which distressed assets to dispose of and group together on an auction block and sold in pools. The government would then decide on the price it is willing to pay and the percentage of assets to cover. Private market participants such as mutual funds, pension funds, and private equity funds may then bid for the assets so that the assets are sold to the highest bidder. The advantage of this is that government is able to transfer risk from taxpayers to the private sector.

Points for consideration

Some may argue that the government should implement the original TARP concept, which is dealing with the toxic assets at banks. Given the recent financial meltdown, lessons have been learned on the dismal effects when it becomes difficult to value financial assets. The image portrayed by the media in such times is that all assets tied to mortgage holdings are dangerous and should be avoided, which causes such assets to be illiquid. (Howard, 78).

The idea of “too big to fail” does not apply to smaller banks, and they, therefore, face more difficulties when raising funds in the public markets than bigger banks. Smaller banks form a significant proportion of the banking sector when all their assets are combined. The government cannot afford to overlook its impact on the economy when making legislation that seeks to strengthen the banking sector. The troubled asset relief program could be reviewed to include these smaller banks in future economic downturns. As a result of their limited inclusion in the TARP, smaller banks are left with the majority of troubled assets in their balance sheets, meaning that they experience difficulties in generating cash flows. The small banks may also face a harder time when transacting with other banks as a result of the number of toxic assets in their accounts.

TARP has been criticized since banks have reduced their lending capabilities as they cope with the requirements of the program (Gramlich 160). Banks also face systematic risks when other financial institutions dispose of their assets, whereby changes are likely to occur in policies regarding required capital. As this problem persists, many banks may cease operations before they are enabled the opportunity of the use of TARP money. Analysts explain that banks may be willing to dispose of their risky assets at whatever price they can get for them, thereby destroying the price mechanism. A possible solution would be to write assets down and inject more capital into the company.

Conclusion

The best solution for the recent debt crisis could best be arrived at when policymakers first determine the root causes of such problems rather than dealing with the effects. The government could reduce its role in the private sector, whereby programs such as TARP require organizations to restrict their compensation policies and bonuses, whereas such programs are meant to motivate executives to better lead the company. Regulatory oversight dampens the profit motive of companies; hence an appropriate strategy would be the use of financial incentives to solve liquidity problems in the economy (Soros 61).

Works cited

Ashcraft, Adam B. Understanding the Securitization of Subprime Mortgage Credit. Collingdale, PA: DIANE Publishing. 2010. Print.

Bonner, William and Addidon Wiggin. Empire of debt: the rise of an epic financial crisis. New Jersey: John Wiley and Sons, 2006. Print.

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Brown, Orice Williams. Troubled Asset Relief Program: Treasury Needs to Strengthen Its Decision-Making Process on the Term Asset-Backed Securities Loan Program. Collingdale, PA: DIANE Publishing, 2010. Print.

CCH Editorial Staff Publication and CCH Tax Law Editors. Tax Legislation 2009 American Recovery and Reinvestment Act of 2009 Conference Report. New York: CCH, 2009. Print.

Cch Editorial Staff. Emergency Economic Stabilization Act of 2008: Text of H.R. 1424, As Signed by the President on October 3, 2008 : JCT Technical Explanations of H.R. 1424. New York: Cch Editorial Staff, 2008. Print.

Gramlich, Edward M. Subprime mortgages: America’s latest boom and bust. Washington D.C.: The Urban Insitute, 2007. Print.

Hillman, Richard J. Troubled Asset Relief Program: Additional Actions Needed to Better Ensure Integrity, Accountability, and Transparency. Collingdale, PA: DIANE Publishing, 2009. Print.

Howard Davies. The Financial Crisis. New York: Polity, 2010. Print.

Muolo, Paul. $700 billion bailout: the Emergency Economic Stabilization Act and what it means to you, your money, your mortgage, and your taxes. New Jersey: John Wiley and Sons, 2008. Print.

Organisation for Economic Co-operation and Development. The financial crisis: reform and exit strategies. Washington D.C.: OECD Publishing, 2010. Print.

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Shiller, Robert J. The subprime solution: how today’s global financial crisis happened, and what to do about it. New Jersey: Princeton University Press, 2008. Print.

Soros, George. The new paradigm for financial markets: the credit crisis of 2008 and what it means. New York: Public Affairs Publishing, 2008. Print.

United States Congress, Senate, Committee on Banking, Housing, and Urban Affairs. Emergency Economic Stabilization ACT: One Year Later: Hearing Before the Committee on Banking, Housing, and Urban Affairs, United States Senate, One Hundred Eleventh Congress, First Session, on Examining the Effects of the Emergency Economic Stabilization ACT After One Year, September 24, 2009. Washington: United States Government Printing Office, 2010. Print.

Vazquez, Nikola. Emergency Economic Stabilization Act. New York: Nova Science Pub Inc, 2010. Print

Zandi, Mark M. Financial shock: a 360° look at the subprime mortgage implosion, and how to avoid the next financial crisis. New York: FT Press, 2009. Print.

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