The Incredible Shrinking TARP Bailout

I seem to be the only blogger talking about this, which makes me think either I am ahead of the curve, or more likely making a bonehead error.  But as of yet no commenter has yet found the bonehead error I am making.

Last time I wrote on this subject the eventual cost to the government from bailing out the big banks was estimated at a negative $7 billion–in other words a profit to Uncle Sam of $7 billion.  There was an expected loss on the AIG bailout of $36 billion, and I acknowledged that could be viewed as a backdoor bailout of the big banks.  Indeed the entire TARP is a giant favor to the banking industry even if every dollar is repaid.  And now it appears it all will be repaid, even the AIG bailout.  (I am excluding the loans to automakers, which I regard as a separate issue.)

When the crisis first broke we were told the main problem was the big banks, and the underlying regulatory problem was “Too Big to Fail,” which encouraged the big banks to take excessive risks.  I now think my original view was wrong.  It appears that at the end of the day the biggest banking fiasco in the history of the universe will not result in any long run net taxpayer transfer to big banks.  And yet the owners and managers of those banks incurred mind-boggling losses.  So how plausible is it that TBTF was the primary cause of excessive risk taking in 2004-07?  If even a crisis this big didn’t result in  the long-run transfer of one cent of taxpayer money to big banks, does it seem likely that expectations of those transfers were a powerful motivating factor in the the MBSs they bought? Were they expecting an even bigger banking fiasco?  I suppose it’s possible, but I just don’t see it.

In contrast, massive quantities of taxpayer funds will be transferred to depositors at smaller banks, who (in collusion with the banks themselves) gambled recklessly by lending taxpayer-insured funds out to risky construction projects.  There I really do see a moral hazard problem, indeed what happened was essentially a repeat of the 1980s S&L crisis.  Once might be a fluke; twice is a systemic problem.  I’m increasingly likely to view the big bank crash as a fluke and the smaller bank crash as a chronic policy problem.  Indeed didn’t the same dichotomy occur during the Great Depression, with most failures being smaller banks?

So here are the eventual taxpayer losses we are looking at:

Fannie and Freddie  — $165 billion and rising

FDIC — Over $100 billion

FHA — Who knows, even today they’re still encouraging new sub-prime loans.

AIG — $0

The big banks — negative $7 billion

Would it be fair to say that the initial reporting of the crash of 2008 was a bit misleading?  The reporting that led most people to form indelible opinions that they will probably never re-visit or re-evaluate?

Some will argue that the Fed policy of buying MBSs indirectly helped the big banks.  Maybe so, but if we are talking about indirect effects from government programs, then what about the indirect effects of the Fed letting NGDP fall 8% below trend in 2008-09?  That hurt banks far more than any Fed MBS purchases helped them.

So tell me, why is my hypothesis wrong?

About Scott Sumner 490 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

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