Paulson Was Right (?)

The New York Times has a story about how the government is making a profit on its TARP investments: “The profits, collected from eight of the biggest banks that have fully repaid their obligations to the government, come to about $4 billion, or the equivalent of about 15 percent annually.” The article has plenty of appropriate caveats – the total bailout went well beyond TARP, the Citigroup (NYSE:C) and Bank of America (NYSE:BAC) investments and asset guarantees are still out there, we still have a ton of money sunk into AIG (NYSE:AIG) – but the fact remains that some of the investments are getting paid back, with interest and with a modest bonus from the warrants issued to Treasury.

There is also an ongoing debate about whether Treasury is getting full value for its warrants, which we’ve covered previously, but let’s leave that aside for now. The bigger question, I think, is this: Did Treasury get a fair deal for its investments at the peak of the crisis?

At the time I said no, and I still think the answer is no. The most important principle to bear in mind is that how a decision turns out has no effect on whether it was a good decision to begin with. In honor of the changing seasons, imagine it’s the first quarter of a football game and you have fourth-and-one at the other team’s 40-yard line. Anyone who studies football statistics will say you should go for it; it’s not even close. (Some people have run the numbers and said that a football team should never – that’s right, never – kick a punt.) If the offense fails to make it, the announcer, and the commentators the next day, will all say that it was a bad decision. That’s completely wrong. It was a good decision; it just didn’t work out.

The same holds true for investing. In this case, Treasury bought some securities from the banks and underpaid significantly, according to both the Congressional Oversight Panel and the Congressional Budget Office. The difference between the amount paid for the securities and their fair value at the time was a subsidy to the banks. What happened here was that Treasury made what was in strictly financial terms a bad investment and then got bailed out by later events. Or, you might say, it bailed itself out by undertaking a series of bank-friendly policies that had the effect of bolstering banks’ share prices and making it easier for them to raise capital. Which raises a whole other question: whether Treasury was counting on their ability to themselves out, and thereby avoid any eventual criticism for losing money on the deal – but which, at the same time, gave them the incentive to do what was best for bank shareholders.