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Evaluating the TARP
Written Testimony for the Committee on Banking, Housing, and Urban Affairs United States Senate
John B. Taylor^1 Stanford University
March 17, 2011
Chairman Johnson and other members of the Committee, I thank you for the opportunity to provide written testimony for the hearing on the evaluation of the effectiveness of the Troubled Asset Relief Program in stabilizing the financial system and the U.S. economy. You requested that I consider empirical evidence regarding the rollout and the implementation of TARP. I begin with a summary of that evidence.
Rollout and Implementation
My empirical research on the rollout and implementation of TARP goes back to its very early days. Conducted in real time, the research results were first presented^2 in November 2008, prior to the first hearings or reports of the Congressional Oversight Panel or the Special Inspector General for the TARP. As part of an ongoing research project I had been following several measures of stress in the financial markets. I became concerned when these measures started showing that the rollout of the TARP was actually worsening the crisis. So I began to study the issue further.
The chart below summarizes some of the evidence. It is reproduced from my November 2008 study and shows the Libor–OIS spread during the period when TARP was being rolled out. The Libor-OIS spread is a well-known measure of stress in the financial markets. It is the difference between the interest rate on longer term interbank loans (Libor) and an expectation of what the overnight interest rate (federal funds rate) would be over the maturity of the loan (OIS). Higher values of the spread indicate greater stress in the markets.
(^1) Mary and Robert Raymond Professor of Economics at Stanford University and George P.
Shultz Senior Fellow in Economics at Stanford University’s Hoover Institution. (^2) John B. Taylor "The Financial Crisis and the Policy Responses: An Empirical Analysis of What
Went Wrong," A Festschrift in Honour of David Dodge's Contributions to Canadian Public Policy , Bank of Canada, November 2008, pp. 1-
The chart highlights several key events in September and October 2008: the bankruptcy of Lehman brothers, the announcement of TARP, the first congressional testimony about the TARP at this Committee, and a major change in the design of program as it was implemented. Note that the spread started rising sharply in late September and kept rising until mid-October when it started to move down. The sharply worsening conditions in the markets are thus quite evident in the chart. Never before had I seen this spread rise so sharply. The question I addressed then—and am again addressing now—was what caused the worsening conditions.
Many rightly argue that when evaluating policy decisions it is important to try to place oneself close to the time of the events. So let me quote from my November 2008 paper:
“It is evident that the spread moved a bit on 15 September, which is the Monday after the weekend decision not to intervene in Lehman Brothers. It then bounced back down a little bit on 16 September, around the time of the AIG (American International Group) intervention. While the spread did rise during the week following the Lehman Brothers decision, it was not far out of line with the events of the previous year.”
“On Friday of that week, the Treasury announced that it was going to propose a large rescue package, though the size and details hadn’t yet been determined. Over the weekend, the package was put together and on Tuesday, 23 September, Federal Reserve Board Chairman Ben Bernanke and Treasury Secretary Henry Paulson testified at the Senate Banking Committee about the TARP, saying that it would be $700 billion in size. They provided a 2½-page draft of legislation with no mention of oversight and few restrictions on the use. They were questioned intensely in this testimony and the reaction was quite negative, judging by the large volume of critical mail received by many members of the United States Congress….it was following this testimony that one really begins to see the crisis deepening, as measured by the relentless upward movement in the LIBOR-OIS spread for the next three weeks. The situation steadily deteriorated, and the spread went through the roof to 3.5 per cent.”
Here are the corresponding data for equity markets in Britain, Germany, France, Brazil, and Japan. The timing of the moves tells the same story.
S&P FTSE DAX CAC IBOVESPA NIKKEI Sept 12 1252 5417 6235 4332 52393 12215 Sept 15 1192 5204 6064 4169 48419 11609 Sept 19 1255 5311 6134 4324 53055 11921 Oct 10 899 3821 4544 3176 40829 8276
Other views
There have been other assessments of the effectiveness of the TARP. In a book published last year, former FDIC chairman William Isaac concluded^3 that “any objective analysis would conclude that the TARP legislation did nothing to stabilize the financial system that could not have been done without it. Moreover, the negative aspects of the TARP legislation far outweighed any possible benefit.” In recent testimony before the Congressional Oversight Panel, economist Joseph Stiglitz^4 said that “TARP has not only been a dismal failure…but the way the program was managed has, I believe, contributed to the economy’s problems.”
Not everyone of course has such negative assessments. In its last report 5 the Congressional Oversight Panel said, “It is now clear that, although America has endured a
(^3) William G. Isaac Senseless Panic: How Washington Failed America , Wiley, New Jersey, 2010.
p. 175. (^4) Joseph Stiglitz, “Testimony on Impact of the TARP on Financial Stability,” Congressional
Oversight Panel Hearing March 4, 2011 (^5) Final Report of the Congressional Oversight Panel , Congressional Oversight Panel,
Washington DC March 16, 2011
wrenching recession, it has not experienced a second Great Depression. The TARP does not deserve full credit for this outcome, but it provided critical support to markets at a moment of profound uncertainty.” In testimony before the Congressional Oversight Panel, acting Assistant Secretary of Treasury Timothy Massad goes further arguing that the TARP prevented an even more severe crisis,^6 citing as empirical evidence a paper^7 by Alan Blinder and Mark Zandi. However, Blinder and Zandi explain in their paper that they did not do a separate evaluation of the TARP, stating that “We make no attempt to decompose the financial-policy effects into portions attributable to TARP, to the Fed’s quantitative easing policies, etc.” Empirical evidence showing the effectiveness of TARP is lacking.
It should also be noted that many of those economists who view the TARP as having a beneficial effect argue that there were much better alternatives that could have avoided the financial panic and would have been far less costly with fewer long-term side effects. For example, Luigi Zingales^8 notes that “it is both false and misleading to say that there were no other alternatives. False because there were feasible, and in fact superior, alternatives. Misleading because it made TARP appear inevitable, forcing people not to question its costs.”
In my view the TARP was not effective in stabilizing the financial system, especially if one takes into account the panic caused by its chaotic rollout and the fact that other actions could have been taken. Indeed other actions were taken, including the Fed’s support for the commercial paper market and money market mutual funds, and I believe these were effective in mitigating the panic, which evidence shows was in part caused by the TARP
Legacy Costs
Although disagreement remains about whether TARP was destabilizing or stabilizing in the short run, there is very little disagreement about the longer-run legacy costs which are substantial, long-lasting, and already being felt. Consider the views from recent reports by oversight bodies and independent observers.
In January the Special Investigator General of the TARP listed these costs:^9
“damage to Government credibility that has plagued the program,” “failure of programs designed to help Main Street rather than Wall Street,” “moral hazard and potentially disastrous consequences associated with the continued existence of financial institutions that are ‘too big to fail’”
(^6) Massad, Timothy G, “Written Testimony before the Congressional Oversight Panel,” March 4,
2011 (^7) Alan Blinder and Mark Zandi “Policy Responses and the Great Recession,” July 2010 (^8) Luigi Zingales, "Overall Impact of TARP on Financial Stability,” Congressional Oversight
Panel, March 4, 2011 (^9) Quarterly Report, Office of the Special Inspector General for the Troubled Asset Relief
Program, January 26, 2011
