March 10, 2016
Since the TARP has come up repeatedly in the debates between Secretary Hillary Clinton and Senator Bernie Sanders, it is worth briefly correcting a couple of major misconceptions. The first one is that we would have had a second Great Depression without the bailout. This assertion requires rejecting everything we know about the first Great Depression.
The first Great Depression was caused by a series of bank collapses as runs spread from bank to bank. The country was much better positioned to prevent the same sort of destruction of wealth and liquidity most importantly because of the existence of deposit insurance backed up by the Federal Deposit Insurance Corporation.
More importantly, the downturn from the collapse persisted for over a decade because of the lack of an adequate fiscal response. In other words, if we had spent lots of money, we could have quickly ended the depression as we eventually did with the spending associated with World War II in 1941. There is no reason in principle that we could not have had this spending for peaceful purposes in 1931, which would have quickly brought the depression to an end.
The claim that we risked a second Great Depression in 2008 (defined as a decade of double-digit unemployment) is not only a claim that we faced a Great Depression sized financial collapse but also that we would be too stupid to spend the money needed to get us out of the downturn for a decade. None of the second Great Depression myth promulgators has yet made that case.
The other misconception is that all is okay because the banks paid back the loans and “we made a profit” on the deal. This ranks high in the category of empty truths. Fannie Mae and Freddie Mac have consistently made money on effectively providing government guarantees for mortgages, except in the crisis. (They have again been hugely profitable in the years since the crisis.) This does not mean that the government is not using them to subsidize home mortgages. As a result of the government’s guarantee, homebuyers can get mortgages for interest rates that are between 25 and 75 basis points (0.25–0.75 percentage points) less than they would pay in a free market.
This is the story of the TARP, except the gap between the market rate and the interest rate charged by the government on bailout loans was far larger. To take one example, at the same time that the government was lending money to Goldman Sachs at 5 percent interest, Warren Buffet was lending them money at 10 percent interest. Buffett also got much more favorable terms on warrants for buying stock as part of the deal. Furthermore, Buffett was willing to make his loan in part because he recognized that the government was unlikely to let Goldman Sachs collapse. This effectively provided Buffett with a form of insurance on his loan.
In short, the bailout amounted to a massive transfer of wealth from the rest of the country to the banks, as the government allowed them access to credit in the middle of a financial crisis at rates that were far below the rate of interest they would have had to pay in the market. This enabled many millionaires and billionaires to survive a crisis that was largely of their own making with their wealth intact. People certainly have a right to be unhappy about this use of government money even if we “made a profit” on it.
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