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TARP Revisited

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By: Riley McDermid | September 22, 2009

Half a year into an unprecedented emergency effort to save the credit markets, would we do it all over again? Markets Media talks to key decision makers and financial historians to see just how effective this sweeping effort has been, and where it has fallen short of the mark.

There is no doubt that the vast reaches of the U.S. government's Troubled Asset Relief program have fundamentally reshaped the way global financial institutions, and indeed private industry everywhere, think about the role of regulators. But a year after TARP's ambitious attempt to save the fiscal world, has the behemoth of a program actually worked?

“My guess is that had more financial institutions been allowed to fail, the situation we have been through would seem like a little slice of heaven compared to the situation which may have erupted,” Dan Cook, a senior analyst with IG Markets. “So, in that respect, I do feel that it worked. With regard to actually restoring credit in the manner it was intended, I think that is a point that is sure to be argued for years to come.”

Thawing a Deep Freeze Indeed, in interviews for this story, the argument that TARP's benefits were felt largely in restoring confidence to the credit markets – not buying up the billions of “toxic” assets still left on banking balance sheets – has been the true bright side of the $700 billion rescue plan.  “The TARP's Capital Purchase Program has been a success in the sense that banks look financially healthier,” said Espen Robak, president of Pluris Valuation Advisors.

He added that while credit markets have been slowly unfreezing over the last two months, TARP has been particularly helpful at unlocking the markets, where investors are looking to snap up bargain basement deals on distressed assets.

“We have seen a similar trend in the secondary markets to somewhat tighter discounts for certain assets that were primarily impaired due to lack of liquidity, but were otherwise in pretty good shape in terms of creditworthiness,” said Robak. “To the extent that TARP has provided a greater sense of stability as banks have been shored up and today look much less wobbly, that may have helped.”

Robak said that TARP, for the most part, had done a good job at restoring calm to spooked markets and in that sense had been quite successful at tempting skittish investors back into the market. Subsequent emergency lending programs will still need more time to be assessed for their efficacy, however, as market player move into the next, “post-emergency” phase.

“The TARP CPP investments were likely very necessary and well-timed, as there was considerable fear at the time that we would have widespread bank failures, and more than the system could handle,” said Robak. “Now that this is less of an emergency, the focus has shifted towards repayment.”  As such, some of the recent moves by federal regulators to revive formerly frozen credit markets have only been “partially successful” and have done little to convince many market players such as private equity and hedge funds to come off the sidelines and actively trade many types of distressed assets, Daniel Alpert, managing director at Westwood Capital, told Markets Media.

“ There has been some resuscitation of some distressed credit markets based on selling it down to the government facility, but I don't sense that credit markets are out of the woods,” said Alpert. “Instead, they've move out of a freefall stage into just a terrible stage.”

Execution a Mixed Bag

Still, historians charting TARP's progress have been quick to point out that while thus far it has been “a well-executed plan,” it ultimately did not reflect “good crisis management” by the U.S. government, a leading financial historian told Markets Media.

Richard Sylla, an economist and financial historian at NYU's Stern School of Business, said that although the “idea” of TARP struck him as “a bold intervention,” then-Treasury Secretary Henry Paulson ultimately undermined the plan's original goals by switching its focus early on. “Secretary Paulson should not have said that he hated to do what he was doing but had to do it because the situation was so dire when he announced TARP, and he should not have flip-flopped a month later by saying purchasing troubled assets was out and injecting capital was in,” said Sylla.

“Neither of these actions reflected good crisis management.” In addition, Sylla said that forcing banks that did not need TARP funds to “take the money anyway” did not send a clear signal of confidence to the market and may be judged in a historical context as overkill.

That “did not seem like such a good idea before stress tests were done, and coupled with clamors for regulating bankers' pay, the action made stronger banks want to repay TARP money as fast as they could,” said Sylla. “In the panic of 1907, the first thing J. P. Morgan, the crisis manager that year, did was to have his people perform stress tests on troubled banks, then he organized rescues of sound banks facing runs, and the crisis was over in a couple of months.”

But this time around, federal regulators were slow to take the financial crisis as seriously as they should have – resulting in a deepening global recession and spreading lack of faith in the American banking system that could take decades to repair.

“A century later, the authorities let the crisis go on for a year and a half before doing the stress tests, and before the stress tests were done, it rescued banks that didn't need rescuing,” said Sylla. “This, unlike Morgan's actions, amounted to putting the cart before the horse,” he adds. Nonetheless, Sylla said that TARP had done much to breathe life into formerly deadlocked credit markets and had combined with other sweeping regulatory interventions to stabilize the global financial system during a time of unprecedented crisis.

“TARP has done some good. But it is just one of many fairly bold interventions on the part of the Treasury, the Fed, and the FDIC. Together these interventions are helping to unfreeze previously frozen credit channels,” he said. “In the early stages the TARP interventions were not well executed, which may have delayed the program's good effects. But better late than never,” he added. “Anyone familiar with the 1930s knows that 2007-2009 could have been much worse if the authorities had done nothing or even some wrong things, as during 1930-32.”