Opinion: Studies Show TARP Worked, But We Should Never Do It Again

By John Sedunov, Allen Berger, and Raluca Roman.

Amid the throes of the financial crisis exacerbated by the collapse of Lehman Brothers, Congress passed the Emergency Economic Stabilization Act (EESA) of 2008, which created the Troubled Asset Relief Program (TARP) — a $700 billion relief package aimed at stabilizing the banking system and restoring economic security to the real economy. At the time, opinions on the package were split. Then-Senators Barack Obama and John McCain were in favor of the bailout, while other politicians like Senators Christopher Dodd and Richard Shelby expressed concerns over it. 

As we look back at 10 years since the implementation of TARP, much controversy remains about how effective the program was. Questions persist today about whether TARP achieved its two main goals of preventing further collapse of the financial system and keeping the economy from plunging into a deeper recession or depression. Our research suggests that the answer to both of these questions is a resounding yes. 

Our analysis of publicly traded U.S. banks suggests that TARP significantly reduced recipient banks’ contributions to systemic risk, helping prevent financial system collapse.  This outcome occurred primarily through increasing the value of recipient banks’ common equity, which reduced their market leverage, making them safer and less likely to suffer financial distress and harm other institutions.

The overall results suggest that TARP made the banking system safer, and likely saved Wall Street.

TARP was most effective in reducing contributions to systemic risk in the short run — primarily during the heart of the financial crisis — consistent with policymakers’ interest to lessen systemic risk during the most disruptive times. 

However, the effects on systemic risk faded and may have been reversed in the long run. These consequences are consistent with the possibility that moral hazard incentives to take on excessive risk caused by bailouts like TARP return in normal times.

Other research finds that TARP led to increased net job creation and net hiring establishments in the United States, as well as decreased business and personal bankruptcies.  These outcomes primarily resulted from increases in commercial real estate lending and off-balance sheet real estate guarantees. Thus, TARP appeared to significantly help the real economy, saving Main Street as well as Wall Street.

What does this mean going forward? TARP accomplished its two main goals of rescuing the financial system and real economy, but that does not mean that bailouts are the best policy. 

Recent research compares bailouts like TARP with bail-ins, like the Orderly Liquidation Authority instituted by the Dodd-Frank Act of 2010. Under bail-ins, the private sector rather than the government injects the funds into large problem financial institutions.

The research suggests that while generating some of the same benefits of bailouts, bail-ins provide superior incentives to bailouts for banks to hold higher capital ratios during normal times and raise them when the banks become distressed. Thus, an even better regime may be in place when the next financial crisis occurs.

John Sedunov and Allen Berger are professors at the Villanova School of Business and University of South Carolina, respectively.  Raluca Roman is an economist at the Federal Reserve Bank of Philadelphia.

Related Links:

Opinion: The 'Powell Put' Is In Place As Round Four Of QE Looms

What To Consider Watching In March: Tariffs, Fed, Oil