Holding Treasury's TARP Exit Strategy to a Higher Standard

When Congress passed the Troubled Assets Relief Program in October, 2008, it also created the Congressional Oversight Panel (COP), a five-member board charged with the responsibility to "review the current state of financial markets and the regulatory system." In a report to Congress released on Jan. 14, COP says the Treasury Department should more clearly articulate an exit strategy from TARP. It also wants Treasury to reduce the "moral hazard" now seen in the financial marketplace, thanks to the widespread belief that the government will "rush in to rescue financial institutions deemed too big to fail."%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%%COP thinks this belief distorts "prices, giving large financial institutions an advantage in raising capital that mid-sized and small banks. . .do not enjoy. These implicit guarantees also encourage major financial institutions to take unreasonable risks out of the belief that, no matter what happens, taxpayers will not allow their failure."

While there is no doubt that this moral hazard exists, Treasury alone can't fix it. Congress will also have to act. But so far, new financial regulations that passed the House are still stalled in the Senate. Fed Reserve Chairman Ben Bernanke also recently blamed the financial crisis on lax regulations. That also puts the blame on inaction by the Fed and other regulators.

So while the COP rightly recognizes the moral hazard, blame doesn't fall solely on Treasury or the Obama Administration. The COP report does conclude that, "So long as markets continue to believe that an implicit guarantee exists, moral hazard will continue to distort prices and endanger the nation's economy, even after the last TARP program has been closed and the last TARP dollar has been repaid."

What's Left in TARP

The first major milestone for exiting TARP will be on Oct. 3, 2010, when Treasury's authority to make new commitments to purchase assets, commit funds and establish guarantees using TARP funds will expire. This won't end TARP; it just means Treasury can't commit new funds that weren't already committed by Oct. 3, 2010. That will leave a large pool of TARP funds in the system, including:

• Unpaid TARP-related assets in preferred securities issued by banks, which was $58 billion as of Dec. 31, 2009
• $25 billion in Citigroup common stock if still owned by the government on Oct. 3
• $46.9 billion in AIG preferred stock if not sold by the government before Oct. 3
• $61 billion in shares and debt of GM and Chrysler, if not repaid or sold before Oct. 3

In addition to these major holdings, TARP also holds significant assets under the Public-Private Investment Program, the Term Asset-Backed Loan Facility and the Capital Purchase Program. Treasury plans to increase these holdings with the purchase of new assets, such as the planned small-business initiative to increase available funds for small-business lending.

So Broad As to Be Meaningless

COP's biggest worry about exiting from these commitments concerns the principles used to make the exit decisions. Treasury has announced the three principals it will use to determine when to sell assets: maintaining the stability of the financial system, preserving the stability of individual financial institutions and maximizing the return on the taxpayers' investment.

But COP says the "principles as announced are so broad that they provide Treasury with a means of justifying almost any decision. This means that there is effectively no metric to determine whether Treasury's actions met its stated goals." The panel believes that "any approach may alternatively be justified as maximizing profit, or maintaining the stability of significant institutions, or promoting systemic stability."

COP also wants Treasury to do a better job of tracking how any additional funds committed under TARP are used. Treasury never required institutions that received the first TARP infusions to account for what they did with these funds. "Taxpayers have not had a clear understanding of how their money has been used," COP concludes. It wants Treasury to "require that future recipients provide much greater disclosure of their use of TARP data."

COP's asking for clearly stated, measurable principles to guide Treasury's exit from TARP seems eminently reasonable. So does its request that moral hazard be avoided. Now it's up to not just Treasury but also financial regulators and Congress to act.