The Congressional Oversight Panel overseeing the Troubled Asset Relief Program (TARP), also known as the bank bailout, issued its year-end audit results (.pdf) today. Overall, the report found that the TARP was effective in stabilizing the financial sector. It also, however, lists quite a few criticisms of the TARP. With Treasury Secretary Timothy Geithner asking for the TARP's extension today, considering its failures is particularly timely. I agree with much of the report, though it included few revelations.

First, here's the mission accomplished declaration about stabilizing banking:

Because so many different forces and programs have influenced financial markets over the last year, TARP's effects are impossible to isolate. Even so, there is broad consensus that the TARP was an important part of a broader government strategy that stabilized the U.S. financial system by renewing the flow of credit and averting a more acute crisis. Although the government's response to the crisis was at first haphazard and uncertain, it eventually proved decisive enough to stop the panic and restore market confidence.



I actually don't think the effects of the TARP are particularly difficult to isolate. It's pretty clear that the U.S. government used it to establish an implicit guarantee of large financial institutions. That calmed markets. While the Federal Reserve also had a great many programs, its work was more focused on market logistics and macroeconomics, rather than calming panic.

And to that end, the TARP was indisputably successful. I mean, it would almost have to be by definition. Anytime the government, particularly the U.S. government, will stand behind something no matter the cost, you can assume it's quite safe. After all, if the government can't manage to live up to that promise, then the country will have much bigger problems than just a credit crunch.

So, yes, government guarantees calm people down. No surprise there. But that doesn't mean that the TARP was completely effective. In fact, there are seven ways in which the TARP failed, according to the report. I wanted to go through those briefly, and add one more:

Getting Credit Flowing

No matter how red-in-the-face Congressmen got during hearings, they just couldn't get the bailout banks to lend more. And that's not surprising: the TARP contained no tangible mechanism with which to require them to do so. But that's okay -- it shouldn't have. By forcing banks to lend more in their fragile state, such a strict lending requirement could have endangered the very capital cushion that the TARP sought to create. So I think this was more of a misguided goal of the legislation. In fact, this end was better accomplished by the Federal Reserve through its programs like the Term Asset-Backed Securities Loan Facility.

Regional Bank Failures

While the TARP did a great job in healing the big banks very quickly, the same can't really be said of the smaller regional banks. I wrote about this problem yesterday, so I won't rehash all of that analysis here. As the report says, since January 1, 2008 there have been 149 bank failures. As commercial real estate struggles, there may be more to come. So while Wall Street is stabilized, regional banking is hardly out of the woods.

Removing Toxic Assets

The original purpose for the TARP was to purchase toxic assets from banks, as its name indicates. For whatever reason, former Treasury Secretary Hank Paulson couldn't make that happen, so it used the fund as a blunt instrument to recapitalize banks instead. That worked for stabilization purposes in the short-term. But in the long-term, these bad assets continue to plague bank balance sheets. No effort to purge them with the TARP has been successful. At this point, banks will likely slowly sell some here and there and just allow the others to run off, with the losses spread out over time.

Preventing Foreclosures

The homeowner bailout, a sub-bailout within the TARP, hasn't done particularly well. Foreclosures continue to soar. I reported yesterday on how poorly the Treasury's program has done modifying troubled mortgages, according to Chase Bank's statistics. It's got around an 8% success rate for trial foreclosures that manage to be made permanent under the TARP-funded program. Obviously, the success rate is even lower for the total number of applicants who apply for the government program, as many probably don't even make it into the trial period. From any measure, that's a pretty awful result.

Slowing Job Losses

This is one of the few areas where I disagree with the COP report. I didn't see slowing job losses as a direct goal of TARP. I guess you could argue that, by making sure credit was available, fewer businesses would need to lay off workers. So, maybe in some indirect manner twice-removed, job loss prevention was a goal. But I don't think you can really blame unemployment on the TARP.

The Market Still Reliant On Government

This problem overlaps with a few others. So, while I find it legitimate, I'll defer to the next failure which better addresses this worry.

Created An Implicit Government Guarantee Of Big Banks

This is one of the most serious problems resulting from the TARP. Big financial institutions are now seen as having an implicit government guarantee. I was watching CNBC this morning and the COP chairwoman Elizabeth Warren actually made an interesting comment regarding this guarantee.

When asked whether she worried that banks were now rushing to pay back their bailout money before they were really ready, Warren cited this implicit guarantee as the reason why she wasn't so concerned. She said that, even if big banks appear to run into trouble again, the market won't worry, because it understands that the government will continue to stand behind the big financial institutions. So after paying back Uncle Sam, banks will still have the benefit of the government guarantee without any of those pesky pay constraints.

Here's that whole CNBC clip if you want to watch it. She makes some other interesting comments as well:



Of course, this implicit guarantee isn't an entirely good thing. It creates significant moral hazard for banks to continue taking risks, because everyone assumes the government will just bail them out again, if necessary. The TARP report notes this problem. If financial regulation is done right, however, this issue can be quickly eliminated. With a non-bank resolution authority in place, bank failure plans will be submitted. Then the systemic risk regulator can weigh if those plans will work, and if not the institution will be deemed too big to fail and will be broken up. At that time, the market should understand that the government will not stand behind any firm going forward.

Staying On Task

There's one final pretty clear flaw in the TARP that the report only kind of mentions in passing. The plan called for in the legislation barely resembled what actually occurred. Toxic assets were not purchased. To make matters worse, the money started being used for purposes other than stabilizing the financial market, like bailing out U.S. automakers. TARP never should have become the Treasury's a slush fund. If the Obama administration ends up using it for another jobs stimulus without Congressional approval, then it would be hard to describe it as anything other than that.

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