With the Troubled Asset Relief Program (TARP) officially over, the debate has begun about whether or not it was a good idea. Although it appears to have worked fairly well, having to employ such a program is still ultimately regrettable. It's clearly a problem that the financial market got itself into a situation where a federal bailout by Congress was necessary. Or was it? Former Federal Deposit Insurance Corporation Chairman Bill Isaac isn't convinced. He says the FDIC could have handled the bank rescues without involving Congress.
In a recent op-ed through Forbes, Isaac wrote:
However, the TARP was not needed for capital infusions because the FDIC had existing authority to provide capital to banks. I preferred strongly that the FDIC manage a capital infusion program rather than the highly politicized program Treasury implemented.
He made the same point last night on CNBC's Kudlow Report, when we debated whether TARP worked. He argued against it, while I said it worked pretty well. (Clip below.)
Of course, Isaac knows more about the FDIC than I do; after all, he ran the joint. So I gave the FDIC a call to better understand how its bailout authority works. A spokesperson informed me that the FDIC did, in fact, have the authority to step in and rescue a depository institution that was determined by its board, the Fed, and Treasury to be systemically vital in an emergency situation -- without winding it down. Indeed, it did so with Bank of America and Citigroup.
So why didn't the FDIC just rescue all the big banks without the help of Congress? There are a few reasons.
First, the FDIC's authority only extended over depository institutions. That would have left out firms like AIG, Goldman Sachs, and Morgan Stanley. Of course, all three and other non-bank financial firms ultimately received TARP money.
Second, it might not have been possible for the FDIC to step in to provide capital to all of the big banks, since some didn't need it. You may remember that there was a huge controversy with TARP where banks that didn't want a bailout were force fed capital anyway. The FDIC would likely have only saved a handful of the sickest big banks instead.
That might sound favorable, but in the market it would have been devastating. For example, if it was determined that only Citi and Bank of America needed a rescue, then investors would have immediately shunned those institutions and turned to healthier banks like Wells Fargo, JPMorgan, and others. That would have made their situation worse, and increased the likelihood that they would end up in receivership.
Again, that might sound okay in theory. But if they had to be wound down, then more uncertainty would result. The market would worry about all of those banks' obligations. How significant of a haircut would bondholders have to take? Would their derivative counterparties be made whole? Only the sometimes length wind down process could decide. Uncertainty would mount and contagion would spread. That's precisely the sort of systemic risk that TARP was designed -- and implemented -- to avoid. Under the terms of the FDIC's systemic risk authority, however, it must publicly disclose such activities to the public. This contrasts with the Federal Reserve's secrecy regarding who it rescues through emergency lending -- a controversial but practical rule in place to avoid precisely this sort of panic.
Forcing TARP through Congress was both a blessing and a curse. It gave the Treasury broad discretion to distribute funds without getting bogged down by a formal process of determining a bank's problems. This provided TARP the advantages of speed and flexibility. But it also came with lots of strings attached, like bailouts for GM, Chrysler, and struggling homeowners, which is where most of TARPs losses will come from. An FDIC bailout would have avoided such politics.
Of course, now that the summer's Dodd-Frank financial regulation bill is in place, the FDIC loses its systemic risk authority, but has far more power to handle sick financial firms, whether banks or not. That's through the new non-bank resolution authority. If it works as advertised, even a few big firms should be able to fail without taking down the economy with them. But we'll have to wait to see if theory matches up with practice. Let's hope we never have to find out.
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