TARP Is Dead. Long Live TARP!

In case you missed the news, the Trouble Asset Relief Program, also known as TARP, also known as the bank bailout, officially expired on Sunday. But that doesn't mean taxpayers have all their money back -- it just means that the government can't give what's left of the $700 billion dollar bailout fund for any more distressed banks. That makes now a good time to reflect on why the program worked and whether we'll see anything like it again in the future.

Americans Hated TARP. But It Worked!

Much to the dismay of free market-loving Americans, TARP actually worked incredibly well. Sure, it will still end up costing Americans something. How much? It depends who you ask. Debra Borchardt at The Street reports:

The Congressional Budget Office (CBO) says $36 billion, the Office of Management and Budget (OMB) comes in at $50 billion and the Treasury has the number at $45 billion. AIG's outstanding TARP bill is $49.1 billion.

Of course, just last week, AIG announced its exit strategy. Even the biggest bailout recipients of all might manage to pay back what it owed. That will make the cost of TARP likely boil down to the foreclosure prevention programs, the money lost from small banks that still failed, and the money that went to the auto companies.

What about those "too big to fail" banks? They were rescued -- and taxpayers actually made money on them. The Treasury recently bragged about selling a stake in Citigroup securities, which led to a net profit of $2.25 billion for taxpayers. And Citigroup was one of the sickest big banks during the financial crisis.

Of course, things didn't go as well for smaller banks. Some still failed. As explained here, they weren't able to diversify away as many real estate-related losses, they had more trouble finding investors to raise capital, and they didn't have big trading profits in 2009. But TARP was never really aimed at them anyway -- its target was big banks. It hoped to mitigate the systemic risk of lots of them failing, and it worked.

Why It Worked

So how did it manage to succeed so wildly? It calmed fears. Bank stocks were trading below their rational prices at the height of the financial crisis. Investors were scared of a domino effect where troubled big banks begin failing and cause each others' problems to intensify. But when the government stepped in and declared that it wouldn't let any more financial institutions fail, investors breathed a sigh of relief, and the financial industry healed relatively quickly. TARP worked because the market had faith in the U.S. government's ability to stand behind the financial system.

Is a TARP 2.0 in Our Future?

In fact, TARP worked so incredibly well that we probably haven't seen the last of it. Despite the best efforts by the summer's giant financial regulation bill to end bailouts, doing so is impossible. If the U.S. financial system manages to get itself into another mess in 10, 50, or even 100 years, then the government won't simply allow the industry to crumble and Americans to return to a state of nature. It will step in; it will have to.

For example, imagine if the economy deteriorated again, investors panicked again, and Citigroup, Bank of America, and JPMorgan were all on the verge of collapse. No resolution authority could possibly simply wind down these institutions simultaneously. Many banks remain too big and intertwined to fail, and nothing in the financial regulation bill will shrink or simplify big financial institutions by much.

In the event of another financial crisis where the bill's novel ideas like the Systemic Risk Council, derivative exchanges, and the non-bank resolution authority can't handle the panic, what will happen? The government will figure out some new bailout plan. And history will show that TARP was actually a pretty successful way of ending panic and restoring sanity to the market. It may very well serve as a model for future bailouts.