The Bailouts Of 2007 - 2009

Following the announcement of the Capital Purchase Program on October 14, 2008, the first program of TARP announced in the pre-election phase, there were broad improvements in the credit markets. Between Friday, October 10 and Tuesday, October 14, the Standard and Poor’s 500 rose by 11 percent and the common stock prices of the nine large financial institutions that were the very first participants of TARP increased by 34 percent (Veronesi and Zingales 2010). From October 13, 2008 (before the announcement of the CPP) to September 30, 2009, the LIBOR rate fell by 446 basis points and TED spread fell by 434 basis points. Costs of credit and perceptions of risk declined significantly in corporate debt markets as well. By the end of September 2009, the Baa bond rate and spread had fallen by 263 and 205 basis points, respectively (US GAO 2009, p. 37)….

Using an event study analysis of bank enterprise values, Veronesi and Zingales (2010) analyze the effect of the initial announcement of TARP assistance to the financial sector. They estimate that the October 13, 2008, announcement resulted in a net social benefit to financial intermediaries, after subtracting the cost to taxpayers, of between $86 billion to $109 billion….

[But] Veronesi and Zingales (2010) underestimate the expected costs of TARP as of October 13, 2008. The first round of assistance provided to the big banks effectively committed the government to a “whatever it takes” approach to keep AIG, Citigroup, and Bank of America alive, and therefore, the continuing cost to taxpayers actually experienced in 2008–2012 was predictable, at least to some degree. In other words, if TARP assistance would be forthcoming (and more junior in form over time) in response to worsening bank condition, the recipients effectively possessed a put option from the government to issue equity in addition to the explicitly recognized preferred stock investments made by the government….

With regard to TARP’s gross benefits, a credible evaluation of the impact of TARP assistance to financial institutions remains elusive. First, it is difficult, if not impossible, to isolate the effects of TARP from other initiatives of the Federal Reserve, Federal Deposit Insurance Corporation, and other financial regulators, or from other influences on the economy unrelated to government programs. For example, on October 14, 2008, the Capital Purchase Program was announced jointly with the Fed’s Commercial Paper Funding Facility Program and FDIC’s Temporary Liquidity Guarantee Program. Furthermore, it is hard to know to what extent the financial markets would have stabilized and the economy would have recovered in the absence of an activist government response. Some have argued that government support for financial institutions during the crisis confused and frightened market participants and was itself possibly a net negative for the economy.

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