TARP crucial for financial system

Posted Feb. 25, 2009, at 7:08 p.m.

In this grim season, here’s something to be thankful for: Our banking system is still surviving. The U.S. Treasury’s “bailout” program probably has saved it.

Still, the bailout program has severe critics. Bloggers, newspaper writers and a new congressional oversight committee have harshly criticized the program — known also as the Troubled Asset Relief Program or TARP. The critics correctly argue that TARP funds have shielded many bankers — who were either very greedy, terribly short-sighted, or both — from the full consequences of their actions. They also claim that TARP money may indirectly have paid for huge bonuses to these undeserving bankers.

But these criticisms, though accurate, miss the main point. They ignore the Treasury’s key objective — to save the banking system. And as Steven Pearlstein of the Washington Post points out, we cannot rescue a banking system without rescuing banks.

Let me tell a story about correct criticisms that miss the main point. Suppose your mother is struck by a car. An ambulance takes her to the hospital, and after a six-hour operation she survives. Later, she is released and returns home with casts on both arms. According to her doctors, the operation saved her life.

The next day a neighbor visits, looks at your mother and states that her casts reflect 15-year old technology. Later he finds out that the ambulance driver, by missing a turn in the road, took 10 minutes too long to reach the hospital. The neighbor says you should sue the hospital for these errors.

But the neighbor missed the main point: the hospital saved your mother’s life. So instead of suing, you write a letter commending the hospital.

Similarly, the Treasury deserves a letter of commendation. To see why, let’s start with a recent bank failure.

Lehman Brothers, an old Wall Street investment bank, declared bankruptcy last September. It left its debt — earlier worth $613 billion but suddenly worth only pennies on the dollar — in the hands of its unlucky lenders. These lenders, along with Lehman’s investors and many others, quickly headed for the exits. Over the fol-lowing two weeks, bank credit tightened sharply and the stock market fell 12 percent.

Because TARP did not exist in September, the Treasury could not save Lehman. But on October 3, at the urging of then Treasury Secretary Henry Paulson, Congress passed the TARP legislation. Since then, no major bank has failed — so far, TARP is achieving its main objective.

What would have happened without TARP? Other major banks almost surely would have followed Lehman into bankruptcy, leading to the collapse of the whole banking system — the critical system that we use to pay for groceries and that our employers use to pay us. An economic collapse on the scale of the Great Depression might well have followed.

What, concretely, has the Treasury done with the TARP funds? About $240 billion were used to buy preferred stock in banks, and this injection of money bolstered the banks’ cash positions and their balance sheets. As a result, banks have been able to continue providing credit to businesses and households — and total bank credit has in fact held steady in recent months. Still, the threat to the banks’ survival is not over; the Treasury now feels it must ease the terms of its assistance.

TARP’s achievement is especially impressive because it had to swim against the current of a deepening recession: GDP has dropped; we have lost over three million jobs; and the unemployment rate, at 7.6 percent, has reached its highest level since 1992.

It’s significant that high administration officials from both parties have supported TARP. Hank Paulson, Bush’s Treasury secretary, and Tim Geithner, Obama’s new Treasury boss, both strenuously argued that TARP is critical to our financial system’s survival. And now, Geithner has started to rid TARP of its worst faults.

Here’s the bottom line: No major bank has failed since the TARP program began; it’s doing its job. Without TARP, we would be in even worse shape than we now are — we would be suffering a complete financial collapse.

So let’s hear three cheers for Paulson, Geithner and the Treasury Department. And three more for those far-sighted members of Congress — mostly Democrats, but many Republicans — who voted for TARP.

Edwin Dean, an economist and seasonal resident of Vinalhaven, writes monthly about economic issues.

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