Saturday, January 17, 2009

Measuring the Cost of TARP

The CBO blog has a very useful discussion of how to measure the cost of TARP:

Through December 31, 2008, the Treasury disbursed $247 billion to acquire assets under that program. CBO valued those assets using discounted present-value calculations similar to those generally applied to federal loans and loan guarantees, but adjusting for market risk as specified in the legislation that established the TARP. On that basis, CBO estimates that the net cost of the TARP’s transactions (broadly speaking, the difference between what the Treasury paid for the investments or lent to the firms and the market value of those transactions) amounts to $64 billion—that is, measured in 2008 dollars, we expect the government to recover about three quarters of its initial investment. The Office of Management and Budget’s (OMB’s) report on the TARP, issued in early December, only addressed the first $115 billion distributed under the program. CBO and OMB do not differ significantly in their assessments of the net cost of those transactions (between $21 billion and $26 billion), but they vary in their judgments as to how the transactions should be reported in the federal budget. Thus far, the Administration is accounting for capital purchases made under the TARP on a cash basis rather than on such a present-value basis—that is, the Administration is recording the full amount of the cash outlays up front and will record future recoveries in the year in which they occur. That treatment will show more outlays for the TARP this year and then show receipts in future years.

One view – popular among certain economists including yours truly – is that the deals under TARP are nothing more than asset trades. If the government exchanges $100 in cash for $100 in other assets, there is no expenditure and no deficit cost. As the Administration uses this cash basis for deficit accounting, it overstates the deficit by ignoring the present value of future recoveries.

But this view is an extreme one if what the government gets back for its $100 in cash outflows is actually assets worth less than $100. CBO is saying here that the government may be getting back $75 in present value terms for every $100 in cash outlays. If this holds up for the rest of the $700 billion in TARP funds, then taxpayers will have spent $175 billion on net to bail out these troubled financial institutions. Not as shocking as $700 billion but still a hefty price for the laissez faire policy of letting these institutions walk away with the upside of risk taking but having the rest of us bear the downside risk.

1 comment:

BruceMcF said...

Precisely the reason why three specific strings should have been attached to the Senior Preferred Shares ...

(1) Most senior equity status, with no dividends to junior equity until preferred dividends have been paid in full for four quarters.

(2) Executive compensation capped at 10x median income until preferred dividends have been paid in full for four quarters.

(3) $1:$1 acquisition of preferred shares to acquisition of troubled assets with accompanying warrant on preferred shares (this last a constraint on Paulson as much as on recipient firms that in retrospect turned out to be just as necessary as (1) and (2)).

However, the important point is that Congress did not wish to put substantial strings on the bail-out ... the hope in subsidizing the professional in finance in the standard of living to which they had become accustomed was that they would in turn repay the source of the subsidy with a share as a means of encouraging the gravy train to keep running.