Troubled Asset Relief Program Analysis - Term Paper Example

Troubled asset relief program The United s implemented the Troubled Asset Relief Program as a policy solution for recapitalizing banks and restoring liquidity in the financial system. This program was executed at the onset of the 2008 global economic crisis. TARP is considered to be the largest government rescue program in the history of United States in terms of funds appropriation (Cornett, Li and Tehranian 731). The Treasury implemented the rescue program at a time when the financial crisis was threatening to bring down the entire US financial system. The program received widespread opposition from the public and was quickly billed as ‘the Wall Street bailout.’ There was greater possibility that the implementation of the policy was largely influenced by the US financial sector. Beginning 2005, the housing prices in the US peaked and began to decline. The same trend happened in the value of mortgage-backed securities (MBS). This trend is known as ‘collateralized debt obligation (CDO). The CDO compromised a greater portion of many financial institutions’ asset portfolios. The situation worsened and this lead to the collapse of Lehman Brothers on September 2008. The proximal event led to the introduction of TARP. The Treasury injected approximately $250 billion in TARP program (Cornett, Li and Tehranian 731). The Treasury injected these funds directly into the US banking system through purchasing senior preferred stock and warrants in qualifying financial institutions. In the end, the total available funds were estimated to have amounted to $700 billion. This amount makes TARP the largest program ever promoted by the government of the United States (Garrica, Puddu and Walchli 7). The situation worsened such that on September 2008; Dow Jones Industrial lost 4.4 percent or 504 points. The crisis escalated resulting in more bankruptcies including AIG’s. Hank Paulson, who was the then Treasury Secretary, proposed that TARP be implemented. The objective of the implementation of TARP was to recapitalize the financial institutions with liquidity problems using federal funds. In general, the US Treasury intention was to use TARP in helping banks to improve their balance sheets and increase the robustness of the financial system (Garrica, Puddu and Walchli 1). Paulson introduced legislation to the Congress known as EESA. This legislation was an authorization of $700 billion for the purchase of troubled assets including MBSs from banks through TARP. The announcement of TARP by Paulson on September 19 resulted in many large financial institutions recording significant increases in their stock valuations (Garrica, Puddu and Walchli 3). For example, Bank of America rose 23%, WaMu rose 42%, Citigroup rose 24%, Merill Lynch jumped 34%, JP Morgan Chase rose 17%, and Morgan Stanley climbed 21%. These banks benefited immensely from TARP, and as a result they were requested to keep providing credit to firms, small businesses, and households. The resulting effect was a crisis due to the achievement of two goals at the same time. If the banks were to continue providing loans to business that were in distress, they were likely to experience an increase in banks non-performing loans. Such an action might result in a further weak banking system. The Treasury divided TARP program into four categories namely Bank Support Program, Housing Programs, Credit Market Programs, and Other Programs. Bank Support Program accounted for $250.46 billion, Credit Market Programs accounted for $26.52 billion, Housing Programs accounting for $45.60 billion, and Other Programs accounting for $147.53 billion (Garrica, Puddu and Walchli 7). The main interest is on the Bank Support Program because the banks were the ones that were largely affected by TARP, and they are the ones that were allocated the largest percentage of TARP funds. The funds injected to the banks through the Capital Purchase Program helped to restore confidence in the banking sector and sustained the financial institutions to keep financing other firms. The CPP funds temporarily helped unhealthy banks out of financial distress and stimulating lending in healthy banks through injecting capital into them. This injection of funds into the financial institutions helped to improve the financial performance in the whole country (Cornett, Li and Tehranian 731). Many banks experience financial health. That is; they maintained a positive return on assets during the financial crisis. Banks reacted differently to CPP funds. While some banks chose to avoid applying for CPP funds, others viewed CPP as a means of uplifting relatively low cost of capital funds in tight financial markets. The government was very optimistic about CPP injections into financial institutions because it felt that it was a way of stimulating lending in the economy. However, the federal regulators forced some banks to apply and others not to apply. Nevertheless, it is not clear about the number of banks that withdrew voluntarily despite being qualified by the federal regulators. The Treasury made the terms of acquiring the CPP funds quite attractive in order to encourage the banks to participate (Cornett, Li and Tehranian 732). This attractiveness induced thousands of banks to apply for the funds. However, the CPP capital was infused in stages with financing being availed to larger banks and those with weaker capital ratios. The CPP funds were later availed to “smaller and better-capitalized banks” (732). Nevertheless, the CPP program was characterized by big banks. It has been established that $163 billion of the total CPP funds was allotted to 19 largest banks (732). In addition, it is assumed that small financial institutions were unable to apply and participate in the CPP program. Unhealthy financial institutions were also not allowed to participate in the CPP program because they would pose a financial risk to the Treasury’s investment. The Treasury also avoided buying preferred shares in QFIs that were S-Corporations. However, later in 2009, the Treasury announced a program for availing CPP funds to S-Corporations. Through CPP program to S-Corporations, the Treasury purchased subordinated debentures. TARP program was not in favor of the US taxpayer because the gains went to the banks’ bondholders while the US taxpayers incurred the cost (Garrica, Puddu and Walchli 2). TARP has not received much support from the taxpayers. The program is considered to be of less importance to the general public. The small scale businesses were the most vulnerable because of their dependence on banks for external funding. These businesses lack any access to public capital markets. This lack of capital access explains why they totally depend on the financial institutions for funding. Garrica, Puddu, and Walchli observed that 87 percent of these firms indicated that they depended on banks for external funding (3). One empirical study found out established that TARP is effective only for financial institutions that have high geographical coverage (3). They further observe that if TARP were located in sounder countries, the quality of those countries rather than TARP would be driving the results. This is evident because “several TARP funds recipients were not healthy at all. Cornett, Li and Tehranian (732) observed that after two years of TARP program, many recipients still found it difficult pay their TARP dividends. The recipient banks were also not able to find new private capital. This shows that many TARP recipient institutions were not as healthy as they were assumed to warrant rescue. By 2010, over 145 TARP recipients had missed payments at least once while others had missed payment several times. Garrica, Puddu and Walchli (4-5) conclusions are that: i. TARP had a positive effect of small firms loan originations; ii. The banks located in areas with higher geographical coverage found TARP effective; iii. The banks investing in counties that have high unemployment rates also found TARP effective; iv. Banks investing in counties with high poverty rate did not find TARP effective. To large financial institutions such as BOA, Citigroup, and Merill Lynch among others benefited greatly from TARP. However, these banks found themselves more exposed to troubled loan classes and “expected costs of regulatory downgrades” (Garrica, Puddu and Walchli 5). In this perspective, TARP was not an effective tool for helping the financial institutions to provide loans to small businesses and households. However, TARP helped banks to increase their loan supply by an annualized rate of 6.43 percent. He increase did not affect the quality of the loans. Each dollar provided to the financial institutions through TRAP about 33 percent was used for financing new loans (Garrica, Puddu and Walchli 5). In addition, the remaining 67 percent was used by the financial institutions to restructure their balance sheets. The bank risk-taking behavior has also been assessed (5). The risk-taking behavior was greater for the big banks than smaller banks. There are other factors related to TARP. For example, the greater the connectedness of TARP and political factors the greater the likelihood of obtaining the financial sustain. The stock markets also reacted to the participation of financial institutions in the TARP program. Financial institutions also exited early from the TARP program, and there are key features that made them take such a step. In conclusion, many healthy banks that participated in TARP CPP program found out that the cost of participating in the program was higher than they had anticipated (Cornett, Li, and Tehranian 732). Due to public outrage at the growing cost of ‘bailing out’ program, the government attached more and more restrictions on TARP CPP recipients. Works Cited Cornett, Marcia, Li, Lei and Tehranian, Hassan. The performance of banks around the receipt and repayment of TARP funds: Over-achievers versus under-achievers. Journal of Banking & Finance. 37 (2013): 730-746. Print. Garrica, Judit, Puddu, Stefano and Walchli, Andreas. TARP Effect on Bank Lending Behavior: Evidence from the last Financial Crisis. University of Lausanne and Study Center. Seminal Paper. Web. January 2013. Read More