What Did TARP Teach Us?

A new television advertisement from American International Group, Inc. ( AIG - Analyst Report ) shows the company thanking America for the bailout it received from the Troubled Asset Relief Program (TARP). AIG received a massive $182.3 billion, $70 billion of which was received from the Treasury and the balance from the Federal Reserve Bank of New York (FRBNY).

Both the Federal Reserve and the Treasury have already recovered the full amount from AIG. An additional $22.7 billion of positive return have also been generated from this exercise. The ad mentions this clearly and thanks the taxpayer for that too.

However, this campaign may have little effect since it emerged that the company was considering suing the government for the unfair terms under which it received the bailout.

The company was considering joining a $25 billion lawsuit by former CEO Hank Greenberg which claims the terms under which the bailout was provided was unconstitutional. Following widespread public outrage, the firm has now decided not to join the lawsuit. However, this has once again brought to the fore the discontent about TARP, which is close to recouping the amount it invested in its bailout initiative.

Nearly $418 billion has been spent on the TARP initiative, and the Treasury’s sale of outstanding AIG shares has been a big step in bringing the process to a close, at least in the collective mind of the public. The other move has been the Treasury's decision to sell its 32% stake in General Motors Company ( GM - Analyst Report ) within the next 15 months. Nearly $49.5 billion was injected into the automaker to keep it from folding.

It is generally being agreed that TARP is a success, but a qualified success at best. The Treasury has now received $375 billion of the $418 billion it spent. But these returns could have been greater. All banks and financial institutions were disbursed funds under identical terms irrespective of their financial health.

As a result, relatively robust institutions such as The Goldman Sachs Group, Inc. ( GS - Analyst Report ) and JPMorgan Chase & Co. ( JPM - Analyst Report ) paid a 5% annual dividend on the preferred shares that the Treasury received. This was the same rate at which those with far weaker financial health received funds.

In contrast, Berkshire Hathway Inc. ( BRK.A - Snapshot Report ) , ( BRK.B - Analyst Report ) invested $5 billion in Goldman Sachs September 2008 at 10%. This has resulted in a profit of $3.7 billion compared to the $1.1 billion positive return the Treasury has received for the $10 billion that it invested.

The more fundamental issue is whether legislation and monitoring has been successful at curbing the unhealthy business practices that caused the crisis in the first place. The New York Federal Reserve has said that with the help of government support, banks have made some loans that are even more questionable.

Additionally, the Dodd-Frank Financial legislation and the Volcker Rule which was incorporated into it were designed to curb the practice of proprietary trading. This is a situation where a bank or financial institution invests its own funds in stocks and bonds instead of using funds received from depositors. However, the Volcker Rule only restricts short-term investments. JPMorgan Chase and Morgan Stanley ( MS - Analyst Report ) had announced that they would shut down or reduce the size of such units to comply with these provisions.

But that has not ended the tendency to indulge in risky bets. According to a report by Bloomberg Businessweek, Goldman Sachs has a unit named Multi-Strategy Investing that utilizes about $1 billion of the bank’s own funds to make investments. Short-term trades are now defined as those which last over 60 days or less. An email for a spokesman for Goldman Sachs claims that this new unit is involved only in long-term investing and lending. The Bloomberg Businessweek report claims that the unit acts like an internal hedge fund.

The major complaint is that the bailout has done little to aid distressed homeowners. Only $6 billion was spent on combating foreclosures and the Obama administration’s recent attempt to expand the program has also received little support.

There is no doubt that TARP pulled the economy back from the brink, but the wisdom gleaned from this experience must not be forgotten. That will possibly be its greatest benefit.