Editor's note: This article was originally published on June 13, 2015 by James Hamilton here.
The latest issue of the Journal of Economic Perspectives had a very interesting symposium on the costs and benefits of the various bailouts implemented during the Great Recession.
The first article in the issue is by University of Chicago Professor Austan Goolsbee and Princeton Professor Alan Krueger. Goolsbee served on the President's Council of Economic Advisers from March 2009 to August 2011, and Krueger spent much of 2009 to 2013 in the Treasury Department and CEA, so one might not expect them to be big critics of the policies. Their review is quite candid in communicating the misgivings that many of those in government had about the measures. Here's Goolsbee and Krueger's summary of the bottom line:
The US Treasury recovered a total of $39.7 billion from its investment of $51.0 billion in GM. By the end of 2014, Treasury sold its remaining stake in Ally Financial (ALLY), recovering $19.6 billion from the original $17.2 billion investment in Ally, for a $2.4 billion gain for taxpayers. In May 2011, Chrysler (FCAU) repaid its outstanding loans from the Troubled Asset Relief Program (TARP) six years ahead of schedule. Chrysler returned $11.2 billion of the $12.5 billion it received through principal repayments, interest, and cancelled commitments, and the Treasury fully exited its connection with Chrysler.
And what did any of the rest of us gain from this?
Since bottoming at 623,300 jobs at the trough of the recession in June 2009, employment in the motor vehicles and parts manufacturing industry has increased by 256,000 jobs (as of July 2014). This is a stark contrast from the previous recovery, when jobs in the industry steadily declined. The increase in the number of jobs in motor vehicles and parts manufacturing accounted for nearly 60 percent of the total rise in manufacturing jobs in the recovery's first five years. In addition, some 225,000 jobs have been added at motor vehicle and parts dealers. Counting both manufacturers and dealers, auto-related jobs accounted for 6 percent of the total 8.1 million jobs that were added, on net, in the first five years of the recovery - triple the sector's 2 percent share of total employment.
The authors conclude:
It is fair to say that no one involved in the decision to rescue and restructure General Motors (GM) and Chrysler ever wanted to be in the position of bailing out failed companies or having the government own a majority stake in a major private company. We are both thrilled and relieved with the result: the automakers got back on their feet, which helped the recovery of the US economy. Indeed, the auto industry's outsized contribution to the economic recovery has been one of the unexpected consequences of the government intervention.
The symposium also features an analysis of assistance to financial institutions under the Troubled Asset Relief Program (TARP) by Professord Charles Calomiris and Urooj Khan, both at Columbia. Calomiris is a prominent conservative economist, so one might have expected this review to be somewhat critical of the intervention. But the authors acknowledge the favorable bottom line:
For the most part, the [TARP] transactions with the banks, the focus of this paper, yielded a net cash flow gain. The net cash flow costs were largely from the assistance provided to AIG, the automotive industry, and the programs aimed at avoiding home mortgage foreclosures. The net cash flow gain estimated for the Cash Purchase Program was $16 billion with only $2 billion of preferred stock remaining outstanding. The CBO estimated a net cost of $15 billion to the Treasury for the assistance provided to AIG under the Systemically Significant Failing Institutions program. All of the supplementary support provided to Citigroup and Bank of America through the Targeted Investment Program had been paid back and resulted in a net gain of roughly $4 billion dollars to the federal government. Finally, the loss-sharing agreement with Citigroup through the Asset Guarantee Program yielded a net gain of $3.9 billion.
The authors review evidence for the benefits of these programs and find it difficult to make a definitive statement:
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.
The Journal of Economic Perspectives symposium on the bailouts also included an analysis of the federal government assumption of conservatorship of mortgage giants Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) by Scott Frame of the Federal Reserve Bank of Atlanta and Andreas Fuster, Joseph Tracy, and James Vickery of the Federal Reserve Bank of New York. Here again the bottom line so far has been a net financial gain for the government:
As of end-2014, the cumulative Treasury dividend payments by Fannie Mae and Freddie Mac have now exceeded their draws: specifically, Fannie Mae has paid $134.5 billion in dividends in comparison to $116.1 billion in draws, while Freddie Mac has paid $91.0 billion in dividends in comparison to $71.3 billion in draws.
And what did ordinary citizens gain from this?
Was it important to promote mortgage supply during this period given the already high levels of outstanding US mortgage debt? We would argue "yes," for two reasons. First, mortgage origination was necessary to enable refinancing of existing mortgages… Second, continued mortgage supply enabled at least some households to make home purchases during a period of extreme weakness in the housing market.
And I have separately examined the Federal Reserve's participation in emergency lending and concluded that the Fed came out making a profit from its intervention as well.
Like Calomiris and Khan, Frame and co-authors suggest that a positive net cash flow is not the right metric:
As an economic matter, one cannot simply compare nominal cash flows but must also take into account that the Treasury took on enormous risk when rescuing [Fannie and Freddie] in 2008 and should therefore earn a substantial risk premium, similar to what private investors would have required at the time, in addition to the regular required return.
Here I disagree. A key argument for intervention was that private risk premia at the time were too high. Prices of risky assets and the volume of risky lending were depressed by fire sales and a scramble for liquidity and safety, which posed a danger of pushing the economy deeper into crisis. Yes, the government was assuming risk in all these actions, risks that ultimately would have been borne by taxpayers. But taxpayers also faced a very real risk of falling revenues associated with a worsening economic downturn. The contributors of the symposium were all correct in emphasizing the risks the government took in making the bailouts, and I agree with their warnings that we should only enter into such ventures with great reluctance and careful evaluation of the costs and alternatives. But I think an objective observer would conclude that this time, at least, it all turned out well.
This article was written by