Bailout payback

The news has been full of stories about the major U.S. banks paying back their TARP funds. So far all 9 of the massive institutions that have entered negotiations with the U.S. to exit the bailout program. However, over 700 institutions received bailout funds. Ultimately of the over $700 billion that was slated for TARP, only $245 billion has been injected. Right now the U.S. Treasury expects to make $19 billion on its infusions into banks. That is a 7.75% return. Not bad.

There is a lot of investment information content in these announcements; let’s take these in turn…

1. A Massive Success

First, the Troubled Asset Relief Program (TARP) may be one of the most spectacularly successful government programs in the history of any nation. But by what criteria? Here the criteria that is most telling is time. Specifically, over what time frame do we measure the success of TARP.

As loooong term readers of the blog know, I was very opposed to bailing out the U.S. financial system. Why? Because the collapse of the U.S. financial system was not a failure of capitalism or of economics, it was an ethical failure. The quickest way to cure people of poor choices is to let them suffer the full consequences of their poor choices. Without the balancing of effects and causes bad choices are under-priced/under-punished and they will be repeated. The whacky euphoria of financial institutions in the mortgage bubble came less than a decade after the dot.com bubble bursting! Stunning proof that the Federal Reserve’s dot.com era slashing of interest rates to cope with the collapse of the equity markets did nothing to convince financial institutions and their executives that measuring success on a quarterly, and at most, an annual basis was dangerous. If you receive enormous compensation based on one year’s choices then you have tremendous incentive to swing for the fences. If you receive compensation based over the success of your choices over a decade, you look to hit a lot of singles and doubles. So is there evidence of “bubble mentality” returning to the corridors of the U.S. financial system? That is, is there evidence of lessons being learned?

At this juncture it is hard to say. One thing that certainly has NOT changed is the compensation programs of the financial institutions. Most are still based on a “swing for the fences” mentality. Additionally, there is a lot of blow back from these institutions about too much government interference in setting pay at these firms. The argument is always, “we can’t attract talent unless they are guaranteed to be multi-mutli-millionaires” in one year. As long as that remains the case then the lessons of our most recent bubble-bursting will remain unlearned. Switching gears…

But if we measure the success of the TARP program in having averted what would likely have been another Great Depression then we call TARP an overwhelming success. Fascinatingly, deeeeep recessions are referred to as Depressions. That title is very apt. Because largely that kind of a melt down is purely emotional and represents a slaughtering of confidence in consumers, business people, investors and in government officials. At the time that TARP was initiated most people had “Depression” on the tips of their tongues. TARP averted that. So for the little folks of the U.S. a lot of pain as been averted. A good thing. But…

Unless real lessons have taken root at U.S. financial institutions there will be other financial bubbles driven largely by greed. So the reckoning for this kind of thing has been pushed into the future.

2. A Huge Success for Keynesianism

John Maynard Keynes was an economist who wrote during the worldwide Great Depression of the 1930s. Specifically Keynes said that to exit periods of economic recession and depression that governments should spend money to prop up confidence and the economy. The logic behind this is that GDP is calculated as Consumer spending + Investment by businesses + Government spending + Xports, net. If any one of these factors dips radically (usually its consumer spending) then by increasing G, government spending, the economy remains buoyant. How does the government spend money? By raising taxes? No. If the government raises taxes to increase spending then it lowers C, consumer spending by the same amount. So Keynesianism says that governments should borrow money to temporarily prop up the economy. Can we see that this is exactly what they did during TARP?

Not surprisingly, Republicans hate Keynesianism. Why? Because their preferred economic tack is to alter the economy through monetary policy, or monetarism. This is because the Republican party believes that to increase government spending by borrowing leads ultimately to higher taxes as the government is forced to pay off its borrowings. Additionally, they believe in a “crowding out effect.” That is, they believe there are only so many lenders in an economy. If the U.S. government is borrowing money, then businesses cannot borrow as much money. Presumably this leads to businesses not being able to invest in new, high growth projects using debt capital and leaves them mired in recession or depression. So monetarism argues that interest rates should be lowered, or the money supply increased, to provide the economy with needed funds. However, Republicans generally are very stingy with increasing the money supply as they have a near paranoid fear of inflation. Too much money leads to increased prices and inflation.

Whatever one’s preferred economic policy belief, the TARP program is gigantic evidence that Keynesianism has worked in this situation. Not only was this recession just a recession and not a depression, but the U.S. government is getting paid back and making a return on its investment. Additionally, it was the manipulation of interest rates (i.e. them being far too low for too long) that contributed to bad lending behavior and the mortgage bubble being created. So long term, this is a diminishment of economic authority on the part of Republicans. So this is very signficant. It is very likely that future economic problems will be looked to be solved by Keynesianism, rather than monetarism. This is a reduction in Republican economic authority.

3. Which Companies Recovered the Fastest?

As investors we always like evidence of strength. In fact, some of my initial blog postings were about the usefulness of recessions for identifying truly powerful institutions. The crucible of soured economic times reveals business acumen. So which financial institutions fared well in the last recession?

J.P. Morgan, Morgan Stanley, Goldman Sachs and Bank of America.

This is very, very noteworthy.

*****

But we are not out of the woods, yet. The possibility of a “double-dip” recession remains. This is because of the high unemployment rate and the lack of good quality jobs. So many U.S. families remain on the cusp of personal financial disaster. Economic data is barely better than neutral; there are some positive statistics, but there are also many negative ones. Vigilance remains important until we are clear of the fallen trees of economic decisions past and out of the dark forest.

Jason