Encyclopedia of Money: TROUBLED ASSET RELIEF PROGRAM

The Troubled Asset Relief Program, known as TARP, was the cornerstone of the United States program to address the U.S. financial crisis that began in 2008. It came into being in October 2008 with the enactment of the Emergency Economic Stabilization Act of 2008. The legislation was commonly billed as a $700 billion bailout for banks.

The TARP plan evolved over time but originally its purpose was to buy bad loans, mortgage-backed securities, and collateralized debt obligations from banks. These assets went by the term “toxic assets” because they had no market value, and amounted to a severe threat to solvency of the banking system. At first it was thought that the government might be able to recover its investment because it would be purchasing these assets at bargain basement prices, and selling them for a profit later when the financial crisis had passed. Further consideration brought the realization that purchasing these assets at low prices undercut the capitalization of the banking system. Two weeks after the program’s enactment, the secretary of treasury shifted the focus of the program to emphasize the purchase of preferred stock in banks and guaranteeing troubled assets. If a bank recovers with the benefit of the government’s help, and its stock climbs, the government can sell its stake and recover at least some of the taxpayers’ investment.

Citigroup was one of the large banks that benefited from the program. The United States Treasury first purchased $25 billion in preferred stock in Citigroup, and later another $20 billion. The United States government in addition guaranteed troubled loans and securities on Citigroup’s balance sheet on the order of $306 billion. In return for the guarantees, the government received another $7 billion stake in Citigroup (Curran, November 25, 2008). The government forced the top banks to participate in the government bailout. Otherwise, banks that elected not to participate would appear financially stronger, which might give a competitive advantage over the banks that did participate. For smaller banks, participation was voluntary. In the beginning, many smaller banks worried that participation in the program was equivalent to a confession of financial weakness. Once the government let it be known that it would not let banks that were fundamentally unhealthy participate in the program, perceptions changed. Banks began to fear that not applying for participation might be regarded as financial weakness.

TARP drew criticism from the outset.

The government did not seem to be doing enough to track how banks were using the infusions of government capital. Homeowners facing foreclosures received no relief from TARP funds. People wondered why it was more important to bail out Wall Street than to bail out families facing bankruptcy and home foreclosure. None of the TARP funds helped homeowners refinance mortgages that they could not pay. In December 2008, President Bush used his executive authority to make TARP funds available to U.S. automobile manufacturers. Both General Motors and Chrysler received TARP funds. The most controversial beneficiary of TARP funds was American International Group, a large insurance company. In January 2009, the new administration of President Obama vowed to revise the TARP plan to alleviate the rate of home foreclosures.

Bank bailouts became a global phenomenon in 2008. The United Kingdom established a plan similar in strategy and scale to the one in the United States. The Royal Bank of Scotland was the largest beneficiary of government bailout money in the United Kingdom. In 2008, Sweden announced a sweeping bailout plan to save its banking system. Belgium bailed out a large bank in October 2008. Germany and Iceland both bailed out financial institutions. Switzerland, eager to protect its status as global banking center, put together a massive recapitalization of the United Bank of Switzerland.