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Monday, September 27, 2010

Troubled Asset Relief Program (TARP): Implementation and Status

Baird Webel
Specialist in Financial Economics

The Troubled Asset Relief Program (TARP) was created by the Emergency Economic Stabilization Act (EESA; P.L. 110-343) in October 2008. EESA was passed by Congress and signed by President Bush to address an ongoing financial crisis that reached near-panic proportions in September 2008. EESA granted the Secretary of the Treasury authority to either purchase or insure up to $700 billion in troubled assets owned by financial institutions. This authority was granted for up to two years from the date of enactment and was very broad. In particular, the definitions of both “troubled asset” and “financial institution” allowed the Secretary wide leeway in deciding what assets might be purchased or guaranteed and what might qualify as a financial firm.

The financial crisis grew out of an unprecedented housing boom that turned into a housing bust. Much of past lending for housing was based on asset-backed securities, which used the repayment of housing loans as the basis for repaying these securities. As housing prices fell and mortgage defaults increased, these securities became illiquid and fell sharply in value, causing capital losses for financial firms. Uncertainty about future losses on illiquid and complex assets led to some firms having reduced access to private liquidity, with the loss in liquidity being in some cases catastrophic. September 2008 saw the government takeover of Fannie Mae and Freddie Mac, the bankruptcy of Lehman Brothers, and the near collapse of AIG, which was saved only by an $85 billion loan from the Federal Reserve. There was widespread suspicion in the financial markets as participants were unsure which firms might be holding so-called toxic assets that might now be worth much less than previously estimated, and thus might be unreliable counterparties in financial transactions.

As EESA was moving through Congress, most attention focused on the idea of the government purchasing mortgage-related toxic assets, thus removing the widespread uncertainty and suspicion. The initial TARP Capital Purchase Program, however, directly added capital onto banks’ balance sheets through preferred share purchases, rather than removing assets that had become liabilities through purchasing mortgage-related assets. Several other TARP programs followed, including an asset guarantee program; programs designed to spur consumer and business lending; financial support for companies such as AIG, GM, and Chrysler; and programs to aid homeowners at risk of foreclosure. Eventually, the Public-Private Investment Program did result in the purchase of some mortgage-related assets from banks, but this has remained a relatively small part of TARP.

With the immediate crisis subsiding through 2009, congressional attention in financial services turned largely to consideration of broad regulatory changes. The resulting Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203) amended the TARP authority, including (1) reduction of the overall amount to $475 billion; (2) removal of the ability to reuse TARP funds that had been repaid; and (3) removal of the authority to create new TARP programs or initiatives. TARP authority to purchase new assets or enter new contracts is set to expire on October 3, 2010. Outlays under the existing contracts, however, may continue through the life of these contracts. Overall cost estimates for TARP have decreased significantly since the passage of EESA, with August 2010 estimates from the Congressional Budget Office foreseeing approximately $67 billion in losses for the government. Most of this loss is from aid to homeowners, AIG, and the automakers. The assistance to banks is generally showing a profit for the government.

Date of Report: September 21, 2010
Number of Pages: 11
Order Number: R41427
Price: $29.95

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