Wednesday, October 6, 2010

TARP and the Church Lady

Will I harp on TARP again?  Well, I will….one last time…….at least for now.  But this time, let’s have some fun with it.  Imagine the Church Lady from Saturday Night Live.  What would she say about TARP?

First, let’s imagine that the Church Lady has a $200,000 house with an $180,000 mortgage right before the fall of 2008.  This means that she has $20,000 in equity.  She has no credit card debt (I mean, would anyone think that the Church Lady would have credit cards?), and she has $50,000 in savings.   So, her total assets are $250,000 from the house and the savings account.  Weighed against a liability of $180,000 for the mortgage, her personal net fortune is $70,000. 

Most readers will probably recognize the basic accounting relationship of assets equal’s liabilities and equities here.  This is the basic balance sheet formula.

Imagine also that during the crisis, the Church Lady’s neighbor had an identical house with a higher mortgage.  Both houses went down in value by $50,000, except that her neighbor defaulted on her mortgage, and the bank had to write off the mortgage as well as those of many others.  Well, the balance sheet of the bank went from a positive equity position to a negative equity position.  It had more liabilities than assets.   

Though the Church Lady has lost $50,000 in net equity, she continues to support the house.  The bank, however, is not as fortunate.  The government through the Federal Reserve Board has set a minimum reserve level, which the bank can no longer meet.  The bank goes bankrupt.  It can no longer give loans to people who want houses or businesses that employ people who buy houses.  Other banks raise loan requirements because they have bad loans on their books and they cannot afford acquiring any more.

The government passes a law called the Toxic Assets Relief Program in which the government will buy the banks’ bad loans.  The bad assets go away in exchange for cash, and miraculously, the banks balance sheet is healthy.  The banks can lend money again. 

The Treasury changes its mind.  It buys stock in the banks.  The balance sheets are better, but not as healthy and credit is still difficult to come by. 

What would the Church Lady say?  Well, first, she would say that the Congressmen and Senators who voted for the original program were lied to.  She would note that despite the lying, the Treasury department did make money on the bank investments.  She also noted that despite the change in plans, banks closures did slow and that gradually, people began to get the credit they deserved.  The devastating losses decelerated, and the bottom was within reach.  This was TARP. 

To answer the question, I personally believe the Church Lady would have refrained from ranting at the program and the Congressmen and Senators who voted for it.  Something had to be done.  The destructive cascade had to stop.  Their motives were in the right place.    Execution?  Well…  We all can improve that.

However, she would note one particularly bad government bailout.  Oh, how would she say it?  Maybe something like “Who, after being bought by the Federal government, sold the government assets, assets purchased with taxpayer money, at a loss to corporate investors, some from China who demanded it to share its technological advancements?  Who could it be?  Who could it?  Could it be …… General Motors?”

Okay…I bashed GM again.  I couldn’t resist.

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