This paper examines the Troubled Asset Relief Program (TARP), enacted in fall 2008 in response to the U.S. financial crisis. It traces the origins of the crisis — including Federal Reserve monetary policy, subprime mortgage lending, and the collapse of mortgage-backed securities — before evaluating TARP against its five stated objectives: stabilizing the broader economy, stabilizing the banking system, stimulating lending, creating a secondary market for troubled assets, and minimizing waste. The paper finds that TARP achieved partial success at the macroeconomic level but fell short in most other areas, citing lack of oversight, continued bank failures, minimal lending stimulation, and an illiquid secondary market for collateralized debt obligations as key shortcomings.
The paper demonstrates criterion-based policy evaluation: the author explicitly defines five measurable objectives drawn from TARP's stated goals, then assesses each independently using economic data, regulatory outcomes, and sourced reporting. This technique is useful in public policy and economics papers because it prevents vague, impressionistic judgments and forces the writer to engage with evidence at each dimension of the policy's intent.
The paper opens with a brief framing introduction, then builds necessary background in two sections — one on the crisis itself and one on the "too big to fail" doctrine. A third background section explains TARP's specific mechanisms. The analytical core then evaluates TARP objective by objective. The conclusion synthesizes the findings, acknowledging uncertainty about long-term outcomes. This background-then-analysis structure is well-suited to policy papers where readers need contextual grounding before evaluation can be meaningful.
In the fall of 2008, the financial crisis hit its critical mass. The crisis had been brewing for a couple of years, as the collapse of the housing bubble began to reveal a banking industry that was far too heavily invested in risky mortgages and mortgage-backed securities. First, Bear Stearns was acquired by JP Morgan. Then, in September, two catastrophic banking failures occurred: Lehman Brothers went under, and the FDIC orchestrated the sale of Washington Mutual to JP Morgan (Dash & Sorkin, 2008). Banks, wary of having too many bad assets on their books, began to constrict credit. Fearful of both the economic impacts of a credit crunch and the panic that would ensue among both the public and investors if more major bank failures occurred, the federal government initiated what would become known as the Troubled Asset Relief Program (TARP).
This paper examines TARP and its role in alleviating the financial crisis. Special attention is paid to the ways in which TARP achieved its goals and the ways in which it failed to do so. TARP was controversial from the outset, with opposition and support coming from both economic conservatives and liberals alike. The program has five main objectives, but can genuinely claim success in only one area thus far. TARP may not end up a failure, but successes are few as of yet.
It is widely argued, with considerable merit, that the Federal Reserve precipitated the financial crisis in the early part of the decade by holding interest rates at unusually and unsustainably low levels. "The Federal Reserve's expansionary monetary policy supplied the means for unsustainable housing prices and unsustainable mortgage financing" (White, 2009). Investors wary of technology stocks were flush with money and seeking a haven, and so they turned to real estate. The monetary expansion also left banks with surplus capital to lend, encouraging them to take on an increasing amount of risk in the form of subprime mortgages. A portion of this risk was then portioned off and sold in the form of allegedly high-grade mortgage-backed securities. When the Fed initiated a rapid increase in rates to slow the monetary expansion in the middle part of the decade, the housing market collapsed. Many of the subprime mortgages had been made at low introductory rates, with higher rates kicking in after a few years. Borrowers were unable to make their new payments at the higher rate, and with housing prices stagnant or declining were also unable to liquidate.
Banks sitting on stockpiles of foreclosures found themselves unable to meet their liabilities or their reserve requirements and began to restrict their lending as a result. As some banks began to collapse under the weight of their bad assets and others curtailed lending, the economy began to slow and then finally contract.
The problems, therefore, were manifold. The Fed contributed with its monetary expansion. Banks contributed by lowering their lending standards in an attempt to use their excess lending capacity. Consumers contributed by taking on mortgages they could not afford. Investors contributed by adopting a "herd mentality" with respect to the risky bundled securities of subprime mortgages (Tetangco, 2009).
The federal government and the regulators responsible for the banking industry took immediate steps to address the issue. The FDIC began aggressively managing the financial services industry — not just with the takeover of Washington Mutual but eventually with over one hundred other financial institutions as well (Glass, 2009). For its part, the federal government began to take steps to alleviate the distress on the banking industry.
The Bush administration, in consultation with a range of regulators and the two presidential candidates, acted to draft legislation to protect key financial industry players. The companies were deemed "too big to fail." The phrase, first coined during the Reagan administration — and applied then to a handful of banks as well — has been invoked by governments multiple times throughout history (Smith & Yandle, 2009). The implication of the phrase is that if a firm deemed too big to fail were to do so, that failure would result in considerable economic catastrophe. In the case of major U.S. banks such as Citigroup, AIG, and a few other firms during the financial crisis, two factors played into the government's decision to intervene.
The first factor is the interdependency within the financial system. If a major bank were to fail, its creditors would also likely fail. This is especially true during an ongoing financial crisis. The failure of one major firm would precipitate the failure of other firms already in a precarious situation, creating a spinoff effect and potentially leading to a catastrophic collapse of the economy.
The second factor is the issue of consumer confidence. With housing prices dropping, gas prices high, and banks failing, consumer confidence was shattered by the fall of 2008. Any further erosion of confidence — in particular with respect to the soundness of the nation's banking system — could result in a bank run or worse, precipitating a financial collapse with all of its attendant consequences.
The case for too big to fail sounds reasonable but has its critics. Some critics attack the policy on the grounds that government should not become so deeply involved in private business. Others take a less fundamental, more pragmatic approach and contend that the economy could withstand such failures. Alternatively, it is argued that banks are encouraged toward risk-taking behavior by the knowledge that they will be bailed out anyway because they are "too big to fail" (Smith & Yandle, 2008).
Smaller banks did not receive the too-big-to-fail designation. The FDIC's role in the banking industry is to monitor the industry and become involved in the liquidation of banks when they become insolvent. Since the onset of the crisis, the FDIC presided over 100 such liquidations. Aside from the Washington Mutual action, most of the fallen banks were small and medium-sized regional players. The larger banks, however, were deemed too big to fail. Indeed, the way in which the Washington Mutual takeover was orchestrated indicates that the government viewed it as too big to fail as well — its assets were transferred immediately to JP Morgan, allowing operations to continue without interruption. The federal government's response to the other banks that were too big to fail was the bailout, which became known as the Troubled Asset Relief Program, or TARP.
It is not that TARP has been a total failure. Some of its goals will take longer to come to fruition than others. There is no definitive reason to believe that the issues with respect to the secondary market will not eventually be resolved. It should be considered, however, what will happen if that market does not develop. These assets will remain worthless, and the Treasury and the FDIC are responsible for losses that accrue from the troubled assets. Thus, the long-term effects of TARP have yet to be seen, and it may well turn out that TARP is an even costlier program than it already has been.
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