Going Cross-Eyed Thinking About TARP
I started thinking about this last night and had to reboot my mind. After writing this post, I realized that I had left out a huge consideration: risk. Even if the government ends up making an accounting profit on the Capital Purchase Program component of TARP, that doesn’t really prove that it was a good use of taxpayer funds. This is because private investors were afraid of the huge risk involved. (Don’t worry, when I predicted that TARP would lose money, I didn’t mean it in this tautologous/vacuous sense–I meant the government would pay $700 billion for toxic assets that it would end up selling for less than $700 billion down the road.)
To illustrate with a ridiculous example: Suppose Henry Paulson took $100 billion of taxpayer money down to Vegas, and placed it on Black (following Wesley Snipes’ advice). There’s a 47.37% probability of winning, and so it wouldn’t be that unusual for Paulson to walk away with a profit for the taxpayers. But we still wouldn’t say he did a wise thing.
By the same token, investing in the teetering banks last October was a risky move. People weren’t sure–and Paulson and Bernanke couldn’t be, either–what would happen with the financial sector. Yes, everybody knew that the bank stocks (and more particularly, the prices of “toxic” assets) were heavily discounted in the event that things quickly stabilized, but the point was, nobody was sure if the financial market would be stabilized. So buying toxic assets, or more generally investing in US financial stocks, was a high-risk, high-return wager when Paulson decided to go for broke (ha ha).
Anyway, I am just making sure you understand the academic point; I understand that the proponents of TARP would say that was the whole point, that the huge discounts and risk were a self-fulfilling prophecy, and that Paulson’s moves were a primary reason that things stabilized. OK fine, let’s not argue over that right now.
What I want to focus on is this: If you wanted to demonstrate the different risk/return options available, you would normally say, “Well, instead of plunking $700 billion [or $204.4 billion] in financial stocks and warrants, Paulson instead could have parked it in something really safe, like Treasurys.”
But what would that mean? Is it really true that the federal government itself could make a “very safe” investment in its own debt? (This is what made me go cross-eyed.) Obviously, what it would mean in practice is borrowing less from the private sector. So does it all work out to be equivalent?
If so, it’s not obvious to me how. The reason private investors view the US government as very safe, is that the government can just tax the entire class of productive Americans to make its interest payments. So, how does that figure in here? Paulson shouldn’t have put so much money at risk in one sector, when he instead could have reduced the borrowing strain now, thus letting the economy grow stronger for future fleecing?
