Bullworthy.com is all about extracting the emotion to reveal sound observation on financial events that affect our lives, and with this article we will examine the indivertible TARP funds. While massive unpopular, bailouts have been as much a part of the relationship between our government and the economy as supply and demand, and are about as American as apple pie. The reason I say so is because Keynesian economics-the school of thought that government should step in and provide support to an ailing macroeconomic environment-serves as the fundamental theory behind big brother’s intervention into the private sector. While these “bailouts” just rub people the wrong way, there are legitimate justifications behind implementation of the programs. TARP is an acronym for Troubled Asset Relief Program, a $700 billion fund established by Congress earmarked for injecting capital into financial and auto companies to shore up their destructive balance sheets. Remember that American Insurance Group (AIG), Bank of America (BAC), and General Motors (GM) for example, were eligible for these bailout funds because they met a few criteria that at the time were of dire concern:
- They were negative cash flow and had been without sufficient working capital for months.
- Overwhelming liabilities directly tied to the extravagant abuse of mortgage security derivatives right around the same time the world realised these assets were likely worthless. The sheer exposure to these assets caused lenders to become nervous, dropping their credit ratings.
- These companies relied on credit ratings to obtain commercial paper loans; very short-term loans, typically 2 to 3 days only, used to finance day-to-day operations at large, billion-dollar companies.
- Without cash or accessibility to commercial paper markets, these companies were literally teetering on the brink of bankruptcy. If these companies couldn’t get money quickly (in the case of the financial companies, within days) they would fall apart in front of our eyes. And in at least one case, they did. Investment banking firm Bear Sterns collapsed under a pile of subprime-related asset-backed securities in a mystifying and many would say frightening few days.
Let them burn, the common American would say, who’s driven by emotion and self-indulgence. Here’s what I mean: at the time, people were losing their jobs, small businesses were shutting down every day, and the stock market was just crumbling. Everyone was looking for answers, essentially, their own personal “bail-out”, so as TARP came on the scene, first with the billion-dollar bailout of AIG, an American insurance company who sunk themselves with subprime, and then again with the bailout of Bank of America and Fannie Mae/Freddie Mac, two of the largest public mortgage originators in the world. Americans went in an uproar – with good reason! Why should these jerk-offs on Wall Street get to not only keep their jobs at now government-owned firms, but also pay themselves bonuses?
Traditional investment banks and colossal billion-dollar companies pay their executives huge bonuses based on some performance measure and the profitability of the company during the period. These bonuses are put into place sometimes years before, and they are all contractually guaranteed: even in the worst year of any company, executives are guaranteed at leastbonus, maybe a third or half of their salary. The reason is because these individuals are compensated for their skills and experience among many more attributes a seasoned CEO acquires-sky-high salaries are nothing more than talent retention expenses. In boom times, execs can be paid sometimes 5, 10, or 15 times their salary. So was the case in 2008 and 2009 when everyone was upset that AIG and Bank of America paid their year-end bonuses. However, in the case of BOA, the bonuses were not declared in what are called “proxy statements” as required by the Securities and Exchange Commission, causing immediate legal lashes against them. The executives who received the bonuses were legitimately entitled to these boisterous bucks; perhaps it was unethical to accept that money, yes, but not wrong. The founding fathers and early capitalist built this county on many beliefs and rights, one of which is contractual obligation and trust in business.
Look at is this way. If you fix the roof on someone’s home, you expect that customer will honour the contract you two have signed and make pay. Your small business relies on credit with net 30 terms when purchasing from your vendors, and they are happy to extend that credit-because they expect you to honour the contract and pay. If we decided to just stop honouring contracts (for this example, bonus contracts), our country would probably look a lot more like Somalia’s.
I’m not saying enormous bonuses being paid out to corporate executives in the midst of one of the worst financial crises the world has ever seen is OK. It’s a repugnant waste of money. The point is, that money has to be paid because it was written into employment contracts before the crisis hit.
TARP was totally inevitable, and it’s all based on macroeconomics. Investment capital comes from only two basic sources: investors (private) and government (public). If private investors are not stepping up to inject new money into whatever markets are failing, providing companies with the liquidity and cash to operate and produce goods, and ultimately stimulate the economy, someone else has to, and there are no other options – the government has to step in. We are not alone-bailouts aren’t exclusive to America. Countries all over the world stepped in with their own TARP and economic stimulus packages, and most recently, nearly a trillion dollars was set aside to prop up the European currency after Greece and a few other Euro-zone countries battered their economic growth with crushing fiscal debt.
Bailouts are a global effort that was necessary to get the gears of the economic machines moving again. Although these programs were understandably received poorly by taxpayers, it was still the right thing to do. TARP saved us from what was likely the next Great Depression because these companies were so complex and so large that their failure, bankruptcy, or demise would have wrecked global economies and markets even further. Just imagine five or six or 10 Bear Stearns all vaporizing at the same time, wiping out tens of trillions of dollars in private and public wealth.
It’s an investment! The TARP funds were literally used to purchase preferred stock in these companies. So the TARP funds are an investment! These companies are all dividends paying, and remember: it’s a loan. It must be paid back with interest. This money will go directly back into our pockets. Of course, not all of the loans will be paid back on time or at all, but treasury secretary Tim Geithner has said explicitly that that TARP program will be profitable for American taxpayers.
So if TARP funds boil your blood, it’s time to start relaxing. It was an inevitable, profitable, and strategic investment by the government, not private investors. I don’t believe the government to be in the business of stock picking or wealth management, and I don’t believe our current administration has any ambitions to do so. We’ll receive a nice return on our money and we probably saved the world from total economic and financial failure. Some of the funds will never be paid back (they are expected to be used as taxpayer subsidies), and that’s a sad fact.But it’s a fact we can do nothing about aside from voting for republicans every chance you get from here on out. Government intervention is reserved for desperate times that call for desperate measures: the sudden and widespread loss of confidence from private investors in marketplaces.
As companies line up to pay back funds (they most certainly want to return to profitability and get rid of all the regulation that comes with government bailout), it can serve as a leading indicator for investors like you and I; if companies are paying back TARP heavily, perhaps then we’ll be on the right track to a full, unstoppable recovery. By the way, are you interested in some numbers? $347 billion had been spend and invested with more than $200 billion of it paid back in principle, interest, and dividends. While there is no time line or date for full recovery of the funds, the cash is continually flowing in. Get more dollar figures from the State of the Bailout report from ProPublica here.
Follow this link to a Bullworthy.com post called the “Bad Rap Bankers” that follows the controversy of excessive Wall Street pay during times of economic crisis.
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