Commentary | Budget Taxes and Public Investment

Ray of sunshine for gloomy financial skies?

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Several reports this week on profitable bailout programs provide welcome news at a time of potentially paralyzing worries over government spending and long-term deficits. The findings also correct a common misconception that the government rescue of financial firms has been a one-way drain of taxpayer money.

The injection of hundreds of billions of dollars in capital, loans, and guarantees into a suddenly deflated, hyper-leveraged economy during the past year was certainly unprecedented. And much of what the government got in return for its investment was and remains very risky. But it’s important to understand that the rescue was structured as an investment, and its architects tried to compensate for the risks by building in taxpayer profits, if and when things turned around.

Now there is evidence that — at least in some programs — this approach is paying off. As the New York Times reported, the Treasury made more than a $4 billion profit so far on capital investments in large banks. Also on Monday, the Financial Times calculated that special Federal Reserve lending facilities have earned a $14 billion profit. The Wall Street Journal chimed in with a broader calculation showing an overall profit of about $30 billion, including programs run through the Treasury, Federal Reserve, and the Federal Deposit Insurance Corp.

Similar conclusions were reached by EPI, which ran a series of calculations to estimate the return on investment in the Treasury’s Capital Purchase Program (CPP), a highly visible and unpopular part of the Troubled Asset Relief Program (TARP). Under the CPP, the government injected $158 billion into the 17 biggest U.S. banks (counting Bank of America and Merrill Lynch separately), and in return received preferred stock in the banks paying 5% quarterly dividends, and warrants (like stock options) allowing the government to buy bank stock in the future at a low pre-set price.

As of Sept. 1, EPI found dividend payments from those banks had amounted to $4.4 billion. In addition, nine of the big banks had bought back their preferred stock and five had redeemed their warrants — in some cases at a significant profit to taxpayers.

For example, Goldman Sachs provided taxpayers with a 23% annualized return on total investment. Other firms that have both repurchased Treasury’s preferred stock and redeemed their warrants have provided a similarly attractive return on investment: taxpayers received a 26% annualized return from American Express, an 11.1% annualized return from State Street Bank Corp, and an 8.4% annualized, after-tax return from BB&T.

So far, Treasury has made a profit of $6.1 billion from its $158 billion investment in those big banks, according to EPI calculations (which do not factor in the costs of administering the programs).

Adding the four banks that have already repaid principal, but have not yet bought back their warrants, the picture also looks positive, based on recent estimates of the warrants’ values by Linus Wilson, a professor of finance at the University of Louisiana, and the Congressional Oversight Panel, which was created to keep tabs on TARP investments.

The banks that remain fully in the program are weaker than those that took an early exit, and their ability to weather the crisis and pay off their full obligations remains uncertain. Some warrants could lose value or become worthless. If the eight remaining big banks took more than an 85% discount on Treasury’s expected proceeds, taxpayers would suffer a net loss on their overall investment.

Bloggers have been quick to point out that the early profits touted this week are by no means proof that the government response will transform the worst financial crisis in nearly a century into a pleasant, money-making venture. Indeed, the pain to the nation has been deep, and there is still plenty of loss left to be absorbed.

With mounting unemployment, still-rising home foreclosures, uncounted pools of bad mortgages, and a coming surge of delinquencies in commercial and industrial real estate, things could get worse before they get better.

And there is much to quibble about in the government response: Could the profits have been greater? Did certain banks get better treatment than others? More important, is the system that’s emerging from this crisis just as risky, or worse, than the one that led us to the edge of ruin?

            But it is not helpful or accurate to view the government rescue as a cynical back-door deal intended to transfer taxpayer wealth to greedy, incompetent, and well-connected bankers. However imperfectly it was structured and implemented, the ongoing government bailout of financial institutions was intended to save the economy while compensating taxpayers for their risky investment. Some of the money is coming back, leaving room to spend government funds in other urgently needed areas, such as health care reform.  And that should be something to celebrate.

 —Research assistance was provided by Lucan Puente