Costs of Government Interventions in Response to the Financial Crisis: A Retrospective

Summary

In August 2007, asset-backed securities (ABS), particularly those backed by subprime mortgages, suddenly became illiquid and fell sharply in value as an unprecedented housing boom turned into a housing bust. Losses on the many ABS held by financial firms depleted their capital. Uncertainty about future losses on illiquid and complex assets led to firms having reduced access to private liquidity, sometimes catastrophically. In September 2008, the financial crisis reached panic proportions, with some large financial firms failing or having the government step in to prevent their failure.

Initially, the government approach was largely ad hoc, addressing the problems at individual institutions on a case-by-case basis. The panic in September 2008 convinced policy makers that a system-wide approach was needed, and Congress created the Troubled Asset Relief Program (TARP) in October 2008. In addition to TARP, the Treasury, Federal Reserve (Fed) and Federal Deposit Insurance Corporation (FDIC) implemented broad lending and guarantee programs. Because the crisis had many causes and symptoms, the response tackled a number of disparate problems and can be broadly categorized into programs that (1) increased financial institutions’ liquidity; (2) provided capital directly to financial institutions for them to recover from asset write-offs; (3) purchased illiquid assets from financial institutions to restore confidence in their balance sheets and thereby their continued solvency; (4) intervened in specific financial markets that had ceased to function smoothly; and (5) used public funds to prevent the failure of troubled institutions that were deemed systemically important, popularly referred to as “too big to fail.”

The primary goal of the various interventions was to end the financial panic and restore normalcy to financial markets, rather than to make a profit for taxpayers. In this sense, the programs were arguably a success. Nevertheless, an important part of evaluating the government’s performance is whether financial normalcy was restored at a minimum cost to taxpayers. By this measure, the financial performance of these interventions far exceeded initial expectations that direct losses to taxpayers would run into the hundreds of billions of dollars.

Initial government outlays are a poor indicator of taxpayer exposure, because outlays were used to acquire or guarantee income-earning debt or equity instruments that could eventually be repaid or sold, potentially at a profit. For broadly available facilities accessed by financially sound institutions, the risk of default became relatively minor once financial markets resumed normal functioning. Most of the programs that were introduced have been wound down or have shrunk to a fraction of their previous size. This report presents how much the programs ultimately cost (or benefited) the taxpayers based on straightforward cash accounting as reported by the various agencies. Of the 23 programs reviewed in this report, principal repayment and income exceed initial outlays in 17, principal repayment and income fell short of initial outlays in three, and it is too soon to tell for the remaining three. Of the three programs that lost money, two assisted automakers, not financial firms. Altogether to date, realized gains across the various programs exceed realized losses by tens of billions of dollars. Most of the remaining principal outstanding is to Fannie Mae and Freddie Mac, where net income will exceed principal outstanding once recently announced quarterly payments are transferred. More sophisticated estimates that would take into account the complete economic costs of assistance, such as the time value of the funds involved, are not consistently available. In this sense, cash flow measures overestimate gains to the taxpayers.