The Purpose of TARP

I'm continually amazed by how quickly commentators have forgotten that the primary purpose of TARP was to prevent the complete collapse of the U.S. (and global) financial system, and not just to increase bank lending to consumers and businesses. We were in the middle of an epic financial panic, complete with a classic run on key parts of the shadow banking system, and a devastating margin spiral that had engulfed the entire financial system. Needless to say, a collapse of the financial system would also have meant a collapse of bank lending to consumers and businesses. But the idea that banks' failure to increase lending is somehow proof that TARP failed (or is failing) is simply divorced from reality.

This New York Times op-ed by Harvard's John Coates and David Scharfstein, which criticizes TARP for directing aid to bank holding companies rather than the bank subsidiaries, exemplifies this kind of revisionist history. Coates and Scharfstein claim that TARP didn't have its "desired effect," which they blithely assume was "higher levels of bank lending." Now, by the time TARP was actually enacted, it had more than one purpose. But there's no denying that the overriding purpose was to prevent the collapse of the financial system.

Ben Bernanke, in a speech delivered shortly after TARP was passed, summarized its purpose (emphasis mine):

The intensification of the financial crisis in recent weeks made clear that a more powerful and comprehensive approach involving the fiscal authorities was needed to solve these problems. On that basis, the Secretary of the Treasury, with the support of the Federal Reserve, went to the Congress to ask for a substantial program aimed at stabilizing our financial markets. As you know, last week the Congress passed and the President signed the Emergency Economic Stabilization Act. This legislation provides important new tools for addressing the distress in financial markets and thus mitigating the risks to the economy. The act adds broad, flexible authorities to buy troubled assets, to provide guarantees, and to directly strengthen the balance sheets of individual institutions.
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The TARP's purchases of illiquid assets from banks and other financial institutions will create liquidity and promote price discovery in the markets for these assets. This in turn will reduce investor uncertainty about the current value and prospects of financial institutions, enabling banks and other institutions to raise capital and increasing the willingness of counterparties to engage. More generally, increased liquidity and transparency in pricing will help to restore confidence in our financial markets and promote more normal functioning. With time, strengthening our financial institutions and markets will allow credit to begin flowing again, supporting economic growth.

I understand that all the cool kids are bashing Hank Paulson and TARP, but geez, this was only 5 months ago, and it was the kind of period that people tend to remember. There are plenty of actual criticisms of TARP to be made; no need to make criticisms up.