Troubled Asset Relief Program Research Articles

Did Banks Pay Fair Returns to Taxpayers on TARP?

ABSTRACTFinancial institutions received investments under the Troubled Asset Relief Program in a bad state of the world but repaid them in a relatively good state. We show that the recipients paid considerably lower returns to taxpayers compared to private‐market securities with similar risk over the same investment horizon, resulting in a subsidy of over $50 billion on the preferred equity investment by the government. Ex‐post renegotiation of contract terms limited the upside gains received by taxpayers in good times and contributed to the subsidy. These findings have important implications for the design and implementation of future bailouts. Our simple methodology for calculating the subsidy can be applied to evaluate the financial costs of other bailouts.

Stockholder Wealth Maximization during the Troubled Asset Relief Program Period: Is Executive Pay Harmful?

This study investigates governance mechanisms and their relation to firm value, i.e., executive compensation restrictions during the regulatory period and their effects on the performance of firms that received Troubled Asset Relief Program (TARP) funds. We employ an event study to investigate the market reactions for TARP recipients, followed by OLS regression to examine the stock return effects of 10 announcements. For comparison, we also employ a multivariate regression model (MVRM) based on a system of equations with seemingly unrelated regressions (SURs). Our evidence shows that changes in firm value have a negative and significant relationship with changes in total compensation for TARP companies that have paid back their debts to the government. However, the relationship is weaker than that for TARP companies that have not paid back the bailout money.

The longer-term impact of TARP on banks’ default risk

We analyze the long-term effect of 2008 Troubled Asset Relief Program (TARP) funding through the default risk angle to further our understanding of the TARP program’s benefits and costs. Our sample includes the banks that received funding under the TARP program from October 2008 to December 2009 with the corresponding data on transaction dates, investment amounts and repayment schedules collected from the U.S. Department of the Treasury website, and for which the required financial date is available for the period from 2000 to 2017. We find that both the treatment group (banks receiving TARP funds) and the control group (banks not receiving TARP funds) of banks increased their default risk in the post-TARP period spanning almost a decade after the capital injection. Using a difference-in-difference approach, we find that the long-lasting impact of TARP funding is higher in TARP banks compared to banks that did not receive such funding. Our findings indicate that the TARP funds did not improve but worsened recipients’ default risk, supporting the moral hazard concerns of government guarantee programs.

Value of corporate political contributions from the investors’ perspective

In this study we consider corporate political contributions as a special type of social capital reserved for future contingencies. Firms benefit from making such contributions when the government suddenly intervenes in the market. We explore this value-creation mechanism in terms of the firm-investor relationship, not in terms of the traditional firm-government relationship. When a government intervention is being proposed or approved, firms that have made political contributions coordinating with political candidates are likely to enjoy better stock market returns than those that have not made such contributions. We also argue that firms that have made political contributions may experience lower stock returns than those that have not when the intervention plan is rejected. By focusing on the U.S. government’s Troubled Asset Relief Program (TARP) of 2008, our event study analysis with three news announcements finds that financial institutions that made political action committee (PAC) contributions indeed enjoyed higher stock returns when TARP was proposed and eventually approved. However, we do not find support for the investors’ devaluation of political contributions when TARP was once rejected during the review process. The findings propose that managers can use corporate political contributions as a strategic option to help investors reduce investment uncertainty by presenting their readiness for any unexpected change in the regulatory environment.

There is no capitalist conspiracy and the rich are not all‐powerful

There is no capitalist conspiracy and the rich are not all‐powerful

Supply and Demand Effects of Bank Bailouts: Depositors Need Not Apply and Need Not Run

AbstractWe address two key issues concerning bank bailout effects on depositor and bank behavior. The first is whether bailouts weaken or strengthen market discipline by depositors through deposit supplies. The second is if bailed‐out banks decrease or increase their deposit demands. These questions can only be adequately addressed by analyzing the effects of bailouts on both deposit quantities and prices. We do so for the Troubled Asset Relief Program (TARP) bailouts. Overall, we find that demand changes empirically dominate supply changes, and suggest significantly reduced deposit demand from bailouts. In some cases, however, supply changes dominate and indicate weakened market discipline.

Are outside directors with greater board tenure valuable? Evidence from the last credit crisis

Analyses of bank performance around the 2007–2008 financial crisis indicate that outside directors with financial experience acquired through longer board service at their own banks are more effective than those with financial experience acquired elsewhere. Institutions with more long-tenured independent directors (i) earn higher Cumulative Abnormal Returns (CARs) around the collapse of both Bear Stearns and Lehman Brothers, (ii) limit their risk exposure before the crisis, (iii) exhibit better stock return and accounting performance during the crisis, (iv) are less likely to be bailed out by the U.S. government’s Troubled Assets Relief Program (TARP), and (v) receive proportionally less financial assistance from TARP.

Bank CEO careers after bailouts: The effects of management turnover on bank risk

We study whether bank bailouts affect CEO turnover and its subsequent impact on bank risk. Exploiting the Troubled Asset Relief Program (TARP) of 2008, we find that TARP funds temporarily decreased the likelihood of bank CEO turnover during the crisis (2008–2010) but significantly increased CEO changes afterwards. Our results show that replacing TARP CEOs reduced individual bank's risk as well as the bank's contributions to the systemic risk. Finally, we find that TARP CEO turnover was mainly driven by a decrease in the bank's political capital. Overall we provide evidence that bank bailouts have important implications for banks’ risk-taking and systemic risk, insofar as bailouts affect bank CEO turnover.

Shifts in beta and the TARP announcement

Using high frequency return data, we propose a method for detecting level shifts in stock betas in the context of an event study. Using this method, we identify significant beta changes around the initial announcement of the Troubled Asset Relief Program (TARP). Our findings have important implications for studies of TARP that assume betas remain unchanged following the program’s announcement. Pre-TARP betas are found to be poor measures of post-TARP systematic risk exposure. Holding these betas fixed at pre-TARP levels in the estimation of cumulative abnormal returns (CARs) risks distorting the magnitudes of these CARs by multiple orders.

The effect of TARP on lending: Evidence from the lead bank’s share in syndicated loans

We investigate the effect of the Troubled Asset Relief Program (TARP) on the shares of lead banks in syndicated loans by using quarterly data for the period from 2008 to 2011. We find that TARP capital injections to lead banks have a significantly positive effect on their shares of syndicated loans. Specifically, we estimate that the effect of TARP on the lending of lead banks increases their shares by 6.1% that is equivalent to an additional $50.37 million for an average syndicated loan of $840 million. The significantly positive effect is stronger for a lead bank that is larger, has a greater appetite for risk, and is not under supervisory stress. Overall, our results show that TARP was an effective mechanism for promoting the lending of lead banks. The larger fractional share of lead banks in syndicated loan packages signals both the loan quality and their commitment to mitigating the adverse selection and moral hazard problems. This study sheds new light on the mixed evidence of TARP on lending and contributes to the research and policy debates on the role of stringent supervisory scrutiny in lending.

Bank failures, local business dynamics, and government policy

Using MSA-level data over 1994–2014, we study the effect of bank failures on local business dynamics, in the form of net business formation and net job creation. We find that at least one bank failure in the metropolitan statistical area (MSA) with the mean population prevents approximately 475 net businesses from forming in that area, compared with MSAs that experience no bank failures, ceteris paribus. The equivalent effect on net job creation is 16,433 net job losses. Our results are even stronger for small businesses, which are usually more dependent on bank-firm relationships. These effects point to significant welfare losses stemming from bank failures, highlighting an important role for government intervention. We show that the Troubled Asset Relief Program (TARP) is effective in reducing the negative effects of bank failures on local business dynamics. This positive effect of TARP is quite uniform across small and large firms.

Does bank capital reduce liquidity creation?

This paper investigates the relationship between bank capital and liquidity creation against the backdrop of the 2007–2008 financial crisis. Analyzing an unbalanced panel of 11,617 U.S. commercial banks from 1996 to 2016, we find a negative association between regulatory capital and on-balance-sheet liquidity creation, but positive associations for small banks and after the financial crisis. Further, we observe lower liquidity creation among banks that participated in the Troubled Asset Relief Program (TARP). The results are largely robust to several alternate variable proxies and model specifications. Our findings suggest that “one-size-fits-all” policy may have some unintended consequences for banks.

Book Reviews

Anjan V. Thakor of Washington University in St. Louis reviews “TARP and Other Bank Bailouts and Bail-Ins around the World: Connecting Wall Street, Main Street, and the Financial System,” by Allen N. Berger and Raluca A. Roman. The Econlit abstract of this book begins: “Analyzes theoretical and empirical research evidence on the Troubled Asset Relief Program (TARP) in the United States and other bank bailouts and bail-ins in the US and around the world, assessing the important costs and benefits of these programs in order to suggest potential policy implications for the future.”

Impact of Government Bailout on Banks’ Cost of Equity: Additional Evidence from the Financial Bailout of 2008–2009

The Capital Purchase Program (CPP) was the first and most significant program under the Troubled Asset Relief Program (TARP) during 2008–2009 financial crisis. This study evaluates the effect of the CPP during this period on the cost of equity of 170 publicly listed banks in the United States that received funding. To control for the potential effects of endogeneity on our results, we use a propensity score matched sample of non-CPP banks. Using this approach, we document robust evidence that the liquidity provided by the government bailout reduced the cost of equity for recipient banks, especially for those banks that repaid their bailout funds in full. This decrease in the cost of equity is particularly significant for banks with high market-to-book ratios, low concentrations of institutional ownership, and those banks with at least one large blockholder. Our findings have important implications for the assessment of government bailout programs and the future regulation of financial institutions.

The politics of bailouts: Estimating the causal effects of political connections on corporate bailouts during the 2008\u20132009 US financial crisis

In 2008, as the financial crisis unfolded in the United States, the banking industry elevated its lobbying and campaign spending activities. By the end of 2008, and during 2009, the biggest political spenders, on average, received the largest bailout packages. Is that relationship causal? In this paper, I examine the effect of political connections on the allocation of funds from the Troubled Asset Relief Program (TARP) to the US financial services industry during the 2008–2009 financial crisis. I find that TARP recipients that lobbied the government, donated to political campaigns, or whose top executives had direct connections to politics received better bailout deals. I estimate regression discontinuity design and instrumental variable models to uncover how election outcomes for politicians in close races affected the distribution of bailout funds for connected firms. The results do not imply that some banks were deliberately favored over others, just that favored banks benefited because of their proximity to the right people in power. If being politically connected matters in general, in times of crisis it matters even more.

TARP from the Banks’ Perspective: Evidence from Conference Calls

Using earnings conference calls, we investigate banks’ views of the Troubled Asset Relief Program (TARP). Most banks in our sample did not plan to lend out the funds and our regressions confirm that they did not. The evidence suggests that TARP’s price diminished its usefulness in expanding credit supply. In contrast, banks more often expressed favorable views of the program in terms of its impact on capital ratios. We find that banks often described loan demand during the sample period as weak, but lack of demand does not explain the anemic loan growth that occurred after the TARP injections.

A Tale of Two Bailouts: Effects of TARP and PPP on Subprime Consumer Debt

High levels of subprime consumer debt can create social problems. We test the effects of relatively exogenous income and credit shocks on this debt from TARP and PPP bailouts during the Global Financial Crisis and COVID-19, respectively. We combine over 11 million consumer credit bureau records with bank, bailout, and local market data. We find subprime consumers with more local TARP banks significantly increased debt burdens subsequently, while more PPP bailouts are associated with reduced subprime debt. Findings are robust to instrumental variables and other identification techniques, and yield policy implications regarding bailout structures and strings attached to bailout funds.

The Rescue of American International Group Module Z: Overview

In September 2008, in the midst of the broader financial crisis, the Federal Reserve Board of Governors used its emergency authority under Section 13(3) of the Federal Reserve Act to authorize the largest loan in its history, a $85 billion collateralized credit line to American International Group (AIG), a $1 trillion insurance and financial company that was experiencing severe liquidity strains. In connection with the loan, the government received an equity interest representing 79.9% of the company’s ownership. AIG continued to experience a depressed stock price, asset devaluations, and the risk of ratings downgrades leading to questions about its solvency. To stabilize the company, the government committed additional assistance, including equity investments under the Troubled Assets Relief Program and asset purchases, for a total commitment of $182.3 billion. AIG survived as a smaller entity and repaid all amounts owed to the government, which, along with the government’s sale of its AIG equity stake, resulted in a profit of $22.7 billion for the government and taxpayers (Treasury 2013, 14). In this case we discuss the government’s actions on an aggregate basis and analyze how the rescue was conceived and executed in order to better understand the unique lessons to be learned and possibly applied to future crisis events.

The Virtues of Economic Rescue Legislation: Distributive Justice, Civil Law, and the Troubled Asset Relief Program

AbstractThis study constitutes an ethical analysis through the lens of distributive justice in the case of the Troubled Asset Relief Program (TARP), which was enacted in the midst of the Great Recession of 2007–2009. It begins by engaging with the visions of justice constructed by John Rawls and Robert Nozick, using their insights to locate the injustices of TARP according to their moral imaginations. However, this study argues that Rawls’ and Nozick’s theories of justice primarily envision the nature of law as being restrictive of vice, not as instructors of virtue. Thus, it resources the legal philosophy of St. Thomas Aquinas to demonstrate how the positive pedagogy of law can enable a more just construction of economic rescue legislation, one that not only prevents future repetitions of economic vices and injustice, but is also formative for a society that prizes economic justice and virtues. In doing so, the study proposes two criteria for a more just consideration of economic rescue legislation that embraces law’s positive pedagogy.

Once bitten twice shy? Evidence from the U.S. banking industry during the crash of the energy market

Abstract We explore whether banks learn from past experience and modify their risk culture. Evaluating bank risk culture during the 2014 energy crash fueled by excessive bank lending, we find banks with a quick recovery after the 2007 subprime crisis find it unnecessary to change their risk culture, and banks that struggled to recover modify their risk culture following the subprime crisis. As a result, banks with poorer stock performance and a lower z-score during the subprime crisis that had a quick recovery are more likely to underperform during the energy crash. However, results show that while these banks do not modify their overall risk culture, they have learned from the subprime crisis by better positioning themselves for potential losses. In addition, larger banks and banks that did not receive TARP funding have not significantly changed their risk culture following the subprime crisis.