Financial Regulation

"The big message of the financial crisis is that you want to become too big to fail"

George Mason economics professor Garett Jones on TARP, moral hazard, and the true costs of bailing out the financial sector.


In 2008, in the midst of massive economic turmoil, Congress passed the Troubled Asset Relief Program, or TARP, in hopes of sparing the economy from what many viewed as a near certain collapse. Since then, TARP, which funneled hundreds of billions of dollars into the coffers of the nation's biggest banks, has become a symbol of both Washington's overspending and its corporatist leanings. But while popular sentiment has hardened against the law, elite consensus has come to embrace it as a resounding success. Last fall, Politico's Ben Smith called it "a success none dare mention" and Washington "insiders' finest moment, a successful attempt to at least partially fix their own mistakes." Earlier this week, Washington Post columnist Robert Samuelson, a frequent critic of government intervention in the economy, echoed the sentiment that TARP was a success, writing that the real lesson of the program is that "only the government is powerful enough to prevent a complete collapse." Many of the law's supporters pointed to a recent report by the Congressional Budget Office stating that despite the initial $700 billion price tag, the cost to taxpayers would only amount to about $19 billion.

I've been tempted by these arguments myself. It's not that I ever thought TARP was a great idea or an experiment worth repeating. Clearly there were serious problems with the Treasury Department's claims about the program's effects. But ultimately, TARP seemed like a lesser problem—a relatively small expense that may even have had some short-term positive effects.

Garett Jones, a professor of economics at George Mason University, has spent the last two years arguing otherwise. I spoke with him earlier this week about the why he blames TARP for much of America's economic struggles, and why its long-term consequences could be more serious than most people realize. What follows is an edited version of our conversation.

Reason: The elite consensus seems to be that TARP was actually a pretty successful program. Even market-oriented economists like Bob Samuelson have defended it. I know you disagree. Why are they wrong? Why was it a bad idea?

Garett Jones: There are a few reasons. Normal economics tells me that when the government takes over an industry, it's bad. Normal economics tells me that government takeovers lead to bad performance. And we actually have a lot of evidence on this. Government-owned banks are associated with much worse economic outcomes around the world. That doesn't mean the banks failed. Auto industries in the Soviet Union never went into bankruptcy. But that also doesn't mean that they were good.

What's going on here instead is that the market looked at TARP and said, "Wow, our financial system is going to be a lot worse—a lot less productive—than we thought." That's a major reason, I think, why the stock market collapsed after TARP was enacted. The market had looked at bad economic news about mortgage markets, about financial markets, for a good solid year beforehand. And it took the passage of TARP for it to completely tank.

I'm willing to be pretty bold about this. There really wasn't much new economic news about the state of the banks that came out when the stock market had its eight days of terror. What was coming out was the government's ever-growing willingness to completely take over and micromanage the "too big to fail" banks.

Reason: So you would say that at least the primary cause of the crash was TARP and the government showing itself to be willing to be intervene?

Jones: I think there's a solid shot that it's most of it. It's at least a substantial part of it. I know that I'm in the minority here. It's just me and John Taylor right now who are willing to say this openly.

But yes. The news that still doesn't get enough attention is that the collapse happened after TARP was passed, not before. People have this story they tell each other where the economy was collapsing so we passed TARP. It's closer to the truth to say the opposite.

Reason: When people talk about TARP, when they justify it, they say it was necessary because the alternative was to face a crisis—or at least a very high risk of a crisis.

Jones: Exactly, yes.

Reason: Do you think we were in a crisis situation when TARP passed? And was there any other alternative. That seems to be a big part of the case: First, we were in a crisis. Second, there was no alternative.

Jones: I completely disagree. I said so at the time. I wrote my first words on it just a few weeks after TARP was enacted, and then I spun it out into a full length paper called "Speed Bankruptcy." The basic story is the same story the Irish people are debating now. It's the idea that you make bond holders share the pain. It's called burden-sharing now. It took years to come up with a term to capture what you need to do when your banks are in the tank. And the answer is: You tell long-term bond-holders, "Sorry, you're not going to get paid. You're not going to get paid 100 cents on the dollar. You're going to have to take a haircut."

Reason: So your argument is that the lost money's got to come from somewhere. And bondholders are the people who took the risk and therefore should face the negative consequences.

Jones: Precisely. And if you do the smart thing, you don't just give them haircuts, but you do an equity conversion. You bring in a whole mass of shareholders, many of whom will actually be pretty informed about the business. So if you turned a fraction of the bonds into shares, then you create a whole new class of shareholders who can come in, take over the firm, put in new management, and bring in fresh blood. All the good things the government was trying to do during the months when they owned the banks.

Reason: Let me just challenge you a little bit more on this. Part of the narrative surrounding TARP was that when the initial vote didn't go through, there was panic in the market. Isn't there an argument to be made that TARP did in fact assuage some of the market's fears? We had multiple votes. The first vote failed. And in response, the market reacted negatively.

Jones: When the House rejected TARP, the stock market fell 7 percent. When Congress eventually passed TARP, the stock market fell 40 percent. I know which of those two numbers I prefer. I don't claim that the 7 percent was totally caused by the rejection of TARP. I don't claim that all of the 40 percent was caused by the passage of TARP. But you know, seven versus 40—I'll pick the smaller number of the two.

Reason: Let's talk about costs. The CBO says TARP is only going to cost taxpayers about $25 billion [Update: CBO now estimates it will cost $19 billion]. According to some people, certain investments in the banking sector actually made taxpayers a profit. Maybe you still think that's money we shouldn't have spent. But given that we were looking at something closer to $700 billion initially, isn't TARP a relatively small problem?

Jones: No, I think you have to look at the real cost. If I'm even one third right, if a third of the collapse of GDP was caused by the government takeover of banks and how the market looked at that, then the big collapse in revenues we've seen in federal, state, and local governments—a third of that is the cost of TARP. So the real cost of TARP is not the cost of buying the shares of the banks. The real cost of TARP is the fact that—just like in most countries where banks get taken over by the government—the economy grows worse, and the government brings in less money. That's the real cost of TARP.

Reason: The argument you're making here is about moral hazard. TARP set up a system in which, long term, banks are going to behave worse in the long term, and are not going to make smart cost-benefit decisions. It's already cost the economy to some extent. And it will eventually cost both taxpayers and the economy much more in the long run.

Jones: Yes. A lot of people think of moral hazard as excessive risk taking—as gambling with the government's money. Heads I win, tails you lose. But I think what we should really think about is that this leads to mushy, semi-socialism. That's the real risk. When banks know that the government will come and bail them out, it's not that they're going to take the big gambles. That's part of it, but the other part is that it leads to malaise—organizational sluggishness.

So an equally important risk is that banks just get sluggish. They don't worry about maximizing profit. They just turn into government agencies. They won't do that completely because they're not completely owned by the government. But if they're 5 percent owned by the government, then they're 5 percent mush.

Reason: They understand that they have a safety net below them and therefore will not be as careful.

Jones: Yes. The real risk is the risk of mushy, semi-socialism—institutional lethargy.

Reason: One of the other points critics have made is that it's actually encouraged the consolidation of big banks. Do you think that's true? Do you think that will increase the chance of further long-term financial sector problems?

Jones: The big message of the financial crisis is that you want to become too big to fail. That's a clear message of the financial crisis. To be a successful bank in America, you want to become too big to fail.

NEXT: Reason Morning Links: CIA Working in Libya, Top Buffet Aide Resigns, Congressional Leaders Reach Budget Deal

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  1. I think I want that “Billionaires For Paulsen” slogan on a T-Shirt.

    1. Interesting that they went from “Billionaires for Bush” to “for Paulsen”, skipping Obama.

  2. TARP was not a failure. It did exactly what the investment banking industry and their people at the Treasury wanted it to do. It’s just that what they designed it to do isn’t what they told us it would do.

  3. Good article. Libertarian sites like this and Lew Rockwell, as well as PBS have been doing good reporting on these issues. “Need to Know” on PBS covered a story where Bloomberg News sued the federal reserve to find out who who are still guaranteeing over $12 TRILLION in losses. Two separate judges have ordered the feds to disclose, but the fed is ignoring the order – and instead are going to appeal it to the Supreme Court. Not a word from Fox, CNN or MSNBC. (Not surprising…)

    1. The Fed did a big document release today in response to Bloomberg’s litigation, but there’s really no way of telling whether it’s complete. Nobody can effectively audit the Fed.

      In related news, Neil Barofsky agrees that TARP “failed to meet some of its most important goals” and that HAMP is a “colossal failure”. As Special Inspector General-TARP, he’s a particularly well-informed expert on the topic. See…..ef=opinion for a short version. The complete SIG-TARP report is also online.

  4. Why jump out a window ala 1929 when you can jump on the Gubmint’s back?

    After all you paid for all those senators and representatives fair and square, might as well get some use out of ’em.

  5. TARP was in response to a failure of government fiscal policy, not a failure of the free market. Absent TARP would the existing banking system have collapsed or not? If yes, would the consequences have been good for liberty? If not, explain why Austrian analysis is wrong.

  6. “I think there’s a solid shot that it’s most of it. It’s at least a ubstantial part of it.”

    Excuse me, but what’s a “solid shot”? I mean, could you quantify that for me, dude? Later, Jones says that rejection of TARP cost the market 7 percent, but passing it cost the market 40 percent. That’s laughable. The market fell 7 percent in one day when the House balked at TARP. The market did not drop 40 percent the day after TARP passed. The market decline took months and it wasn’t due to TARP. There’s plenty not to like about TARP, but it was necessary. Congratulations to Reason for finding one economist out of 10,000 who will say that TARP wasn’t necessary. It was a tough job, but you did it!

    1. Why do you even bother? It is not like the establishment has a shortage of cheerleaders, and not like you are adding any value to your already existing excess of banality.

  7. Great picture of three dickwads.

  8. If TARP had not pasted, why we would have U3 unemployment of near 10%, and total and underemployment of near 17%!….
    Deficits would be soaring!
    What’s that? We do have those unemployment numbers and soaring deficits!??!
    Never mind…

    1. What’s that? We do have those unemployment numbers and soaring deficits!??!
      Never mind…Okay, imagine how bad it would be without it? You’ll never know, so it could have been EVEN WORSE! It was a rousing success!


      1. That’s kind of like the argument Lisa Simpson was making with her Dad.

        Lisa: (picks up a rock) I could say that this rock keeps tigers away.
        Homer: How do you know that?
        Lisa: Well, do you see any tigers around here?
        Homer: (Looks around for a moment. Then reaches for his wallet) Lisa, I want to buy your rock!

  9. The problem with “too big to fail” is that it eventually becomes “too big to bailout”.

  10. This reminds me of Vietnam… even in the face of defeat our government still declares victory!

  11. This too big to fail thing also gives incentive for companies that should scale back failed expansions to double down instead of shrink. If they shrink, they will take losses due to a bad idea. If they double down on it, government will bail out their bad ideas.

  12. I typically fall on the side of being anti-TARP. But I also realize that much of the financial mess was created by the government. Regulations made the problem, and easy money made it worse. So if the government is responsible for companies going bankrupt, should they not be held responsible and have to pay? Although, ultimately, it is the taxpayers who are paying. It’s not fair to them.

  13. Golly, it looks like not many people are interested in hearing what Garett has to say. Interesting!

    1. In Alan Vanneman’s world, truth is a fucking popularity contest, and the bandwagon in 2011 is not a clown car but a luxury vehicle with a gold plated, excuse me, fiat plated interior with leather upholstery made from the finest used Gillespie jackets.

      1. This has to be one of the top 5 best H&R comment replies of 2011.

  14. Isn’t a business that’s “too big to fail” more or less a per se monopoly?

    If we are going to bail out businesses that are “too big to fail,” what’s the point of Chapter 11 bankruptcy?

    1. What, would you have Chapter 10 skip right to 12 instead? Where are we, Somalia?

  15. I know this kind of goes beside the point of the article, but it made me think that now is as good a time as any – I want to know your responses to this quote, guys –

    “Of course demonizing the system is a bit silly, but there’s nothing wrong with acknowledging its drawbacks. You don’t have to be anti-capitalism or socialist to recognize that a system based on the philosophy of natural human greed and consumption ultimately creating balance is one that is virtually impossible to sustain in a situation with finite resources. Extreme free-market capitalism that doesn’t blend controls with freedoms is even more likely to lead to this end.

    It all comes down to the fact that if people are encouraged to take as much of a resource as possible and have the notion that if they don’t take it others will, things will go fairly well for a finite amount of time. Enormous problems arise on extended timescales, however.”

    I’m writing an essay for economics class on attitudes and a section on why free markets kick the crap out of any control and regulation, and I’d really appreciate as detailed as possible the responses to this of true constitutionalists and libertarians.

    1. That is nonsense on stilts. Bailouts are not remotely ‘extreme free-market capitalism,’ just the opposite. A genuine free market has the threat of failure with all of the attached penalties as the primary and effective control. It is built-in and inherent if you don’t shield the players from their bad choices.

      The situation we have was not a failure of free markets. It was the result of corruption interfering with the normal mechanism of free markets. Humans are always going to be subject to temptation. Where there is no repercussions that temptation is arguably a good idea. After all, if you have an eight figure income, even for just a few years, it is unlikely that things will get so bad that you won’t live very comfortably for the rest of your life. The only people I know who worked in the home loan business who’ve really suffered were the frontline shlubs pulling in six figures or less. They did what their bosses told them and were tossed aside when reality set in.

      It took government intervention to create these conditions of market distortion and making bad risks a smart choice on an individual basis. None of TARP would be needed if the players had been working with a personal stake rather than having no real penalty for failure.

  16. TARP established that a criminal can get away with it and walk away rich if his crime is on a sufficiently large scale and he has the right connections in the government. Who of the major players in this, across finance and government, has really suffered as a result? None that I know of.

  17. Victors write the history books but those who lived through the bailout {final months of Bush} and watched the bottom drop out know the timeline.

  18. This movie has some nike sb skunk dunks for sale of the same flaws I saw in another attempt at a faithful adaptation of a work of fantastic literature long thought unfilmable, Zach Snyder’s 2009 version of Watchmen…That is, it kobe 7 for sale struck me as a series of filmed recreations of scenes from the famous novel

Please to post comments

Comments are closed.