More on TARP

As a follow-up to my previous post on TARP, here are some more commentaries on the end of this proram. A key point these pieces make is that while TARP saved the financial system it did so at the cost of significantly increasing moral hazard and thus planted the seeds of the next financial crisis:

(1) Count on Sequels to TARP--Gretchen Morgenson

(2) Going Viral: Why TARP, Like Herpes, is a "Gift" that Keeps on Giving--Alain Sherter

(3) The End of TARP: Goodbye and Good Riddance--Henry Blodget and Aaron Task

The Legacy of TARP

Today, Simon Johnson considers the long-term implications of TARP:

TARP was an essential piece of a necessary evil – that is, it saved the American financial system from collapse, but it was put in place in a way that was excessively favorable to the very bankers who had presided over the collapse. And this sets up exactly the wrong incentives as we head into the next credit cycle.

A couple of weeks Ryan Avent reached the same conclusion:

[G]overnment interventions, of which the TARP was a key part, prevented what leaders in the early 1930s did not—a cascade of wealth-destroying, money-supply shrinking bank failures. And because the interventions successfully halted the cycle of fear in financial markets, the programme ended up costing practically nothing... The truth is that the TARP, despite the profit, has come with significant negative costs. It has preserved the structure of the banking system in its current, over-concentrated, too-big-to-fail form. And it has created an absolutely massive moral hazard problem. And so in a way, we're all still paying the cost of TARP, because the legacy of that intervention continues act as a de facto subsidy to size and risk. And one day that bill may come due, in the form of another costly crisis.

 There are other observers, on the other hand, who sing nothing but praise for TARP. If it were possible, it would be useful to look at the difference between (1) the net present value of  future costs created by TARP and (2) the costs that would have been incurred in 2008 and 2009 had there been no TARP.  Of course, such a calculation is not possible because (1) requires knowledge of the future and (2) requires knowledge of a counterfactual.  One thing, though, does seems sure to me: the moral hazard problem is now bigger than ever. 

What Real Financial Reform Might Look Like

I recently received my copy of Laurence Kotlikoff's new book Jimmy Stewart is Dead. In this book Kotlikoff calls for limited purpose banking. I was initially skeptical of the idea, but I am warming up to it as I read more. My initial fear was that that limited purpose banking would turn the banking system into nothing more than a vault and therefore reduce financial intermediation. However, this is not the case with this approach as banks would still provide financial intermediation through mutual funds. Checking accounts, however, would be fully backed by cash or t-bills. Interestingly, this would eliminate the money multiplier and thus give the Fed more control over the money supply. I still have some questions on this approach, but can see how it could bring greater financial stability. I would love to hear your thoughts on this approach. 

Below the fold is an long excerpt from one of Kotlikoff's articles on limited purpose banking.

Update: Tyler Cowen discusses limited purpose banking.