TARP Oversight Report: Bailout Goals Conflict, Moral Hazard Alive And Well

Edward Niedermeyer
by Edward Niedermeyer

The Congressional Oversight Panel, which oversees the TARP program on behalf of the legislative branch, has released an update on the auto bailout [ full PDF here] acknowledging the successes of the government intervention, while airing a number of important concerns. As has been typical of mainstream media coverage of the auto bailout, the good news has already been well-reported. The report, for example, notes that the bailout brought GM and Chrysler’s capacity utilization up, labor costs down, and allowed them to “[start] to reverse” their decades-long declines in market share. Furthermore, estimated government losses on the bailout have been halved, from $40b to $19b. The report’s summary concludes

While it remains too early to tell whether Treasury‟s intervention in and reshaping of the U.S. automotive industry will prove to be a success, there can be no question that the government‟s ambitious actions have had a major impact and appear to be on a promising course. Even so, the companies that received automotive bailout funds continue to face uncertain futures, taxpayers remain at financial risk, concerns remain about the transparency and accountability of Treasury‟s efforts, and moral hazard lingers as a long-run threat to the automotive industry and the broader economy.

Which brings us to the concerns that have received considerably less media attention…

As COP Chairman Ted Kaufman points out in his video introduction to the report, it is functionally impossible to asses the success to the auto bailout for the simple reason that there exists no set standard for success.The report notes

To analyze the success of Treasury‟s intervention in the automotive industry, there must first be a definition of “success.” Treasury has provided its own views on what would constitute a success. In testimony before the Panel, senior Treasury advisor Ronald Bloom defined success as primarily a question of return on investment: “the greater percentage of the money that we invested that we get back, the greater success.” The investment was not, however, made purely for the purpose of seeing a return on those funds. Mr. Bloom also testified to the importance of job preservation and listed a number of other measures for determining whether the program was successful, including the question of “whether these companies have addressed the long-term problems that we identified,” such as “a declining market share, a poor profitability profile” and failing to increase their ability to provide “good, stable jobs.” Austan Goolsbee, Chairman of the Council of Economic Advisers, appeared in a recent video [link added] released by the White House to explain the “Rebirth of the American Auto Industry.” According to Mr. Goolsbee, although taxpayers may soon see a return of the funds invested, the investment “was never really about the stock market. It was about saving American jobs.”

If the success of the overall automotive rescue, and of the government‟s means of implementing that program in accordance with the principles listed in Section H.1, above, is measured by Treasury‟s ability to meet its own definition of success, the program must: (1) provide a return on investment; (2) create or at least preserve jobs that would have otherwise been lost; and (3) set the companies on a path toward ongoing stability. Treasury‟s challenge, given its goals, lies not only in the difficulty of the goals themselves, but also in the fact that they may be mutually exclusive at times. [Emphasis added]

The ways in which these goals conflict has long been a staple of TTAC’s bailout coverage, and include several key points.

  • As TTAC pointed out back in May of last year when GM bought subprime lender Americredit, GM’s “need” for an in-house subprime lender conflicts obviously with the goals of the GMAC/Ally Financial bailout. To the extent that GM succeeds in improving sales through its new in-house lender, GMAC/Ally will suffer, hurting the taxpayer’s chances of repayment from that company. The report concurs, calling Treasury’s decision not to explore the option of folding GMAC/Ally back into GM “disconcerting.”
  • The short-term success of both GM and Chrysler, which determines taxpayer payback, can conflict with their long-term viability, a reality that pits two of Treasury’s main goals against each other. TTAC has also noted:

GM’s understandable impatience with government ownership is pushing it into risky territory. And the dangers of redlining a car business through risky loans isn’t limited to the risk of default: brand degradation, falling resale values, and boom-bust bubbles all come with the territory. Which is not to say GM is incapable of handling more subprime business… but rushing into risky positions in order to goose short-term performance has been a consistent bugbear of The General’s.

  • The financial turnaround of both GM and Chrysler required a significant loss of jobs.
  • The relative success of GM’s IPO trades off with the chances of successful IPOs from both Chrysler and Ally. The report points out:

In the case of GM, Treasury still holds a substantial share of the common stock, which it must sell at a price approximately 64 percent above the IPO price to realize a profit on the government‟s overall investment. Investor interest in GM must therefore remain high enough to absorb such a large number of shares. GMAC/Ally Financial faces various uncertainties before investors are likely to welcome an IPO. And, in the case of Chrysler, the earliest an IPO is likely to occur is 2012, making it difficult to predict both Treasury‟s ability to sell its entire stake and the amount Treasury is likely to receive in such a sale. In any case, $3.5 billion of Treasury‟s investment in Chrysler has already been written off, so even a very successful IPO is unlikely to recoup all of the money invested in that company. Moreover, as discussed in Section E above, Treasury holds only an 8 percent equity stake in Chrysler and is unlikely to be able to exercise its call option to obtain more. This leaves Treasury with a stake that is too small either to command a control premium or to exercise any control over the timing of the IPO. Finally, it is not clear whether the market will have an appetite for shares of another large American auto company soon after the GM IPO.

  • The goals of the government as both an investor seeking to maximize return for taxpayers and the goals of exiting investments as quickly as possible as befits a “reluctant shareholder” also trade off with each other. The COP identifies the recent sale of Chrysler Financial as an area in which the Treasury demonstrably passed on an opportunity to maximize its investment, allowing Cerberus Capital to profit from its desire for a rapid exit. According to the report:

The case of Chrysler Financial may provide an example of the government forgoing potential upside in order to exit an investment as quickly as possible. The issue is not that the implied value of Chrysler Financial increased by 33 percent in the seven months following the sale of Treasury‟s stake to Cerberus in May 2010. The Panel acknowledges that there is no exact science to determining the most opportune time to exit an investment. Rather, the government’s exercise of due diligence in response to the overture from Cerberus to buy out its stake appears to have been surprisingly limited and did not envision other valuation scenarios for Chrysler Financial that would involve a strategic buyer for the asset.

In short, the COP found at least two incidents in which the Treasury not only chose not to pursue maximum payback for taxpayers, but did so without fully exploring its options. The COP report charitably chalks these failures to Treasury’s conflicting goals, but they could just as easily be the product of sheer incompetence. Either way, Treasury did not stick strictly to its first goal (maximize return on investment). The success of its second goal (save jobs) is impossible to determine due to uncertainty about an alternative scenario, although the report does conclude that

It is likely, however, that, had GM‟s bankruptcy been a more prolonged process, a larger number of workers would likely have lost their jobs

As for the third goal (long-term viability), the report concludes that this goal is largely dependent on factors which Treasury can not control, arguing that

Even if the three companies‟ financials are relatively sound now, the domestic automotive sector as a whole must make a strong comeback in order for them to thrive

And even if all three of these goals are eventually fulfilled to the satisfaction of the COP, there remains one final problem: moral hazard. The report notes:

Treasury is now on course to recover the majority of its automotive investments within the next few years, but the impact of its actions will reverberate for much longer. Treasury‟s rescue suggested that any sufficiently large American corporation may be considered “too big to fail,” broadening moral hazard risk from its TARP rescue actions beyond the financial sector. Further, the fact that the government helped absorb the consequences of GM‟s and Chrysler‟s failures has put more competently managed automotive companies at a disadvantage.

And this, in a nutshell, has long been TTAC’s core complaint about the bailout. In a deeply competitive industry, where companies gamble with billions of dollars at a time, rewarding failure sets an incredibly dangerous precedent. Especially when the “more competently managed” competitors also employ Americans to manufacture a high proportion of their US sales volume domestically. The “additional views” addendum to the COP report holds up this invitation to moral hazard as “the most significant analysis” in the COP report (after noting that the bailout could have funded four Nimitz-vclass carriers or 25 years of NIH breast cancer research), arguing

The TARP has all but created an expectation, if not an emerging sense of entitlement, that certain financial and non-financial institutions are simply “too-big-or-too-interconnected-to-fail” and that the government will promptly honor the implicit guarantee issued for the benefit of any such institution that suffers a reversal of fortune. This is the enduring legacy of the TARP. Unfortunately, by offering a strong safety net funded with unlimited taxpayer resources, the government has encouraged potential recipients of such largess to undertake inappropriately risky behavior secure in the conviction that all profits from their endeavors will inure to their benefit and that large losses will fall to the taxpayers. The placement of a government sanctioned thumb-on-the-scales corrupts the fundamental tenets of a market economy – the ability to prosper and the ability to fail.

Join the conversation
5 of 48 comments
  • DC Bruce DC Bruce on Jan 14, 2011

    For our Canadian friends and B&Bs: when we talk about "excessive government intervention" we are talking about government risk-sharing that facilitates private profit. It is generally agreed that the catalyst for the near-collapse of the US financial sector was a massive bubble in residential real estate. The engine that drove that bubble were the federally-chartered "private" companies Fannie Mae and Freddie Mac. They created and supported a secondary market for home mortgages. Ostensibly private companies (you could buy their stock and their debt), everyone knew that their debt was effectively guaranteed by the government, even though, nominally it wasn't. This allowed their shareholders and executives to make money in a way that any stumble-drunk could figure out: borrow money at (low) government rates, then lend it out and (higher) private rates . . . and pocket the difference. Of course, the people who said all along that the government would not allow Fannie and Freddie to fail, or to default, were right. While it doesn't get much ink, the public cost of the bailout of those companies is huge. And the still unanswered question is: How are we going to get the government out of the home mortgage business? Until we do, the public is still assume what is supposed to be a private risk. The same is true for the car business. A reasonable person would have to conclude that there is still some sort of implicit guarantee of the domestic auto companies -- even Ford, which wasn't bailed out. That means the public (taxpayer) is still carrying the risk, while the private owners of those companies are reaping the rewards. That's why I think it would have been better to have let one of them -- Chrysler -- just fail and go into a straight bankruptcy, which, no doubt, would have resulted in liquidation and sale of the few valuable parts of Chrysler's business. A Chrysler liquidation would have had two good benefits: 1. It would have reduced the moral hazard problem, since even auto companies could not be certain that the government would bail them out. (That's the significant benefit of the government's having allowed Lehman Brothers to fail: not every financial "master of the universe" can assume that the government is going to bail him out, if he gets caught with too much risk.) 2. It would have reduced North American production capacity, which everyone agrees is too high. That would have made it easier for the surviving companies -- a restructured GM and Ford -- to succeed.

    • See 2 previous
    • Joeaverage Joeaverage on Jan 17, 2011

      +10 guys. The better lifestyle you mention is why I have remarked several times here that I think the Italians are doing things better than we are on many topics. Yeah their gov't is a mess and the their economy is shaky but the average citizen seemed to do a better job of enjoying his day when I lived there.

  • CapVandal CapVandal on Jan 15, 2011

    If this is the worst that can be said about the US domestic auto bailout, then it was a huge success. At the time, I (and most other commentators) thought this was simply money down the drain. I favored it simply as a a relatively quick jobs program. I think it was likely that it would have paid off on those terms (but of course, could never be proven). The fact that the final net cost is going to be a few billion, one way or another, isn't good news only for someone that lives on a different planet. There is global auto over capacity. The US industry could have bought the farm and we would still drive cars -- only they would be controlled by European and Asian multi nationals. Note also that 'bailouts' are ALWAYS sub optimal. However, we tried to let the economy work itself out of a deflationary spiral in the 1930's with known bad results. There are still people arguing that the government did TOO MUCH in the 1930's. So, this will never go away as a theoretical controversy. However, the final government cost of bailouts is going to be 1% of GDP or less. Not bad. No one ever said bailouts are or were optimal. And the fact that the most important decisions were made in a 3 or 4 week period (or less) means that they can be totally picked apart over details -- again sub optimal. So you have a theoretical objection -- Moral Hazard and counterfactual speculation (how it would have all worked out if the government had stayed out of it) Vs. a real bailout under extreme financial stress that either will break even or cost 1% of GDP. Note that I am leaving out the costs of the GSE's -- which were managed by congress and were the most heavily regulated financial institutions in history -- with hundreds of dedicated regulators. That may cost some money, but also provided liquidity in single family homes that was and remains critical. As far as the future, no one will vote another bailout in our lifetimes, so that aspect of the argument is weak.

  • 28-Cars-Later I'm actually surprised at this and not sure what to make of it. In recent memory Senator Biden has completely ignored an ecological disaster in Ohio, and then ignored a tragic fire in Hawaii until his handlers were goaded in sending him and his visit turned into it's own disaster, but we skipped nap time for this sh!t show? Seriously? We really are through the looking glass now, "votes" no longer matter (Hillary almost won being the worst presidential candidate since 1984 before he claimed the crown) and outside of Corvette nostalgia Joe doesn't care let alone know what day it happens to be. Could they really be afraid of Trump, who AFAIK has planned no appearance or run his mouth on this issue? Just doesn't make sense, granted this is Clown World so maybe its my fault for trying to find sense in a senseless act.
  • Tassos If you only changed your series to the CORRECT "Possibly Collectible, NOT Daily Driver, NOT Used car of the day", it would sound much more accurate AND TRUTHFUL.Now who would collect THIS heap of trash for whatever misguided reason, nostalgia for a much worse automotive era or whatever, is another question.
  • ToolGuy Price dropped $500 overnight. (Wait 10 more days and you might get it for free?)
  • Slavuta Must be all planned. Increase price of cars, urbanize, 15 minutes cities. Be poor, eat bugs
  • Sid SB Not seen a Core without the performance pack yet. Prefer the more understated look of the Core vs the Circuit, but both are great fun to drive.