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