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What Paul Krugman and Ezra Klein Get Wrong About TARP

David Dayen

There’s an old saying that history is written by the winners. As we get further and further away from the financial crisis, we’re seeing that adage play out with disturbing frequency.

Opinion-leading journalists and analysts invoke a conventional wisdom about the history of the crisis and its aftermath, which misstates and omits several key points. They convey to the public an incomplete narrative, unquestionably filtered to them by political leaders who want to take credit for everything that went right and ignore everything that went wrong. This matters for the next crisis, and whether the choices on the policy menu will be limited by a story about what “worked” the last time.

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For example, when newspapers run stories about the government making profits off the Troubled Asset Relief Program (TARP), they usually leave out the fact that the federal government can make money virtually any time it wants by virtue of controlling the money supply and, by association, receiving ultra-low borrowing rates. The government does not have the same goals as a hedge fund; its purpose has more to do with the public welfare than whether it can turn a buck.

Moreover, almost half of the banks that repaid TARP funds did so with money from other federal programs, in particular the 2010 Small Business Lending Fund. It’s impossible to view TARP “profits” in isolation without looking at where the profits came from. And it is meaningless to attribute TARP “working” in any sense to its making money. But that’s the intent of news stories that play up the government’s profit.

This narrative formation works in more subtle ways, too. Take this interview between Vox Media’s Ezra Klein and The New York Times’s Paul Krugman. At one point, Klein discusses the current “dangerous period” in American politics, and how polarization in a system with biases toward divided government virtually ensures legislative dysfunction, outside of responding to crisis. Krugman takes it one step further, noting that he often speaks with leaders in international finance.

“At some point,” Krugman explains, “somebody says, what if we had another major financial crisis? What if we really needed something like TARP again? What are the chances that something like TARP could actually happen in this political environment? And everybody goes quiet.”

This reinforces every false narrative about TARP — first and foremost the idea that it was really needed. TARP was in reality a very small part of the emergency lending programs given to banks in the depths of the crisis. TARP ended up distributing roughly $426 billion in capital loans and grants to otherwise bankrupt banks and auto companies. Just on December 5, 2008, the same banks borrowed almost three times as much, $1.2 trillion, from the Federal Reserve.

Take TARP out of the equation, and the federal government, through the Federal Reserve as well as various other guarantees and lending vehicles, committed $7 trillion to the global banking system from the height of the crisis to March 2009. TARP barely even registers on that scale.

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The way banks got nursed back to health in the crisis was through borrowing at near-zero interest rates from the Fed discount window or emergency programs like the Primary Dealer Credit Facility, using only junk for collateral, and then lending back out, often to government Treasuries, at higher rates. With the “mother of all carry trades” in place, banks needed only to get super-cheap money and invest it in inflated assets. Moreover, the government guaranteed entire markets, like the commercial paper market, and announced by their actions that no other bank would fail. This reduced borrowing costs significantly for banks, as investors viewed them as risk-free. A trained chimp could have made money in this environment.

TARP really provided a way to get Congress publicly hooked into this orgy of largesse for Wall Street, masking the much more massive support delivered secretly. Americans wouldn’t have known at all about the extent of the Federal Reserve loans until Bloomberg sued to get the data under the Freedom of Information Act. But if opinion leaders ignore this primary role played by the Fed in propping up banks during the crisis, and put it all on TARP, Bloomberg’s heroic work was in vain.

Incidentally, Ezra Klein’s response to Krugman, that Congress was moved by a market reaction to pass TARP after failing the first time, is also incomplete. What saved TARP was a promise from then-Senator Obama that, when elected, he would use the program to protect homeowners and prevent foreclosures. Rep. Donna Edwards (D-MD), then a freshman Congresswoman, received a personal commitment from Obama on this point, and Larry Summers, then on President-elect Obama’s transition team, wrote a letter promising that the incoming administration would “commit $50-$100 billion to a sweeping effort to address the foreclosure crisis… while also reforming our bankruptcy laws.”

Democrats relented on their opposition to TARP because of the promises on housing. But the bankruptcy reform never happened, and to date only $12.8 billion of that $50 to $100 billion promise has been spent.

If you want to say that future legislation masquerading as a crisis response will get done through leaders lying about their intentions, the history backs you up. But that story isn’t being told by those celebrating TARP’s success. And if we want to properly assess the program, the 5 million families put into foreclosure since its passage need to have a voice in the discussion.

I point this all out because we’re going to have financially caused catastrophes at some point in the future. Josh Rosner, the analyst who nailed the coming subprime crisis all the way back in 2001 with his paper, “A Home Without Equity is Just a Rental with Debt,” has a new report out warning about manipulation in the massive credit default swaps market. These types of derivatives are big enough to overwhelm the entire financial system if they blow up.

But whether it’s the CDS market or somewhere else, everyone agrees that something will happen eventually. Risk builds up and pools, and when it goes sour, everyone runs for the exits. The question is, what has been learned that can inform policy responses to the recurrence of crisis?

Related: Why Auto Loans Could Be the Next Subprime Crisis

If the narrative holds that Congress can fashion a bailout, which will not only work but make money, then the question is already answered. But if the actual history got told, about massive central bank support, a persistent coddling of the financial sector and virtually no trickle down to the ordinary Americans who needed the help most acutely, I think reasonable people might have second thoughts. And they might think more creatively about how to deliver support more directly, and how to permanently reduce risk, the way we did with the stricter regulatory system for Wall Street ushered in with post-New Deal reforms, one that succeeded for over 50 years until it was legislated out of existence by Washington.

The proper telling of history is absolutely critical to the choices that get offered to the public. Bad history leads to not only bad outcomes, but hidden alternatives. If we don’t question the official narratives, we’ll get stuck with the narrow bands of solutions that result from them.

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