How Much Could the Government Lose on TARP?
A research firm says the U.S. lost $104 billion on the ownership stakes it took in financial companies in return for TARP funds. Losses could mount
While the U.S. government keeps doling out taxpayer money in a frenzied effort to save the financial system, more scrutiny is being paid to what the government is getting in return for its bailouts—and how big a loss taxpayers are likely to suffer in the end.
Elizabeth Warren, who heads the Congressional Oversight Panel responsible for keeping tabs on the Troubled Asset Relief Program (TARP), estimates that $590.4 billion of the total $700 billion approved by Congress has been spent or committed over the past six months. But economic stabilization efforts that have relied on the Federal Reserve's balance sheet have "permitted Treasury to leverage TARP funds well beyond the funds appropriated by Congress," the panel said in its Apr. 7 oversight report.
Although the Treasury has been taking stock and warrants in companies in exchange for TARP funds, from the start the value of assets it has received has been much less than the TARP money it has doled out. For every $100 of TARP money disbursed, the government has gotten stock and warrants worth just $66 at the time of issuance, Warren said in an Apr. 15 interview with Jon Stewart on The Daily Show. The value of those assets has deteriorated further since being issued, she said.
Tracking Taxpayer Losses
Ethisphere, a research think tank that examines whether companies can benefit from using ethical practices, created a TARP Index in December to track losses taxpayers are taking under the TARP program. Since TARP's inception on Oct. 7, 2008, the government has lost $104.2 billion (as of Apr. 10). The Treasury Dept. did not respond to questions about the losses so far.
The index was created out of skepticism about a remark by Senator Judd Gregg (R-N.H.) that TARP would turn out to be profitable for the government. "It rang hollow for us. [Gregg] was taking into account the imputed interest averaging across these investments," says Alex Brigham, Ethisphere's executive director. "You can get paid interest, but if you don't get your principal back, who cares?"
The biggest losses under TARP as of Apr. 10, Ethisphere estimates, are $30 billion for AIG (AIG), $25 billion for Citigroup (C), and $2.4 billion for Wells Fargo (WFC). These loss calculations are based on stock price declines and each company's financial condition, says Stefan Linssen, managing editor of Ethisphere magazine and one of the lead research analysts for the TARP Index. The largest estimated gains under the program are $3.9 billion for Morgan Stanley (MS), $1.0 billion for Goldman Sachs (GS), and $125.2 million for Financial Institutions Inc. (FISI). These gains are based on those companies' higher stock prices, Linssen says.
Citi Shares Took a Beating
As a result of the plunge in Citigroup's stock since February, Ethisphere has marked down the value of the government's $45 billion investment in the bank, says Linssen. In February, Citi converted $25 billion in preferred shares the government had received into common equity, which translated to a 36% stake in the company. That, plus the conversion of an additional $27.5 billion of other publicly held preferred shares, diluted existing shareholders and sparked a sell-off in Citi's shares. The government's stake is now worth just $13 billion, estimates Linssen.
The calculated losses don't include the potential hit the government could take on assets that it has guaranteed for some of these banks, such as $300 billion of Citigroup's assets. "By all indications, it sounds like the government doesn't know what they have in the TARP program," says Linssen. "It doesn't know how much [it has] made. My opinion is they don't know how much they're guaranteeing."
If Citigroup's mortgage-backed assets turn out to be worth close to the value of the assets that other TARP recipients are now trying to sell for 30¢ to 50¢ on the dollar, the government would have to take a writedown of at least $150 billion on them once they're sold, says Brigham at Ethisphere. "They are scary numbers," he says.
Understaffed at Treasury
The government is doing its part to provide more transparency regarding the assets on banks' books through stress tests that are supposed to be completed by the end of April. But skeptics argue the stress tests are nothing more than a public relations stunt aimed at boosting market confidence.
If Treasury weren't so understaffed, it would be much more equipped to do the due diligence necessary to gauge the approximate value of the bank assets it is guaranteeing, says Brigham. Bringing staff on board may be much easier if Herb Allison, chief executive of Fannie Mae since September and former CEO of TIAA-CREF, is put in charge of TARP, given his extensive Rolodex and knowledge of the assets, says Brigham.
Then there's the up to $100 billion in TARP funds the government plans to use to subsidize private investors buying toxic assets off banks' balance sheets under the soon-to-be-launched Public-Private Investment Program (PPIP). The goal is that by matching private investors' contributions one-to-one and providing loans at up to six times leverage, the program can generate $500 billion in purchasing power to buy legacy assets—which could expand to $1 trillion over time. And the hope is that these purchases, by providing more price transparency for the assets, will reignite other investors' confidence in these assets.
Stringing Out Investor Cash Flows
But if the debt markets continue to deteriorate and no one can make a profit on these assets, taxpayers would lose their entire investment in the program. There's an additional risk that at the end of the five-year term of the Federal Deposit Insurance Corp.-backed loans made under PPIP, investors might send back the assets they've bought to the government if they haven't appreciated in value by that time, according to Tom Atteberry, a fixed-income portfolio manager at First Pacific Advisors in Los Angeles,
Moreover, the mortgage-modification program proposed by the Obama Administration increases the likelihood of that scenario, Atteberry believes. By reducing the debt-to-income ratio to 31% and raising the loan-to-value refinance standard to 105%, the program will either continue to generate redefault rates between 25% and 50% or it will string out investors' cash flows over a longer period of time, he says.
Even for loans that don't redefault, lowering monthly payments means it will take twice as long for investors to earn the return they've been promised on an asset. And even though borrowers may be able to keep up monthly payments, they probably won't be able to afford maintenance and improvements needed to preserve or increase the property's value and won't be able to refinance at lower mortgage rates, Atteberry says.
Failing Banks Could be Liquidated
The less cash these assets return to investors, the more likely they will be put back to the Treasury. The government is already holding $1.25 trillion worth of mortgages it bought from Fannie Mae and Freddie Mac and it might also get stuck with assets bought under the Term Asset-Backed Securities Loan Facility (TALF) if investors haven't made enough profit to pay back those loans at the end of their three-year terms, says Atteberry. "What is Treasury going to do with all these assets if they are put back to them?" he wonders. "There's potential for much more in losses."
The premise of all the government's actions so far has been that once functioning markets for troubled assets are re-established, asset values will rebound to healthier levels and the downward self-reinforcing cycle will come to an end. If those assumptions are correct, "the Treasury's current approach may prove a reasonable response to the current crisis," the Congressional Oversight Panel said in its Apr. 7 report.
But if Treasury has underestimated the depth of the crisis and the extent to which the low valuation of these assets accurately reflects their worth, then the Treasury may have to turn to "very different actions in order to restore financial stability," including liquidating failing banks, reorganizing them by placing them into conservatorship, or continuing to subsidize the troubled banks with capital infusions, according to the Panel report.
Pushing for Greater Transparency
Atteberry's view is that the market for these troubled assets is already there and securities backed by Alt-A, near-prime, and commercial mortgages trade every day. "The problem is the banks don't like the prices they trade at," he says.
For its part, Ethisphere's intention is to push for greater transparency around the bank assets that the government is either buying, subsidizing, or guaranteeing. "The more you shine light on something, the more accurately it will be measured," says Brigham.
Bogoslaw is a reporter for BusinessWeek's Investing channel.
