Our basic approach was to treat the financial policies as ways to reduce credit spreads, particularly the three credit spreads that play key roles in the Moody’s Analytics model: The so-called TED spread between three-month Libor and three-month Treasury bills; the spread between fixed mortgage
rates and 10-year Treasury bonds; and the “junk bond” (below investment grade) spread over Treasury bonds. All three of these spreads rose alarmingly during the crisis, but came tumbling down once the financial medicine was applied. The key question for us was how much of the decline in credit spreads to attribute to the policies, and here we tried several different assumptions. All of this is discussed in Appendix B.
While the effectiveness of any individual element certainly can be debated, there is little doubt that in total, the policy response was highly effective. If policymakers had not reacted as aggressively or as quickly as they did, the financial system might still be unsettled, the economy might still be shrinking, and the costs to U.S. taxpayers would have been vastly greater.
To quantify the economic impacts of the fiscal stimulus and the financial-market policies such as the TARP and the Fed’s quantitative
easing, we simulated the Moody’s Analytics’ model of the U.S. economy under four scenarios:
1. a baseline that includes all the policies actually pursued
2. a counterfactual scenario with the fiscal stimulus but without the financial policies
3. a counterfactual with the financial policies but without fiscal stimulus
4. a scenario that excludes all the policy responses.
The differences between Scenario 1 and Scenario 4 provide the answers we seek about the impacts of the panoply of anti-recession policies. Scenarios 2 and 3 enable us to decompose the overall impact into the components stemming from the fiscal stimulus and financial initiatives. All simulations begin in the first quarter of 2008 with the start of the Great Recession, and end in the fourth quarter of 2012. (p.4)
While all of these questions deserve careful consideration, it is clear that laissez faire was not an option; policymakers had to act. Not responding would have left both the economy and the government’s fiscal situation in far graver condition. We conclude that Ben Bernanke was probably right when he said that “We came very close in October  to Depression 2.0.”
While the TARP has not been a universal success, it has been instrumental in stabilizing the financial system and ending the recession. The Capital Purchase Program gave many financial institutions a lifeline when there was no other. Without the CPP’s equity infusions, the entire system might have come to a grinding halt. TARP also helped shore up asset prices, and protected the system by backstopping Fed and Treasury efforts to keep large financial institutions functioning.(p.7)
The Troubled Asset Relief Program (TARP) was established on October 3, 2008 in response
to the mounting financial panic. As originally conceived, the $700 billion fund was to buy “troubled assets” from struggling financial institutions in order to re-establish their financial viability. But because of the rapid unraveling of the financial system, the funds were used for direct equity infusions into these institutions instead and ultimately for a variety of other purposes.
But with the banks deteriorating rapidly and asset purchases extremely complex [I like that euphemism for bankster intransigence], the TARP was quickly shifted to injecting capital directly into major financial institutions. Initially, this meant buying senior preferred stock and warrants in the nine largest American banks, a tactic subsequently extended to other banks…..
The largest use of the TARP funds has been to recapitalize the banking system via the Capital Purchase Program. At its conception, the CPP was expected to amount to $250 billion. Instead, its peak in early 2009 was actually about $205 billion, and as financial conditions have improved, many of the nation’s largest banks have repaid the funds. There is only $67 billion outstanding in the CPP. Banks also paid an appropriately high price for their TARP funds in the forms of restrictions on dividends and executive compensation, and additional regulatory oversight. These costs made banks want to repay TARP as quickly as possible. Since nearly all CPP funds are expected to be repaid eventually with interest, with additional
proceeds from warrant sales, the CPP almost certainly will earn a meaningful profit for taxpayers.
The Treasury and Federal Reserve ordered the 19 largest bank holding companies to conduct comprehensive stress tests in the spring of 2009, to determine if they had sufficient capital to withstand further adverse circumstances—and to raise more capital if necessary. Once the results were made public, the stress tests and subsequent capital raising restored confidence in the banking system.
The housing bubble and bust were the proximate causes of the financial crisis, setting off a vicious
cycle of falling house prices and surging foreclosures. Policymakers appear to have broken this cycle with an array of efforts, including the Fed’s actions to bring down mortgage rates, an increase in conforming loan limits, a dramatic expansion of FHA lending, a series of tax credits for homebuyers, and the use of TARP funds to mitigate foreclosures. While the housing market remains troubled, its steepest declines are in the past…..
In fact, TARP has been a substantial success, helping to restore stability to the financial system and to end the freefall in housing and auto markets. Its ultimate cost to taxpayers will be a small fraction of the headline
$700 billion figure: A number below $100 billion seems more likely to us, with the bank bailout component probably turning a profit.(p.2)
Three rounds of tax credits for home purchasers were also instrumental in stemming the housing crash. The credit that expired in November was particularly helpful in breaking the deflationary psychology that was gripping the market. (p.16)