What If TARP Had Passed the First Time?

I love historical counterfactuals, but I think I’m not buying this one from James Suroweicki:

What if Congress had passed the TARP bill the first time around, instead of voting it down on September 29th? While it’s certainly true that Lehman’s failure provoked a global panic, and in the days immediately after it went under we saw credit markets start to freeze up, stock-market sell-offs, and the like, it’s also true that the news that the U.S. government was working on a toxic-asset bailout plan for the banks actually did stabilize the markets. By Friday, September 26th, for instance, the S&P; 500 Index was trading only slightly below where it had been before Lehman went under. At that point, it seemed, investors were reasonably confident that the government’s actions would bring some order to the chaos in the system.

That confidence disappeared, obviously, on September 29th, when the House of Representatives voted down the TARP. The S&P; fell nine per cent on the 29th alone, and in the weeks that followed kept plummeting, falling almost twenty-five per cent in the next month, even though Congress did pass the TARP the second time around. In effect, the House’s failure to pass the TARP demolished investors’ confidence that they could rely on the government to act, and massively amplified the sense of panic that Lehman’s failure caused. This doesn’t necessarily mean that voting against the TARP was a bad idea (although I think it was): if you think government bailouts of big financial institutions are a mistake, then this was not a bill you could support. But I think it’s inarguable that the vote against the TARP did make things significantly worse in the markets. And I think it’s plausible that had the bill passed on the 29th, much of the chaos that followed over the next couple of months could have been averted.

I think it’s pretty clear that there’s no good case on the merits for having voted “no” the first time and then “yes” the second time. Nothing was gained by doing the flop, so this alternate reality would be all upside with no downside. Still, I think the basic reality is that there were large real losses. A lot of individuals and a lot of firms were making financial decisions that were predicated on false ideas about the value of real estate assets. When both the extent to which people were mistaken about those real estate prices, and the extent to which broader economic trends were predicated on those ideas became clear, some kind of substantial downturn became essentially inevitable.

I think a better counterfactual concerns the timing of the stimulus. What if ARRA had passed in late September when it became clear that massive stimulus would be necessary, or at a minimum in early November when it became clear that politicians who believed massive stimulus would be necessary would be governing the country by February? Instead, we had the three month transition period during which the economy just deteriorated. Faster stimulus wouldn’t have prevented the recession from happening, but it certainly might have made it shorter and somewhat shallower.