TARP - Not the Price It Appears to Be

The Troubled Asset Relief Program (TARP) was enacted by the U.S. Government in 2008 to provide struggling financial firms and key U.S. employers with cash to maintain solvency and avoid bankruptcy. To disburse this cash to the firms, the U.S. Treasury bought shares of preferred stock in the companies, as well as purchased toxic assets, such as mortgage-backed securities, off of the companies’ balance sheet. The total amount allocated to TARP was $700 billion, which is commonly misconceived as the actual price of the program. Many are under the misconception that the $700 billion was a sunk cost – U.S. taxpayer dollars that were spent, added to the U.S. national debt, and will never return. However, the fact of the matter is that in the end, the actual cost of the program will only amount to a fraction of the $700 billion originally budgeted.

The TARP dollars were distributed in the form of a loan or investment in the company being “bailed out,” and the U.S. government distributes those funds under the full expectation that the funds will be repaid and even a certain rate of return will be rewarded. For example, the $45 billion loaned to Bank of America as a part of the TARP program was repaid in late 2009. The $25 billion in preferred shares purchased by the U.S. Treasury in Wells Fargo yielded a $371 million dividend early last month.

Like any loan, some will default and the loaned funds will go unpaid. Of the $700 billion issued, some of the loans or investments will go south and go unpaid resulting in a loss; however, the actual cost of TARP – a fraction of $700 billion – versus the benefit – rescuing the U.S. economy and world financial system – was well worth it. Indeed, the Congressional Budget Office has issued a statement detailing the cost of TARP at $109 billion, a fraction of the original $700 billion. Considering the companies receiving TARP funds can be regarded as “risky” loans or investments, this cost is relatively low.

One’s stance on the bailout and the way the U.S. government has handled it aside, everyone should at minimum be clear as to how the program works, what its goals are, and what the true cost to U.S. taxpayers is. Hopefully this post has been successful in that regard.

The Man for the Job

CIT Group hired ex-Merrill Lynch CEO John Thain earlier this week, marking Thain’s first return to work after resigning from Merrill in January of 2009. CIT, a commercial lender to small and midsize businesses, filed for Chapter 11 bankruptcy in November of last year and anticipates Thain will restore investor confidence about future expectations for the firm as it emerges from bankruptcy. Thain, on the other hand, is marred by his controversial exit from Merrill involving questionably high bonuses and mounting investment banking losses. Critics cite these controversies in arguing Thain was a poor choice to head CIT; however, Thain’s education, work experience, and desire to restore his legacy make him the ideal CEO.

In selecting a company head, the most important factor in the decision-making process is arguably education and work experience. Firms ideally want a leader from an excellent educational institution – preferably the Ivy League – and that leader should also have vast, relevant work experience. Strong performance at an elite school indicates the candidate is intelligent and possesses a strong capability to learn. Work experience shows that the candidate has gained a wealth of industry and product expertise, and he or she has been exposed to a wide variety of company situations and market scenarios. Additionally, the candidate will be able to fix and prevent problems, as well as recognize and expand upon opportunities. Thain has a bachelor’s degree from MIT and a Harvard MBA, and in terms of work experience, Thain was president and COO of Goldman Sachs, CEO of the New York Stock Exchange, and CEO of Merrill Lynch. That kind of a resume speaks for itself – Thain’s work experience coupled with his strong academic credentials prepares him well for the job.

CEOs tend to have big egos, which is unfortunate in most cases as CEOs have made extremely risky business decisions and made high or illegal demands for compensation. However, Thain’s ego is actually a good thing in this situation, because he needs to restore his legacy after it was tarnished during his final days at Merrill Lynch. Thain rose to the top of Goldman Sachs, one of the most elite and prestigious financial firms on The Street, later leaving fortune for fame as he took the helm of the New York Stock Exchange. Following the money, Thain left to be the CEO of Merrill Lynch, and after earning $84 million in 2007, he was at the peak of his career. Merrill suddenly began accumulating massive losses due to investments in mortgage-backed securities and other risky assets. In preventing an almost certain bankruptcy, Thain negotiated the sale of Merrill to Bank of America, and because he believe he “saved” the company, he requested a $40 million dollar bonus. Public and governmental scrutiny obviously fell upon this request, which he lowered to $10 million, then to $0, and now he has been quoted in interviews as saying he never requested a bonus at all. He resigned from Merrill, and his legacy as it stands is the greedy CEO who took down Merrill. He, nor any other CEO wants to be remembered that way. With this in mind, Thain will take over at CIT, wanting to be remembered as the man who saved CIT.

At the surface, it may not appear to be a wise decision to hire a greedy CEO who has run the largest multibillion dollar financial corporations to now lead a somewhat smaller CIT, but as mentioned above, his past experience and need to repair his image make him a perfect candidate. The market shares this sentiment – CIT shares rose 3.5% after the announcement was made.