The Death of Bailouts?

The Troubled Asset Relief Program -- aka "the bank bailout program" -- is scheduled to expire Sunday.

This was, you will recall, the $700 billion "bazooka" President George W. Bush's Secretary of Treasury Henry Paulson requested in 2008 to stop the financial panic once and for all.

With the program now expiring, you can expect to hear pundits and politicians rushing to pass judgment. To save everyone some time: Yes, it was necessary; yes, it should have been more transparent and less generous to Wall Street; and yes, it should have been tied to tougher financial reforms like the Volcker Rule and breaking up "too big to fail" banks so that this never happens again.

While the "mother of all mother of all bailouts" probably saved us all from total economic ruin, critics of the program include ... well, just about everyone.

But our national fixation on TARP misses the bigger picture.

The bigger picture
The Center for Media and Democracy, a nonpartisan media and consumer watchdog that publishes SourceWatch.org and provides a monthly updated bailout tracker, gave me an exclusive sneak peek at its new report.

These folks have done some of the best work out there digging through all the data to tabulate a complete picture of bailout costs. Here's the upshot from their new study:

This graph represents all the money that has gone out the door or was created on the Federal Reserve's balance sheet.

TARP, which invested hundreds of billions of dollars in everyone from community banks, to Goldman Sachs (NYSE: GS), to traditional banks like US Bancorp (NYSE: USB), to GMAC and American Express, was just a drop in the bucket. The bulk of bailout funds took the form of lending to banks and buying up bank assets:

Now, before your head explodes, realize that most of this money has already been returned. Here's what's ongoing:

At $1.1 trillion, the big item here is the Federal Reserve's mortgage-backed security purchases. The program was an attempt to kill four birds with one stone. It 1) helped to stabilize the housing market, 2) restored liquidity during a liquidity panic that threatened to take down everyone relying too heavily on the overnight lending market from Wall Street to General Electric (NYSE: GE), 3) cleaned up bank balance sheets when bad investments were blowing up left and right, and 4) is a means of keeping long-term interest rates down (and credit cheap) when the Fed can't lower short-term rates any further.

The Fed halted its purchases on March 31. (This, of course, prompted civic-minded Fools to launch Motley Fool Mortgage Management, our April Fool's Day foray into the exciting world of leverage and high finance.)

The Fed probably won't sell these assets in a hurry -- doing so could hurt our nascent recovery by driving up interest rates. Also, there aren't many corporate buyers left standing with $1.1 trillion-deep pockets. We can expect the Fed to hold these securities for years, perhaps even to maturity.

An ounce of prevention
Despite drawing all the headlines, TARP pales in comparison to total disbursed bailout funds. While most of this money will ultimately be recovered, it probably won't all be. And bailouts pale in comparison to the full economic and human cost of the financial crisis and ensuing recession.

The recently passed financial legislation bans many of these kinds of bailouts from occurring in the future. Instead, it requires large financial institutions to explain how they could be shut down in an orderly fashion; if the plans aren't credible, they can be forced to hold more capital or stop certain activities. Should a massive financial institution go under, the Federal Deposit Insurance Corp. would liquidate the company.

Will it all work? Only time will tell -- it's a good idea, but I'm skeptical that it would be possible to wind down any of our largest financial institutions in an orderly fashion unless they undergo significant makeovers. If regulators aren't tough, there will be another crisis, and a future Congress will be faced with the choice between bailout and economic collapse.

The real lesson bailouts teach is that it's far better to take precautions against a financial collapse than to expect to navigate smoothly through one. The financial crisis was a mess we don't want to face again for a long time.

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