To illustrate, suppose that Treasury used TARP to buy $10 of preferred stock in Bank X in 2008 and that a year later Treasury sold its position for $12, including accrued dividends. This investment would be recorded as achieving a $2 profit in TARP (subject to one technical caveat, see below).

That’s the normal way of calculating profit on an investment, and is what CBO was instructed to do for its part of TARP oversight. But as Jack and John point out, there’s an important complication here. During the year, the federal government undertook many other policy actions which may have boosted the value of Bank X (remember all the new acronyms?). From the perspective of policy evaluation, some or all of the $2 gain should be attributed to those other policies, not TARP.

It could be, for example, that absent further action, Bank X would have struggled, leaving Treasury with stock worth only $6. Other government actions, however, breathed enough life into the company (or, at least, boosted the value of its assets) that the stock ultimately became worth $12.

In that case, you could argue that TARP, by itself, resulted in a $4 loss, while the other government actions created a $6 gain. That puts the budgetary impacts of TARP in a different light: a 40% loss versus a 20% gain in this example.

Of course, you could also argue that the $6 gain was only possible because of the TARP ownership stake. There’s certainly an element of truth to that. But the basic concern still applies: the $2 gain in this example reflects both TARP and subsequent government actions, not just TARP alone. That’s an essential point when trying to evaluate these policies after the fact, and we commenters should keep that in mind when interpreting CBO’s findings.

And that’s not all. The other government actions may also have imposed additional direct or indirect costs on the federal budget. As a result, the $2 gain in this example may be offset (or more) by other costs that aren’t included in the calculation.

Bottom line: One reason that TARP appears much less expensive than originally predicted is that many of its investments benefitted from other government actions whose costs show up elsewhere in the budget.

Caveat: CBO’s methodology actually judges the profitability of investments relative to benchmark rates of return. The details are surprisingly complex, but just for purposes of illustration, suppose that the appropriate benchmark rate of return for investing in Bank X was 10%. If Treasury sold the stock for $11 after one year, CBO would deem that as breaking even. If it sold it for $12, that would be a $1 profit.

The good news, budget-wise, is that the government is on track to make about $22 billion on its assistance to banks.

However, CBO estimates that TARP’s other activities will cost $47 billion. This reflects aid to AIG ($14 billion), the auto industry ($19 billion), mortgage programs ($12), and a few smaller programs ($2 billion).

[M]ake sure that the direct costs of TARP are paid for by the major financial institutions, not by the taxpayer.  Assessments on these institutions will be determined by the risks they pose to the financial system.  These risks, the combination of high levels of riskier assets and less stable sources of funding, were key contributors to the financial crisis.

The fee would be applied over a period of at least ten years, and set at a level to ensure that the costs of TARP do not add to our national debt.  One year ago we estimated those costs could exceed half a trillion dollars.  However, we have been successful in repairing the financial system at a fraction of those initial estimates. The estimated impact on the deficit varies from $109 billion according to CBO to $117 billion according to the Administration.  We anticipate that our fee would raise about $90 billion over 10 years, and believe it should stay in place longer, if necessary, to ensure that the cost of TARP is fully recouped.

As noted by other participants in today’s hearing, the bank tax raises a host of questions: Is it possible to design the tax so that it is ultimately paid by major financial institutions (by which I presume Geithner means their shareholders and top management), or will it get passed through to their customers? How much, if at all, would the tax reduce bank lending? Is it fair to target the banks even though the bank part of TARP actually made money for taxpayers? Would the tax reduce risks in the financial system?

Those are all interesting questions, but today I’d like to highlight another one: Can Congress embrace the idea of a bank tax that would be used to “ensure the costs of TARP do not add to our national debt”?

As described by the Administration, the bank tax would be used to reduce the deficit, thus offsetting budget costs of TARP. Congress, however, is hungry for revenues that it can use to offset the budget costs of new legislation, e.g., extending the ever popular research-and-experimentation tax credit or limiting the upcoming increase in dividend taxes. With PAYGO now the law of the land (for many legislative proposals), some members are looking at the $90 billion of potential bank tax revenues as the answer to their PAYGO prayers.

All of which points to a looming budget battle: Will the bank tax be used to pay off the costs of TARP, as the President has proposed, or will it be used to pay for other initiatives?

Treasury answered as follows:

As we have previously stated, Treasury is a reluctant shareholder in private companies and intends to dispose of its TARP investments as quickly as practicable.  When it acquired the Citigroup common shares, Treasury announced that it would retain the discretion to vote only on core shareholder issues, including the election of directors;  amendments to corporate charters or bylaws; mergers, liquidations and  substantial asset sales; and significant common stock issuances.  At the time of the exchange, Treasury agreed with Citigroup that it would vote on all other matters proportionately–that is, in the same proportion (for, against or abstain) as all other shares of the company’s stock are voted with respect to each such matter.  Treasury is abiding by the same principles in the few other companies in which it owns common shares, which are very few, as most TARP investments were in the form of nonvoting preferred stock.

Those sound like good principles. So how did Treasury actually vote?

Treasury voted FOR three ballot proposals:

• 15 Nominees to the Board of Directors
• To issue $1.7 billion of “common stock equivalents” to workers in lieu of cash incentive compensation (a way to conserve cash that Citi agreed to in a deal to repay some TARP money)
• Reverse stock split

Treasury voted PROPORTIONALLY on the remaining proposals:

• Ratify KPMG as the firm’s accountant
• An increase in shares for a stock incentive plan
• Executive compensation (nonbinding “say on pay”)
• A “Tax Benefits Protection Plan” which discourages ownership changes that would reduce the value of Citi’s $46 billion in deferred tax assets
• Six shareholder proposals covering such issues as corporate governance and political activity.

Treasury emphasizes that its proportional votes don’t mean it lacks an opinion on these proposals. Referring to two corporate governance proposals, for example, Treasury noted that it may have a policy preference but:

Treasury believes that it would be inappropriate to use its power as a shareholder to advance a position on matters of public policy and believes such issues should be decided by Congress, the SEC or through other proper governmental forums in a manner that applies generally to companies.  For this reason, and because voting on such matters was not necessary in order to fulfill its EESA responsibilities, Treasury refrained from exercising a discretionary vote.

Although Treasury expressed that view with respect to the corporate governance provisions, I can’t help but wonder what it felt about the “Tax Benefits Preservation Plan.”

You can see all the proposals in Citigroup’s proxy statement.

Disclosure: I own no Citigroup securities of any kind (see this post for a summary of my previous thoughts about Citi securities).

Treasury apparently did quite well when it negotiated with banks that wanted to repurchase their TARP warrants. I am still a fan of auctions, but you have to give Treasury credit–they did defend taxpayer interests in the negotiations.

Treasury drove an especially hard bargain with Goldman Sachs. As shown in the following chart from the report, Goldman ended up paying much more than any of the estimates that Treasury considered:

The green line is what Goldman actually paid: $1.1 billion. The yellow lines are Goldman’s earlier bids ($600 million and $900 million). The black bars are the range of estimates from three different modeling efforts. Bottom line: Goldman overpaid.

The report has similar graphs for the other 33 firms that have repurchased their warrants; some of them paid at the upper end of the black bars, but none overshot like Goldman.

Disclosure: I have no investments in Goldman Sachs (or any TARP recipients).

Two factors have been driving the increase:

1. Tax revenues continue to plummet. Revenues fell to $489 billion during the quarter, down $58 billion or 11% from last year.

2. Spending continues to grow rapidly in most programs. For example, Medicaid has grown by 25% since the same period last year, Medicare spending has grown by 8%, and Social Security spending has grow by 10%. After declining last year, interest payments are now on the rise, up more than 17%. Excluding the three programs most closely related to the financial crisis (TARP, the GSE bailout, and the FDIC), federal spending is up about 13% over the same period last year. (All these figures have been adjusted to control for timing differences due to weekends and holidays.)

The one piece of good news, budget wise, is that spending on the three financial programs has declined significantly. CBO estimates that TARP spending during the first quarter fell by $85 billion (from $91 billion to $6 billion), and spending on the GSEs fell by $1 billion (from $14 billion to $13 billion). Net spending by the FDIC fell by $45 billion, primarily because FDIC receipts have increased sharply (and are accounted for as a reduction in spending). Together, those three programs have cost $131 billion less than at this point last year.

Bottom line: Tax revenues continue to fall, most types of spending continue to increase, but spending on the financial rescue has declined.

The House embraced that approach in the bill it passed before Christmas. That bill–H.R. 2847, the Jobs for Main Street Act–would cut TARP authority by $150 billion. For reasons I’ve discussed before, the Congressional Budget Office scores that cut as generating $75 billion in net budget “savings.” The House bill then uses those “savings” to offset $75 billion in new spending on transportation infrastructure, support to state and local governments, and other measures.

I put “savings” in quotes because no one believes that the TARP reduction would help taxpayers by anything close to $75 billion. Back in December, Treasury Secretary Geithner estimated that TARP would use at most $550 billion of its $699 billion in existing authority. As a result, Congress can cut at least $149 billion from TARP without having any effect whatsoever on the budget. In other words, the House’s TARP rescission would reduce TARP activities by at most $1 billion (and, in practice, probably by $0). So there aren’t any real budget savings here.

But that’s not the only problem with using TARP as an offset. As I noted in another post, the drafters of TARP tried to prohibit future Congresses from using TARP rescissions to pay for new spending. That prohibition is spelled out in Section 204 of the law:

SEC. 204. EMERGENCY TREATMENT.

All provisions of this Act are designated as an emergency requirement and necessary to meet emergency needs pursuant to section 204(a) of S. Con. Res 21 (110th Congress), the concurrent resolution on the budget for fiscal year 2008 and rescissions of any amounts provided in this Act shall not be counted for purposes of budget enforcement.

The House vs. Senate debate comes down to the interpretation of that section. The House apparently does not believe that Section 204 applies. As a result, it believes that TARP rescissions can be used to “pay for” other spending increases. The Senate, however, disagrees. It believes that Section 204 forbids the use of TARP rescissions to pay for other spending.

That conflict hasn’t flared up in public yet, but it is apparent in a carefully-worded footnote in CBO’s cost estimate of the House bill:

The House Committee on the Budget does not consider the original TARP authority to have been designated as an emergency requirement. Persuant [sic] to Sec. 204 of the Emergency Economic Stabilization Act of 2008 (Division A, P.L. 110‐343), the Senate Committee on the Budget does consider the TARP authority to have been designated as an emergency requirement.

Under congressional budget rules, emergency spending gets special treatment: it doesn’t need to be paid for (a fact that the House bill uses, by the way, since it designates about $79 billion as emergency spending that needn’t be offset). To avoid some obvious abuses, the budget rules therefore specify that rescissions of emergency spending can’t be used to pay for increases in regular spending (or regular tax cuts). Based on Section 204, the Senate believes that TARP is emergency spending and therefore can’t be used to pay for new jobs programs. For reasons I don’t yet understand [readers?], the House disagrees.

I couldn’t find the Treasury news release on its website (either I’m dense or the person in charge of that took the day off), so here’s the full text with my emphasis added:

Today, the U.S. Department of the Treasury received repayments on its Troubled Asset Relief Program (TARP) investments in Wells Fargo and Citigroup in the sum of $45 billion, bringing the total amount of repaid TARP funds to $164 billion. Wells Fargo repaid $25 billion under the Capital Purchase Program (CPP) and Citigroup repaid $20 billion under the Targeted Investment Program (TIP), both of which will wind down at the end of this year. Treasury now estimates that total bank repayments should exceed $175 billion by the end of 2010, cutting total taxpayer exposure to the banks by three-quarters.

In addition, effective today, Treasury, the Federal Reserve, the Federal Deposit Insurance Corporation and Citigroup terminated the agreement under which the U.S. government agreed to share losses on a pool of originally $300 billion of Citigroup assets.   This arrangement was entered into in January of this year under Treasury’s Asset Guarantee Program (AGP) and was originally expected to last for 10 years.  The U.S. government parties did not pay any losses under the agreement and will keep $5.2 billion of $7 billion in trust preferred securities  as well as warrants for common shares that were issued by Citigroup as consideration for such guarantee.  With this termination, the AGP is being terminated at a profit to the taxpayer.

Treasury currently estimates that TARP programs aimed at stabilizing the banking system will earn a profit thanks to dividends, interest, early repayments, and the sale of warrants. Total bank investments of $245 billion in FY2009 that were initially projected to cost $76 billion are now projected to bring a profit. Taxpayers have already received over $16 billion in profits from all TARP programs and that profit could be considerably higher as Treasury sells additional warrants in the weeks ahead.

Here’s a link to the video of the interview. Going in, I was focused on the following talking points:

• Within current budget rules, the Congress can indeed use unspent TARP money to “pay for” new spending initiatives. However, it needs to cut TARP authority by $2 for every $1 it wants to spend.

• Those “savings” are mythical, however. Treasury Secretary Geithner recently predicted that TARP would use at most $550 billion of its $699 billion in authority. Trimming TARP’s authority by a moderate amount (e.g., $50 billion) will thus generate no actual budget savings. Only deep cuts would begin to generate some savings.

• The financial system is not fully healed, and the United States still lacks a coherent system for dealing with large, failing financial institutions. For that reason, I support Geithner’s extension of TARP as an insurance policy. However, I do not support the TARP extension if its main effect it to allow Congress to use TARP “cuts” to generate mythical budget “savings” or to encourage creative uses of TARP money.

• Usain Bolt had a remarkable year, but Chairman Bernanke is still the right choice as Person of the Year. And he’s the right choice for Fed Chairman.

• But his work is only half done. If he can figure out an exit strategy that keeps the economy growing, avoids new asset bubbles, and sidesteps inflation, then maybe he will be Person of the Year again next year.

A third issue, recently pointed out to me by a friend, is that the original TARP legislation includes language that’s intended to prevent TARP money from being redeployed to other uses. As I say in a new piece at e21:

When Congress created TARP, it specified that future TARP rescissions should not be used to pay for new spending. Section 204 of the Emergency Economic Stabilization Act indicates that the costs of TARP were being incurred because of an emergency (and therefore were exempt from certain congressional budget requirements) and that “rescissions of any amounts provided in this Act shall not be counted for purposes of budget enforcement.” In other words, Congress wanted to make sure that the emergency spending in TARP wouldn’t subsequently be rescinded to pay for new, non-emergency spending.

That limitation has not been a factor thus far when Congress has used TARP rescissions to pay for new legislation. In the spring, Congress used a $1.26 billion TARP rescission to help pay for legislation to help struggling homeowners. A few weeks ago, the House used a $34 million TARP rescission to pay for a new TARP database. In both cases, the resulting budget savings were relatively small ($630 million and $17 million, respectively) and were used to pay for programs related to TARP’s goals (housing and transparency). Looking ahead, a key question is whether Section 204 will play a bigger role now that Congress is considering larger TARP rescissions that would be used to fund programs well outside TARP’s scope.

I am not sure whether section 204 will have any practical relevance to today’s TARP debate (insights from folks close to the process would be appreciated). At a minimum, however, it is interesting that someone in Congress saw the potential for today’s TARP debate and tried to prevent it.

P.S. In case you’d like to check my interpretation, here’s the complete language of Section 204 of the Emergency Economic Stabilization Act:

SEC. 204. EMERGENCY TREATMENT.

All provisions of this Act are designated as an emergency requirement and necessary to meet emergency needs pursuant to section 204(a) of S. Con. Res 21 (110th Congress), the concurrent resolution on the budget for fiscal year 2008 and rescissions of any amounts provided in this Act shall not be counted for purposes of budget enforcement.