The “using TARP funds for stimulus” gimmick

Under current law it is not legally possible to “use” returned TARP funds for a new stimulus proposal.  The Administration and its Congressional allies want to describe their proposal this way to make it appear that their new spending does not increase the federal deficit and debt.  Even if the TARP law is changed, new government spending is just that, new government spending.  No matter what optical gimmicks are created, new spending will increase the deficit and debt.

The TARP law allows up to $700 B to be used for any of several specific purposes:

• buying troubled assets from financial institutions; (§101)
• insuring troubled assets held by financial institutions; (§102)
• foreclosure mitigation efforts; (§109)
• direct assistance to homeowners; (§110)
• or buying or insuring any other financial asset that the Secretary of the Treasury and Fed Chairman agree “is necessary to promote financial market stability.” (§3(9)(B)).

The last bullet is the one we used for direct capital investments to large financial institutions (and auto manufacturers).

Unemployment benefits, COBRA subsidies, infrastructure spending, export subsidies, tax cuts, and a whole range of other stimulus ideas are not in this list.  Under current law, TARP funds cannot be used for any of these purposes.

The Administration can legally use TARP funds to further subsidize credit for small businesses, through creative use of the above authorities.

Some (many) people are confused by another aspect of the TARP law.  The $700 B acts as a revolving fund.  The $700 B is a limit on how much can, in total, be spent at any one point in time, but only for the above purposes.  In a silly extreme example, Treasury could buy $700 B of troubled assets from Bank A.  Suppose the market went up, and those troubled assets were then worth $800 B.  Treasury could sell those assets, and the debt held by the public would decline by $800 B.  The way the law is written, Treasury could then buy up to another $700 B of troubled assets.

There is therefore no theoretical limit on the total amount of money over time that Treasury can spend for the above listed purposes.  There are instead limits on how much can be spent at any one point in time, on how long that authority lasts for, and on how those funds can be spent.

Let’s look at some pictures to better understand the optical gimmick Congress may try to employ to mask deficit-increasing spending.  Last October Congress appropriated $700 B for the Troubled Assets Relief Program.  The primary purpose of those funds was to inject capital into banks.  (For now I’ll duck the buying troubled assets vs. direct equity investments question.  I wrote about that a few months ago.)

Under current law when a bank pays back the TARP, Secretary Geithner can recycle that money and use it to help another bank (or for any other purpose allowed by the TARP law).

If Secretary Geithner does not recycle the funds paid back by Bank A, they return to the general fund and automatically reduce the federal deficit and debt:

The $700 B is in effect a revolving fund.  $700 B is not a limit on total spending, but a limit on how much can be out the door at any one point in time.  The taxpayers loaned the government $700 B to bail out a failing private financial system, when private capital would not do so.  In theory the deficit was to temporarily increase by $700 B, and then eventually decline by $700 B as the taxpayers were repaid for their loan.  If all went exceedingly well, the loaned funds would be invested, and even more than $700 B would be returned, allowing the taxpayer to be paid and some more debt to be paid down.  This wasn’t a reason to do the program, but a possible benefit of it if things went well.

In practice, not all of those $700 B would likely be returned to taxpayers.  The auto loans were high risk and a little probability of being repaid.  In addition, the Obama Administration has used TARP authorities in other ways that are unlikely to be repaid.

After the authority to spend expires, the revolving fund closes and no more funds can be spent.  The expiration date was December 31, 2009, but Secretary Geithner just used authority granted to him by the TARP law to extend it to October 3, 2010.

While Secretary Geithner can recycle TARP funds and re-spend them for other TARP purposes, he cannot spend any TARP on infrastructure spending or unemployment benefits:

To spend more money on unemployment benefits or on roads & bridges requires a change to law.  Let’s look at three scenarios.

Scenario 1:  Current law.  No new spending on unemployment benefits or on roads & bridges.  Any repaid TARP funds not recycled for TARP purposes automatically pay down the deficit and debt.

Net effects of scenario 1:

• No change in government spending.
• When Bank A repays TARP, the federal deficit and debt are reduced by $25 B.

Scenario 2:  Congress appropriates new stimulus spending normally, leaving TARP untouched.  I will make up numbers for each component: +$10 B for unemployment benefits, and +$15 B for new infrastructure spending.  These are two separate streams of funding, and neither has anything to do with TARP.  As always, you can click on any picture to see a larger version of it.

And at the same time, Bank A’s repayment still automatically pays down deficits and debt:

Net effects of scenario 2:

• Congress increases government spending by $25 B.
• The federal deficit and debt are reduced by $25 B by Bank A’s repayment, then increased by $25 B by Congress’ new spending.  While these two net out, the federal deficit and debt are $25 B higher than in scenario 1.  In other words, the new spending increased the federal deficit and debt.   Budget experts would say that the $25B of Bank A’s TARP repayment was “in the baseline,” since it was expected to happen under current law.

Scenario 3:  Congress changes the law to “use TARP funding” to pay for this new spending.  I’ll highlight in blue the differences with the first method:

Net effect of scenario 3:

• Congress increases government spending by $25 B.
• As in scenario 2, the federal deficit and debt are net unchanged, meaning they are not reduced by $25 B as in scenario 1.  The federal deficit and debt are $25 B higher than in scenario 1.  As in scenario 2, the new spending increased the federal deficit and debt.

The net effects of scenarios 2 and 3 are exactly the same.  Government spending is $25 B higher than if there is no change to law, and the federal deficit and debt are $25 B higher than under current law.

“Using TARP funding” is a useful political construct to suggest that the new spending will somehow not increase the budget deficit.  That’s misleading, because under current law the deficit will be automatically reduced when TARP funds are repaid.  There is no practical difference in the deficit or debt impact of “using TARP funds” for new spending, compared to a traditional new Congressional appropriation.

A budgeteer would say that they’re trying to use savings built into the baseline to offset proposed new spending.  That’s a gimmick.

At the same time there is a further danger if Congress enacts a law following scenario 3 over scenario 2.  If Congress just makes unemployment benefits and infrastructure spending (for example) allowable uses of TARP without limiting the dollar amounts, then the Administration will have up to $700 B of money to spend on the new allowable uses.

Recommendation:  If Congress wants to spend even more money and label it as stimulus, don’t mess with the TARP, and don’t pretend you’re “using TARP funds” and therefore somehow not increasing the deficit.  Just appropriate the funds and decide whether or not you will offset them with other spending cuts or tax increases.

Related Posts

1. Intro to TARP — TARP II: Direct investment
2. Intro to TARP — TARP I: Buying bad assets
3. Intro to TARP — TARP III: The Geithner Plan
4. Four unpleasant options for TARP funding
5. Intro to TARP — Summary of the series
6. Intro to TARP: Banks have two problems
7. A new $29 B gimmick in the reconciliation bill
8. Let’s not hide $1.4 trillion of IOU’s