Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Troubled Asset Relief Program (TARP)

What it is:

The Troubled Asset Relief Program (TARP) is a U.S. government program created in an attempt to mitigate the fallout from the subprime mortgage crisis of 2007-2008. 

How it works (Example):

The subprime mortgage crisis came to the forefront of the U.S. economy in March 2008 with the forced sale of Bear Stearns to Bank of America. But only after Lehman Brothers, a large investment bank and major player in the global economy, was allowed to fail in September 2008, did the subprime mortgage crisis reach a head. 

During the post-Lehman global credit crisis, it became apparent that many of the major American financial institutions  -- Fannie Mae, Freddie Mac, American International Group, Bank of America, Citibank, Wells Fargo, Goldman Sachs, Morgan Stanley and many others -- had large amounts of "toxic assets" on their balance sheets. Unless they were able to sell these toxic assets and raise some cash, many of these financial institutions would have failed in the same way Lehman Brothers failed. 

These circumstances directly led to the passage of the TARP by Congress on October 3, 2008. TARP immediately gave the U.S. Treasury the ability to purchase up to $700 billion to buy mortgage backed securities (MBS) from financial institutions that wanted to sell them. For much of 2008 and 2009, TARP was the only global buyer of these troubled assets

By purchasing toxic assets from the nation's troubled financial institutions, the U.S. Treasury pumped much-needed liquidity into the financial system. This allowed many major banks and financial institutions to stay afloat long enough to get their balance sheets back in order.

Why it Matters:

TARP changed the way investors need to look at systemic risk and government intervention as they relate to private enterprise. In 2008 and 2009, the U.S. federal government had to decide whether to let private investors absorb billions in losses from the breakdown of the global financial system, or whether to step in to prevent a economic catastrophe that was likely to wreak economic havoc across the globe. In the end, the U.S. government (as well as the Bank of Japan, European Central Bank, etc.) chose to step in to stabilize the financial system via programs like TARP.

The Congressional Budget Office originally expected TARP to cost U.S. taxpayers up to $300 billion, but ultimately, the final cost to taxpayers will be less than $25 billion. Though highly controversial, it is indisputable that TARP and other government interventions around the world staved off what could have been the biggest economic disaster since the Great Depression.