The Impact of the Troubled Asset Relief Program on the US Financial System and Economy

by Simon Johnson, Peterson Institute for International Economics

November 19, 2009

To save the banking system in the face of generalized panic, the United States must: 1) prevent banks from collapsing in an uncontrolled manner; 2) take over and implement orderly resolution for insolvent banks; and 3) immediately address underlying weaknesses in corporate governance that created potential vulnerability to crisis. Considering these three recommendations, Simon Johnson testifies that the Troubled Asset Relief Program (TARP) has been badly mismanaged. Its funds supported troubled banks and the executives who ran them into the ground. Additionally TARP's implementation exacerbated the perception that some financial institutions really are too big to fail.

However, the overall US policy response did well by preventing a collapse in spending via monetary policy that responded quickly and appropriately. The 2009 stimulus kept domestic spending relatively buoyant despite the credit contraction and rising unemployment. In the midst of what is arguably the largest global financial shock the world has seen, things could have been a lot worse. There is no question that passing TARP was the right thing to do, but if bank regulators do not limit the direct and indirect risk exposures of US financial institutions to the new "carry trade," we face the prospect of another even larger crisis.

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